Question

Refer to the information in QS 10-19 for Vodafone Group Plc. The following price quotes relate to its bonds payable. The price quote indicates that the 4.625% bonds have a market price of 111.67 (111.67% of par value), resulting in a yield to maturity of 1.710%.

Price	Contract Rate (coupon)	Maturity Date	Market Rate (YTM)
111.67	4.625%	15-Jul-2018	1.710%

1. Assuming that the 4.625% bonds were originally issued at par value, what does the market price reveal about interest rate changes since bond issuance? (Assume that Vodafone’s credit rating has remained the same.)
2. Does the change in market rates since the issuance of these bonds affect the amount of interest expense reported on Vodafone’s income statement? Explain.
3. How much cash would Vodafone need to pay to repurchase the 4.625% bonds at the quoted market price of 111.67? (Assume no interest is owed when the bonds are repurchased.)
4. Assuming that the 4.625% bonds remain outstanding until maturity, what market price will the bonds sell on the due date in 2018?

Short answer

1. Market rate is 1.710%
2. The change in market rates since it issued the bonds does not affect interest expense.
3. The market price of the bonds is higher (111.67); thus, it would cost more to retire them than their par value on the balance sheet.
4. At bond maturity, Vodafone must pay the bonds' face value.

Step-by-step solution

Meaning of Bonds

Bonds are tradable assets that are securitized versions of the corporate debt that the companyissues. Bonds are fixed-income instruments since they verifiably pay debt holders a fixed interest rate (coupon).

(a) Explaining the market price reveals interest rate changes since bond issuance.

Bond prices and market rates have an inverse relationship.Given that Vodafone's credit ratings are still unchanged and that the 4.625 percent debentures are currently trading at a premium (111.67), we conclude that since the bonds were issued, market rates for this particular type of debt have declined below 4.625 percent. Its market rate of 1.710 percent attests to this.

(b) Explaining if the change in market rates since the issuance of these bonds affects the amount of interest expense

No, the change in market rates after the bonds were issued does not affect interest costs. After the bonds are recorded on the balance sheet, neither the abdicate (market) rate nor the coupon rate used to calculate interest cost are altered. The cost of bonds and notes is recorded all through time.

(c) Evaluating the cash needed by Vodafone to pay to repurchase the 4.625% bonds at the quoted market price of 111.67

The market price of the bonds is higher (111.67); thus, it would cost more to retire them than their par value on the balance sheet. Retire would require $376.3279 million ($337 million 111.67 %) in cash. The cash outflow must be compared to the bond's carrying value to calculate a gain or loss. This comparison yields a loss of $1.3279 million ($375 million carrying value - $376.3279 million cash outflow), which would reduce the current period’s income.

(d) Determining the market price at which the bonds sell on the due date in 2018.

When the bonds mature, Vodafone must pay the full principal. The market price of the bonds will be equal to the par amount at that point because this is the sole cash flow that the bondholders will ever get. At maturity, $337 million would be due for the bonds with a yield of 4.625 percent. This is presuming that the interest payment has already been recorded.