Skylab Technologies issued 10-year bonds yesterday at their par value of $1,000.

Question

Skylab Technologies issued 10-year bonds yesterday at their par value of $1,000. These bonds pay $60 in interest every six months, and their price has remained at the $1,000 issue price. Skylab's CFO has determined that the firm needs an additional $2,000,000, and has decided to issue 10-year, $1,000 par value bonds that pay only $40 in interest every six months. If both bonds are to provide investors with the same yield, how many new bonds must Skylab issue to raise $2,000,000? (Ignore the day or two difference between the bonds' issue dates)

Explanation / Answer

When Coupon Payment is $60, then the semi-annual Coupon Rate = $60 / $1,000 = 0.06 = 6%

When Coupon Payment is $60, then the semi-annual Coupon Rate = $60 / $1,000 = 0.06 = 6%

, therefore the annual coupon rate = 12% Since the original bonds were issued at par, then the Yield to Maturity = Coupon Rate = 12% (Annually) When Coupon Payment is $40, then the semi-annual Coupon Rate = $40 / $1,000 = 0.04 = 4%, therefore the annual coupon rate = 8% But since the new bonds will have a lower Coupon rate (8% as opposed to 12%), then the bonds will be issued at a discount. I have used excel to calculate the price of the new bonds, which is $770.60 Since $2,000,000 are needed, therefore Skylab would have to issue ($2,000,000 ÷ $770.60) = 2,595.38 – approximately 2,596 bonds

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