The problem refers to the bonds of The Apollo Corporation, all of which have a c
ID: 2759029 • Letter: T
Question
The problem refers to the bonds of The Apollo Corporation, all of which have a call feature. The call feature allows Apollo to pay off bonds anytime after the first 15 years, but requires that bondholders be compensated with an extra year's interest at the coupon rate if such a payoff is exercised. Apollo's Alpha bond was issued 10 years ago for 30 years with a face value of $1,000. Interest rates were very high at the time, and the bond's coupon rate is 20%. The interest rate is now 14.5%. Assume bond coupons are paid semiannually. At what price should an Alpha bond sell? Round the answer to the nearest cent. At what price would it sell without the call feature? Round the answer to the nearest cent.Explanation / Answer
Q: a.
The Alpha bond is expected to be called, hence the bond price should be calculated assuming the bond will be called while the call feature allows in 5 more years.
n = (15-10) × 2 = 10 period
r = 14.5÷2 = 7.25% semi annually
FV = 1,000+200=1200;
PV = FV ÷ (1 + R)n
= 1,200 ÷ (1+.0725)10
= 1,200 ÷ 2.013599
PV = $595.95
Q: b.
n = 20 × 2 = 40 period
r = 14.5 ÷ 2 = 7.25% semi annually
FV = 1,000;
PV = FV ÷ (1 + r)n
= 1,000 ÷ (1+.0725)40
= 1,000 ÷ 16.43963
PV = $60.83
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