Question

Bond Valuation: Netflix is issuing a new series of coupon bonds. The bonds will mature in 10 years, have a $1,000 face value, have a 6.5% coupon rate (paid annually). Netflix’s credit rating is B (Yield rate - 8.9%).

a. How much can Netflix expect to sell each bond for?

b. Suppose that, in exactly one year (so immediately after the bond pays its first coupon), Netflix experiences a credit rating upgrade from B (8.9%) to B+ (8%). What would be your one year return if you bought the bond when it was issued and sold it immediately after the credit upgrade?

c. Suppose Netflix also has a call provision in place that allows them to buy back their bonds for $1,000 at any time after 5 years. If the yields associated with each credit rating remain constant over time, what is the minimum credit rating Netflix must achieve to profitably exercise the call option?

Answer 1

a.

Assumption: Buyer is rational and unbiased

Expected sale price of bond = Net Present value of Bond

=

where C= all cashflows received

r= yield to maturity

t= number of period during cashflow

NPV= $845.29

b. Sale price after 1 year for the bond = $906.30

Purchase price = $845.29

Coupon payment received = $65

Rate of Return =

= 14.91%