Ace Apparel, Inc., a manufacturer, has just issued $1,000,000 principal amount o

Question

Ace Apparel, Inc., a manufacturer, has just issued $1,000,000 principal amount of bonds with an 8% semiannual coupon and a maturity of twenty-five years. The market rate of interest on similar bonds is six percent (compounded semiannually) a. How much did Ace Apparel receive for each $1,000 bond (ignore issue costs)? b. If the market rate of interest were to increase to ten percent in exactly five years, at what price would the bonds then sell? c. If you were to purchase a single $1,000 bond at issuance (part a) and then sell it at the market price five years later (part b), what would be your annual rate of return (APR) on this investment (ignore transactions costs)?

Explanation / Answer

a. market price = 40/(1+3%) +40/(1+3%)^2 ...............1040/(1+3%)^50 market price = $1,257.30 Ace received $1,257.30 for each bond b. no of years remaining = 20 years market price = 40/(1+5%) +40/(1+3%)^2 ...............1040/(1+5%)^10 market price after five years = $828.41 c. APR =( 828.41 + 40*10 - 1,257.30)/1,257.30 =-2.30%

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