Question

A 10-year bond of a firm in severe financial distress has a coupon rate of 14% and sells for $955. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to reduce coupon payments on the bond to one-half the originally contracted amount. The firm can handle these lower payments. What is (a) the stated and (b) the expected yield to maturity of the bonds? The bond makes its coupon payments annually. (Do not round intermediate calculations. Round your answers to 3 decimal places.)

Answer 1

(a): Stated yield to maturity (YTM) : This can be computed using the "rate" function. Here annual coupons = 14% of 1000 = $140, PV = 955, FV = 1,000 and nper = 10. We can use the "rate" function and the syntax will be:

RATE (10, 140, -955, 1000)

This gives a value of 14.893% (rounded to 3 decimal place). Thus stated rate of YTM = 14.893%

(b): Expected YTM: Here PMT = 140/2 = $70

So YTM = RATE (10, 70, -955, 1000)

= 7.660% (rounded to 3 decimal place). Thus expected rate of YTM = 7.660%