Question

Suppose Ford Motor Company issues a five year

bond with a face value of $5,000thatpaysanannualcouponpaymentof$150.

a. What is the interest rate Ford is paying on the

borrowed funds?

b. Suppose the market interest rate rises from 3% to 4% a year after Ford issues the bonds. Will the

value of the bond increase or decrease?

Short answer

Part (a). 15%

Part (b). The value will decrease.

Step-by-step solution

Step 1. Definition

The annual interest rate as a percentage of the face value paid from issuing till maturity of a bond is known as coupon value.

Step 2. Part (a).

The interest rate paid is calculated below:

let interest rate is A%,

$$\begin{gathered} A\%\times \frac{\$5000}{5}=\$150 \\ A\%=\$150\times \frac{5}{\$5000}=0.15 \end{gathered}$$

So the rate is 15%

Step 3. Part (b).

After issuing the bond the interest rate increases from 3% to 4% per year. It will have an effect of a decrease in the value of the bond. Because as the interest increases people may swap their preference to a low-interest bond so the value of this bond must decrease.