A bond has the following features: Coupon rate of interest: 8%, Principal: $1,00

Question

A bond has the following features: Coupon rate of interest: 8%, Principal: $1,000, Term to maturity: 10 years

a.) What will the holder receive when the bond matures? b.) If the current rate of interest on comparable debt is 12%, what should be the price of this bond? Would you expect the firm to call this bond? Why? c.) If the bond has a sinking fund that requires the firm to set aside annually with a trustee sufficient funds to retire the entire issue at maturity, how much must the firm remit each year for 10 years if the funds earn 9% annually and there is $10 milion outstanding?

Explanation / Answer

a) For most of the bonds the maturity value is the face or par value of the bond. Let us calculate the maturity value of the bond using excel sheet: Step1: Go to excel and click "Insert" to insert the function. Step2: Select the "FV" function as we are finding the future value in this case. Step3: Enter the values as Rate = 12%; Nper = 10; PMT = -80; PV = 0 Step4: Click "OK" to get the desired value. The value comes to "$1,403.9" b) Calculating the Present value of the bond using excel sheet: Step1: Go to excel and click "Insert" to insert the function. Step2: Select the "PV" function as we are finding the future value in this case. Step3: Enter the values as Rate = 12%; Nper = 10; PMT = -80; FV = -1000 Step4: Click "OK" to get the desired value. The value comes to "$773.99" Therefore, the current price of the bond is $774. This bond cannot be callable because the bond is paying less coupon rate than the market interest rate. If the bond is paying higher coupon rate than the market interest rate, then the bond can be callable. Therefore, the bond cannot be callable. c) Calculating the annual payment amount using excel sheet: Step1: Go to excel and click "Insert" to insert the function. Step2: Select the "PMT" function as we are finding the annual payment value in this case. Step3: Enter the values as Rate = 9%; Nper = 10; PV = 10000000 ; FV = 0 Step4: Click "OK" to get the desired value. The value comes to "$1,558,200.9" Therefore, the annual payment that must be kept aside for trustee sufficient funds is $1,558,201 Step1: Go to excel and click "Insert" to insert the function. Step2: Select the "PMT" function as we are finding the annual payment value in this case. Step3: Enter the values as Rate = 9%; Nper = 10; PV = 10000000 ; FV = 0 Step4: Click "OK" to get the desired value. The value comes to "$1,558,200.9" Therefore, the annual payment that must be kept aside for trustee sufficient funds is $1,558,201                                            

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