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Chapter 5: Q8PB (page 528)

Question:The yield to maturity for 10-year bonds is as follows for four different bond rating categories:

Aaa 9.40% Aa2 10.00%

Aa1 9.60% Aa3 10.60%

The bonds of Falter Corporation were rated as Aaa and issued at par a few weeks ago. The bonds have just been downgraded to Aa2. Determine the new price of the bonds, assuming a 10-year maturity and semiannual interest payments. (Refer to “Semiannual Interest and Bond Prices” in Chapter 10 for a review if necessary.)

Short Answer

Expert verified

Answer

The price per bond is computed as $962.61

Step by step solution

01

Definition of Par Value

The par value is also known as the nominal value which is the face value of the bond or any other financial instrument.

02

Computation of price of the bond

SemiannualCoupon=CouponRate2×FaceValue=0.0942×1,000=$47Priceperbond=CouponPayment×(1-1+r-nr)+FaceValue(1+r)n=47×(1-1+0.05-10×20.05)+1,000(1+0.05)10×2=$962.61

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Most popular questions from this chapter

Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The \(30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.

a. First compute the price of the old bonds in the open market. Use the valuation procedures for a bond that were discussed in Chapter 10 (use annual analysis). Determine the price of a single \)1,000 par value bond.

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