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Chapter 5: Q9BP (page 528)

Question:Twenty-five-year B-rated bonds of Parker Optical Company were initially issued at a 12 percent yield. After 10 years the bonds have been upgraded to Aa2. Such bonds are currently yielding 10 percent to maturity. Use Table 16-2 to determine the price of the bonds with 15 years remaining to maturity. (You do not need the bond ratings to enter the table; just use the basic facts of the problem.)

Short Answer

Expert verified

Answer

The price per bond is computed as $1,153.72

Step by step solution

01

Definition of Coupon rate

The coupon rate is defined as the normal rate paid by the financial instrument. It is the annual coupon payment paid by the issuer of the securities.

02

Computation of price of the bond

SemiannualCoupon=CouponRate2×FaceValue=0.122×1,000=$60Priceperbond=CouponPayment×(1-1+r-nr)+FaceValue(1+r)n=60×(1-1+0.05-15×20.05)+1,000(1+0.05)15×2=$1,153.72

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Most popular questions from this chapter

Tyson Iron Works is about to go public. It currently has after-tax earnings of \(4,400,000, and 4,200,000 shares are owned by the present stockholders. The new public issue will represent 500,000 new shares. The new shares will be priced to the public at \)25 per share with a 3 percent spread on the offering price. There will also be $280,000 in out-of-pocket costs to the corporation.

e. Determine what rate of return must be earned on the proceeds to the corporation so there will be a 10 percent increase in earnings per share during the year of going public.

Bonds of different risk classes will have a spread between their interest rates. Is this spread always the same? Why? (LO16-2)

What was the primary purpose of the Securities Act of 1933?

Richmond Rent-A-Car is about to go public. The investment banking firm of Tinkers, Evers & Chance is attempting to price the issue. The car rental industry generally trades at a 20 percent discount below the P/E ratio on the Standard & Poor’s 500 Stock Index. Assume that index currently has a P/E ratio of 25. The firm can be compared to the car rental industry as follows:

Richmond

Car Rental Industry

Growth rate in earnings per share.....

15%

10%

Consistency of performance.............

Increased earnings

4 out of 5 years

Increased earnings

3 out of 5 years

Debt to total assets.....................

52%

39%

Turnover of product.........................

Slightly below average

Average

Quality of management..................

High

Average

Assume, in assessing the initial P/E ratio, the investment banker will first determine the appropriate industry P/E based on the Standard & Poor’s 500 Index. Then a half point will be added to the P/E ratio for each case in which Richmond Rent-A-Car is superior to the industry norm, and a half point will be deducted for an inferior comparison. On this basis, what should the initial P/E be for the firm?

How does the bond rating affect the interest rate paid by a corporation on its bonds?
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