A previously issued A2, 15-year industrial bond provides a return one-fourth hig

Question

A previously issued A2, 15-year industrial bond provides a return one-fourth higher than the prime interest rate of 12 percent. Previously issued A2 public utility bonds provide a yield of one-eighth of a percentage point higher than previously issued A2 industrial bonds of equal quality. Finally, new issues of A2 public utility bonds pay one-fourth of a percentage point more than previously issued A2 public utility bonds.

What should be the interest rate on a newly issued A2 public utility bond?

A previously issued A2, 15-year industrial bond provides a return one-fourth higher than the prime interest rate of 12 percent. Previously issued A2 public utility bonds provide a yield of one-eighth of a percentage point higher than previously issued A2 industrial bonds of equal quality. Finally, new issues of A2 public utility bonds pay one-fourth of a percentage point more than previously issued A2 public utility bonds.

Explanation / Answer

Industrial bond return = 12%*(1+1/4) = 15%

Previously issued public utility bond return = industrial bond return + 1/8% = 15%+0.125% = 15.125%

Newly issued public utility bond return = Previously issued public utility bond return + 1/4% = 15.125%+0.25% = 15.375%

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