Question

Assume you pay $1,343 for a Tesla bond (14 year maturity, 6.5% coupon bond, paid semi-annually, with a YTM of 3.4%, $1,000 principal). If Tesla is downgraded and the default risk premium of Tesla increases by 5.0%, all-else-equal, what is the new bond price of Telsa?

Group of answer choices $1,200 $845 $950 $935

Answer 1

Given about Tesla's bond,

Face value = $1000

coupon rate = 6.5% paid semiannually

years to maturity = 14

So, semiannual coupon payment = (6.5%/2) of 1000 = $32.5

YTM = 3.4%

If Default risk premium on the bond increases by 5%, new YTM on the bond = 3.4 + 5 = 8.4%

So, new price of the bond can be calculated on financial calculator using following values:

FV = 1000

N = 2*14 = 28

PMT = 32.5

I/Y = 8.4/2 = 4.2

Compute for PV, we get PV = -845

So, new price of the bond = $845

Option B is correct.