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.
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Chapter 15 Solutions
EBK CORPORATE FINANCE
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