Question

On October 15, 2016, Koala, Inc. issued a 10 year bond (with a typical $1000 face value) that had an annual coupon value of $60. [We are assuming that the 2020 coupon has just been redeemed.]

• Initially, the bond was sold for the premium price of $1,025.
• On October 15, 2020, this bond was selling for only $975.
• The market rate of interest for a riskless corporate bond, of this maturity, was 4.5% on October 15, 2016, which reflects market expectations about future rates of inflation.
• The market rate of interest for a riskless corporate bond, of this maturity, was 4.0% on October 15, 2020, which reflects market expectations about future rates of inflation.

A-What was the risk premium for this bond on October 15, 2020? [To 3 decimal places.]

B-It is now October 15, 2020 and suddenly the Federal Reserve announces a massive program to reduce inflation. Instantly, the market rate of interest for a riskless corporate bond that would apply to this bond, falls from 4.0% to 2.5%. If there is no change in the risk premium expected for this Koala, Inc. bond, what will be this bond’s yield to maturity? [To 3 decimal places.]

Answer 1

Hi

The answer of the following question are as follows :

Ans.A). The Face value = 1000 $

Annual coupon payment = 60 $

Nominal Yield = Annual coupon payment / Bond Face value * 100

(Nominal Yield is always calculated on Face value of the bond, is dosent change irrespective of bond price)

= 60 / 1000 * 100

= 6 %

Ans.B) The coupon payment will be= 60 $

Now the Bond price on 15th Oct 2016 = with 4.5% interest rate the present value of bond will increase 1118.69 $ based on Excel calculation due to fall in interest rate

Current Yield on October 15, 2016 = Coupon Payment / Current Market Bond Price * 100.

= 60 / 1118.69 * 100

= 5.36 %.

I hope I have served the purpose well .

Thanks. ?