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Question 2 (8 marks) a) A bond of 10 years maturity is left with 8 years...

Question 2

  1. a) A bond of 10 years maturity is left with 8 years to maturity today. Its coupon rate is 10%, paying annual coupon with par value of $1,000. What is the price of the bond today if the yield to maturity is 8%? Is it a premium bond or discount bond?

  2. b) Recently, a 30-year corporate bond issued by Liz Co. has been downgraded by a credit rating agency from AAA to B. Other things being constant, what would you expect to happen to the price and yield of the bond as a consequence of the downgrade?

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Answer #1

Solution>

Part a) The price of the bond is $1,114.93. It is a premium bond since its value is greater than the face value of the bond.

I have solved this question in Excel. The formula used are written along with the values. If you still have any doubt, kindly ask in the comment section.

The formula for calculating the bond price is:

Part b) Rating downgrade of a bond leads to rise in yield payable on the bond and that leads to fall in price. Hence, if a 30-year corporate bond issued by Liz Co. has been downgraded by a credit rating agency from AAA to B, the yield of the bond will increase and its price would decrease.

Note: Give it a thumbs up if it helps! Thanks in advance!

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