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Lourdes Corporation's 14% coupon rate, semiannual payment, $1,000 par value bonds, which mature in 25 years, are callable 5 years from today at $1,025
Lourdes Corporation's 14% coupon rate, semiannual payment, $1,000 par value bonds, which mature in 25 years, are callable 5 years from today at $1,025. They sell at a price of $1,330.37, and the yield curve is flat. Assume that interest rates are expected to remain at their current level.
1) What is the best estimate of these bonds' remaining life? Round your answer to the nearest whole number. years)
2) If Lourdes plans to raise additional capital and wants to use debt financing, what coupon rate would it have to set in order to issue new bonds at par?
a) Since the bonds are selling at a premium, the coupon rate should be set at the going rate, which is the YTM.
b) Since Lourdes wishes to issue new bonds at par value, the coupon rate should be set the same as that on the existing bonds.
c) Since Lourdes wishes to issue new bonds at par value, the coupon rate should be set the same as the current yield on the existing bonds.
d) Since interest rates have risen since the bond was first issued, the coupon rate should be set at a rate above the current coupon rate.
e) Since the bonds are selling at a premium, the coupon rate should be set at the going rate, which is the YTC.
Expert Solution
1) We can calculate the yield to maturity by using the following formula in excel:-
=rate(nper,pmt,-pv,fv)
Here,
Rate = Yield to maturity (semiannual)
Nper = 25*2 = 50 periods (semiannual)
Pmt = Coupon payment = $1,000*14%/2 = $70
PV = $1,330.37
FV = $1,000
Substituting the values in formula:
= rate(50,70,-1330.37,1000)
= 5.15%
Yield to maturity (YTM) = Rate * 2
= 5.15% * 2
= 10.30%
We can calculate the yield to call by using the following formula in excel:-
=rate(nper,pmt,-pv,fv)
Here,
Rate = Yield to call (semiannual)
Nper = 5*2 = 10 periods (semiannual)
Pmt = Coupon payment = $1,000*14%/2 = $70
PV = $1,330.37
FV = Call price = $1,025
Substituting the values in formula:
= rate(10,70,-1330.37,1025)
= 3.29%
Yield to call (YTC) = Rate * 2
= 3.29% * 2
= 6.57%
As YTC is less than YTM, the bonds will be called early, thus the answer is 5 years.
2) Correct option is e) Since the bonds are selling at a premium, the coupon rate should be set at the going rate, which is the YTC.
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