Stella’s Dog Biscuits Inc. has outstanding a high-yield bond with the following features:

Principal ..............$1,000

Coupon.....................10%

Maturity ...................5 years

Special features: .....Company may extend the life of the bond to 10 years

The current interest rate on comparable debt is 8 percent.

a) If you expect that interest rates will be 8 percent five years from now, how much would you currently pay for this bond?

b) What is your potential gain or loss if you buy the bond based on that expectation but interest rates are 12 percent five years from now?