8. (30 points). Cornwall Agency issued $50 million of 20-year corporate bonds in
ID: 2784028 • Letter: 8
Question
8. (30 points). Cornwall Agency issued $50 million of 20-year corporate bonds in 2010. The bonds were issued in $1000 denominations with an annual coupon interest rate of 8%. Give your answers to a, b, and c below:
What is the current rate of return also called the current yield on these bonds if they are purchased at a current price of $900 each?
……………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………… $___________
b.. Value the bond, that is, find the intrinsic value (Vb) of the $1,000 bond assuming a client is requiring an interest rate of 11.5%. You could use the Excel spreadsheet, a financial calculator or the formula as we did in the study of time value of money (TVM). Note that the bond has 13 more years to expire and therefore N = 13 and the market price is $900.
…………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………… $___________
c.. From the results in (b) above would you recommend her to invest in the bond?
YES ________ NO _______
YOUR REASONING IS: ………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………
Explanation / Answer
a. Absolute value of coupon = 8% of $1000 = $80
Thus rate of return or current yield = value of coupon/current price = 80/900 = 8.89%
b. N = 13, I = 11.5%, PMT = 8% of 1000 = 80 and FV = 1000
Thus using the "PV" function in excel we enter the following syntax/formula: PV(11.5%, 13, 80, 1000) = $769.58
Intrinsic value = $769.58
c. My recommendation is "NO". This is because intrinsic value of bond (769.58) < current price of 900. Thus the bonds are overpriced.
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