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Chapter 3: Q-10-271 (page 330)

Question: A 10-year bond of a firm in severe financial distress has a coupon rate of 14% and sells for $900. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to reduce coupon payments on the bond to one-half the originally contracted amount. The firm can handle these lower payments. What are the stated and expected yields to maturity of the bonds? The bond makes its coupon payments annually.

Short Answer

Expert verified

Answer

Expected YTM = 8.526

Stated YTM = 16.075

Step by step solution

01

Given information

n = 10,

PV = 900

FV = 1000

PMT = 140

Expected coupon payments = $70 annually

02

Calculation of the YTM

Yield to Maturity = [Annual Interest + {(FV - Price)/Maturity}] / [(FV + Price)/2]

= (70 + 1000 – 900/ 140) / (1000 + 900) /2

= Expected YTM = 8.526

Therefore the stated YTM = 16.075

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Most popular questions from this chapter

What would be the likely effect on the yield to maturity of a bond resulting from:

a. An increase in the issuing firm’s times-interest-earned ratio?

b. An increase in the issuing firm’s debt-equity ratio?

c. An increase in the issuing firm’s quick ratio?

Question: The yield curve is upward-sloping. Can you conclude that investors expect short-term interest rates to rise? Why or why not?

Consider a bond paying a coupon rate of 10% per year semi-annually when the market interest rate is only 4% per half-year. The bond has three years until maturity.

a. Find the bond’s price today and six months from now after the next coupon is paid.

b. What is the total rate of return on the bond?

A member of a firm’s investment committee is very interested in learning about the management of fixed-income portfolios. He would like to know how fixed-income managers position portfolios to capitalize on their expectations concerning three factors influencing interest rates. Assuming that no investment policy limitations apply, formulate and describe a fixed-income portfolio management strategy for each of the following interest rate factors that could be used to exploit a portfolio manager’s expectations about that factor.

( Note: Three strategies are required, one for each listed factor.)

a. Changes in the level of interest rates.

b. Changes in yield spreads across/between sectors.

c. Changes in yield spreads as to a particular instrument.

Question: Assume you have a one-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 10 years. The first is a zero-coupon bond that pays \(1,000 at maturity. The second has an 8% coupon rate and pays the \)80 coupon once per year. The third has a 10% coupon rate and pays the $100 coupon once per year.

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b. If you expect their yields to maturity to be 8% at the beginning of next year, what will their prices be then? What is your rate of return on each bond during the one-year holding period?
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