xOrder Up- Release du/courses/46357/quizzes/73591/take LO3 Bond Features Maturit

Question

xOrder Up- Release du/courses/46357/quizzes/73591/take LO3 Bond Features Maturity (years) Face Value- Coupon Rate- Coupon dates (Annual Market interest rate today Time to call (years) 3 Price if Called Market interest rate in Year 3 $1,000 7.00% $1,070.00 4.00% The above bond is callable in 3 years. When the bond is issued today, interest rates are 7.00%. In 3 years, the market interest rate is 4.00%. Should the firm call back the bonds in year 3 and if so, how much would the firm save or lose by calling back the bonds? O no it should not call back the bonds, it will lose $13.42 O yes it should call back the bonds, it will save $13.82 O yes it should call back the bonds, it will save $13.42 O no it should not call back the bonds, it will lose $13.82 O no it should not call back the bonds, it will lose $12.75 O yes it should call back the bonds, it will save $12.75 D | Question 5 5 pts Firms issue callable bonds to give them financing flexibility in case future interest rates

Explanation / Answer

First option is correct, it should not call back by doing so it will lose 13.42 because price then is lower than call price.

Price in 3 years is:

Particulars Cash flow Discount factor Discounted cash flow Interest payments-Annuity (4%,2 periods) 70.0 1.8861 132.03 Principle payments -Present value (4%,2 periods) 1,000 0.9246 924.56 A Bond price                 1,056.58 Face value                 1,000.00 Premium/(Discount)                      56.58 Interest amount: Face value 1,000 Coupon/stated Rate of interest 7.00% Frequency of payment(once in) 12 months B Interest amount 1000*0.07*12/12= 70 Present value calculation: yield to maturity/Effective rate 4.00% Effective interest per period(i) 0.04*12/12= 4.000%

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