5. 10 points in total; 2.5 points for each Land\'o Toys is a profitable, medium
ID: 1155989 • Letter: 5
Question
5. 10 points in total; 2.5 points for each Land'o Toys is a profitable, medium sized, retail company. Several years ago, it issued a 5% percent coupon bond, which pays interest semi- annually. The bond will mature in ten years and is currently priced in the market as $1,037.19. The maturity for 10-year corporate bonds are reported in the following table by bond rating. average yields to Yield (%)Bond R Yield (% 7.3 8.2 9.2 10.5 12.0 4.5 Bond 5.7 6.0 6.5 cC Periodically, one company will purchase another by buying a of the target firm's stock. The bonds of the target firm continue to exist. The debt obligation is assumed by the new firm. The credit risk of the bonds often changes because of this type of an event. Suppose that the firm Treasure Toys makes an announcement that they are purchasing Land'o Toys. Due to Treasury Toy's projected financial structure after the purchase, Standard & Poors states that the bond rating Land'o Toys bonds will change to BB A. Compute the yield to maturity of Land'o' Toys bonds before the purchase announcement and use it to determine the likely bond rating. What is the likely new rating? B. Assume the bond's price changes to reflect the new credit Did the price increase or rating. What is the new price? decrease? C. What is the dollar change and percentage change in the bond price? D. How do the bond investors feel about the announcement?Explanation / Answer
Answer:
a)
Using excel the following parameters will be inputted: Nper = 20, PV = -1,037.19, PMT = 32.50, FV (future value or the value that will be paid at maturity)= 1000. PMT = coupon rate/2*face value of the bond = 6.5%/2*1000 = 32.5
Yield will be calculated using the "rate" function in excel. The syntax is Rate(Nper,Pmt,PV,FV) = Rate(20,32.5,-1037.19,1000)
Excel gives a value of 3%. Thus YTM = 3%*2 = 6%. The likely rating will be "A".
b)
New credit rating is BB and the applicable rate is 7.3%. Thus Nper = 20, rate = 7.3/2 = 3.65%, PMT = 32.5 and FV = 1000. In this case we have to find the PV.
Present value of annuities of 32.5 = 32.5*PVIFA (3.65%, 20) = 32.5*[1-1/(1+3.65%)^20]/20
= 32.5*14.02 = 455.70
Present value of maturity amount = 1000/[(1+3.65)%^20] = 488.22
Thus new price = 455.70+488.22 = 943.91
The new price decreased.
c)
Price change = $943.91 ? $1,037.19 = -$93.28
% change = -$93.28 / $1,037.19 = -8.99%
d)
In this case the bond rating is being downgraded for the combined firm. There is a negative % change in the prices of the bond as well. This will make the bond investors unhappy.
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