Question

Orange District Hospital issued a 30-year, 10 percent annual coupon bond (par value $1,000) two years ago. The bond now has 28 years remaining to maturity and sells for $1,400. The bond has a call provision that allows the hospital to call the bond in ten years at a call price of $1,100. If an investor expects a call and requires a 6.5 percent rate of return, will the investor be likely to purchase the bond? Explain your answer

Answer 1

Answer:

Par value = $1,000

Annual coupon Amount = 1000 * 10% = $100

Bond was issued two year ago.

The bond has a call provision that allows the hospital to call the bond in ten years at a call price of $1,100

Investor expects a call and requires a 6.5 percent rate of return

Time to expected call of the bond = 8 years

To calculate price the investor will be willing to pay, we will use PV function of excel:

= PV (rate, nper, pmr, fv, type)

= PV (6.5%, 8, -100, -1100, 0)

= $1,273.53

Since the current price of the bond is $1,400 which is much higher than the present value of the bond, the investor is not likely to purchase the bond.

The investor is not likely to purchase the bond.