Sue owns a bond that was issued by Wayne Enterprises. The Wayne Enterprises bond

Question

Sue owns a bond that was issued by Wayne Enterprises. The Wayne Enterprises bond's maturity date is five years from today (par value = $1,000). The coupon rate on Wayne's bond is 10% with semi-annual coupon payments. Today, Garth Industries issued a 5-year bond at par. The coupon rate on Garth's bond is 11% with semi-annual coupon payments. Both Wayne Enterprises and Garth Industries operate in the entertainment industry; investors require identical rates of return on both bonds. Sue would like to sell her Wayne Enterprise bond. Calculate a fair price for the Wayne Enterprise Bond.

Explanation / Answer

If the coupon rate on Garth's bond is taken to be the current market interest rate, fair value for the Wayne Enterprise bond would be its present value, discounted at 11%.

The fair price of the bond should be = $ 50 x PVAi=5.5%, n=10 + $ 1,000 x PVi=5.5%, n=10

Or 50 x 7.5375 + 1,000 x 0.5854 = $ 962.28

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