Question

Your firm has a credit rating of A. You notice that the credit spread for five-year maturity A debt is 85 basis points (0.85%). Your firm’s five-year debt has a coupon rate of 6%. You see that new five-year Treasury notes are being issued at par with a coupon rate of 2.0%. What should the price of your outstanding five-year bonds be per $100 of face value?

Answer 1

Answer:

The market price should be: $114.67

Explanation:

the risk free rate is          2.00%

this firm has a spread of 0.85%

            firm cost of debt 2.85%

The market will adjust the bond price so the yield ofthe bonds relfect this rate.

So we will calculate the present value of a coupon 100 with a 6% rate

We use the ordinary annuity for the coupon payment:

$C \times \frac{1-(1+r)^{-time} }{rate} = PV$

Coupon payment: 100 face value x 3% bond rate = 3

time 10 (5 years with 2 payment per year)

market rate: 0.01425  (2.85%/2)

$3 \times \frac{1-(1+0.01425)^{-10} }{0.01425} = PV$

PV $27.7768

and lump sum present value for the maturity:

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

Maturity  100

time  5

rate  0.0285

$\frac{100}{(1 + 0.0285)^{5} } = PV$  

PV   86.89

Last, we add them to get the market price:

PV c $27.7768

PV m  $86.8917

Total $114.6685