a.
To determine: What will be the market value of the bonds if they are non callable.
Introduction:
Callable bond is a bond type that let the bond issuer to retain the privilege of redeeming the bond at some point before the bonds attains its maturity date. The bond issuer has an option to pay for by providing a higher coupon rate.
a.
Answer to Problem 11QP
Solution: The price of the bond today is $1,121.48.
Explanation of Solution
Calculate the price of the bond in one year when the interest rate increases:
It is given that coupon rate is 6.50%, interest rate is 8%, and
Therefore, the price of the bond is $877.5.
Calculate the price of the bond in one year when the interest rate decreases:
It is given that coupon rate is 6.50%, interest rate is 5%, and the future value is $1,000.
Therefore, the price of the bond in one year is $1,365.
Determine the price of the bond today:
It is given that profitability in one year is 35% probability that interest rate increases to 8% and there is 65% probability that it will decrease by 5%.
Therefore, the market value of the bond is $1,121.48.
b.
To determine: The value of the call provision to the company.
b.
Explanation of Solution
If the rate of interest increases, the bond prices will decrease. If the bonds price decreases, the organization will not be able call them. In this situation, the bondholders will obtain the coupon payment, C, plus the current worth of the outstanding payments. So, if interest rate increases, the bonds rate in one year will be:
If interest rates decrease, the supposition is that the bonds are callable. In this situation, the bondholders will obtain the call rate, added to the coupon payment, C. Hence, the rate of the bonds if interest rates decreases will be:
The current selling rate of the bond is the present value of the anticipated payoff to the bondholders. To determine the coupon rate, the desired issue price should be equal to the present value of the anticipated value at end of year payoffs, and solve for C.
Therefore, the present value coupon rate is $68.88.
Calculate the coupon rate required to sell the bonds at par value:
Therefore, the coupon rate required to sell the bonds at par value is 6.89%.
c.
To determine: The value of the call provision to the company.
c.
Explanation of Solution
Determine the value of the call provision:
The call provision value will be given by the difference between the value of an outstanding, call provision and non-callable bond.
Determine the value of a non callable bond with the similar coupon rate:
It is given that interest rate will be 5% and present value of coupon rate is $68.88.
Therefore, the non callable bond value is $1,377.59.
Calculate the value of call provision to the company:
Therefore, the value of call provision is $188.42.
Want to see more full solutions like this?
Chapter 15 Solutions
CORPORATE FINANCE (LL)-W/ACCESS
- Bond Valuation with Semiannual Payments Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity of 8.5%. What is the price of the bonds?arrow_forwardYield to Maturity and Yield to Call Arnot International’s bonds have a current market price of $1,200. The bonds have an 11% annual coupon payment, a $1,000 face value, and 10 years left until maturity. The bonds may be called in 5 years at 109% of face value (call price = $1,090). What is the yield to maturity? What is the yield to call if they are called in 5 years? Which yield might investors expect to earn on these bonds, and why? The bond’s indenture indicates that the call provision gives the firm the right to call them at the end of each year beginning in Year 5. In Year 5, they may be called at 109% of face value, but in each of the next 4 years the call percentage will decline by 1 percentage point. Thus, in Year 6 they may be called at 108% of face value, in Year 7 they may be called at 107% of face value, and so on. If the yield curve is horizontal and interest rates remain at their current level, when is the latest that investors might expect the firm to call the bonds?arrow_forwardBond Valuation and Interest Rate Risk The Garraty Company has two bond issues outstanding. Both bonds pay 100 annual interest plus 1,000 at maturity. Bond L has a maturity of 15 years, and Bond S has a maturity of 1 year. a. What will be the value of each of these bonds when the going rate of interest is (1) 5%, (2) 8%, and (3) 12%? Assume that there is only one more interest payment to be made on Bond S. b. Why does the longer-term (15-year) bond fluctuate more when interest rates change than does the shorter-term bond (1 year)?arrow_forward
- Bond Yields and Rates of Return A 10-year, 12% semiannual coupon bond with a par value of 1,000 may be called in 4 years at a call price of 1,060. The bond sells for 1,100. (Assume that the bond has just been issued.) a. What is the bonds yield to maturity? b. What is the bonds current yield? c. What is the bonds capital gain or loss yield? d. What is the bonds yield to call?arrow_forwardBond Value as Maturity Approaches An investor has two bonds in his portfolio. Each bond matures in 4 years, has a face value of 1,000, and has a yield to maturity equal to 9.6%. One bond, Bond C, pays an annual coupon of 10%; the other bond, Bond Z, is a zero coupon bond. Assuming that the yield to maturity of each bond remains at 9.6% over the next 4 years, what will be the price of each of the bonds at the following time periods? Fill in the following table:arrow_forwardCurrent Yield for Annual Payments Heath Food Corporations bonds have 7 years remaining to maturity. The bonds have a face value of 1,000 and a yield to maturity of 8%. They pay interest annually and have a 9% coupon rate. What is their current yield?arrow_forward
- CHALLENGE PROBLEM The long-term liabilities section of Guyton Enterprises follows. The bonds outstanding on January 1, 20-1, have an annual coupon rate of 4% and had been issued several years ago at a price to yield 5% per year. The discount is amortized using the effective interest method. On December 31, 20-1, 900,000, 5% bonds were issued at a price to yield 6%. REQUIRED Compute the cash received from issuing the bonds on December 31, 20-1. (Hint: If you have not covered the effective interest method, assume that bond interest expense for 20-1 was 44,767.)arrow_forwardInterest Rate Sensitivity A bond trader purchased each of the following bonds at a yield to maturity of 8%. Immediately after she purchased the bonds, interest rates fell to 7%. What is the percentage change in the price of each bond after the decline in interest rates? Assume annual coupons and annual compounding. Fill in the following table:arrow_forwardCurrent Yield with Semiannual Payments A bond that matures in 7 years sells for $1,020. The bond has a face value of $1,000 and a yield to maturity of 10.5883%. The bond pays coupons semiannually. What is the bond’s current yield?arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTIntermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage LearningCollege Accounting, Chapters 1-27AccountingISBN:9781337794756Author:HEINTZ, James A.Publisher:Cengage Learning,
- Financial Accounting: The Impact on Decision Make...AccountingISBN:9781305654174Author:Gary A. Porter, Curtis L. NortonPublisher:Cengage Learning