Question

Use the following information to answer the question(s) below.

security	term(yrs)	yield(%)
Treasury	20	5.5%
AAA Corporate	20	7%
BBB Corporate	20	8%
B Corporate	20	9.6%

A) Wyatt Oil is contemplating issuing a 20-year bond with semiannual coupons, a coupon rate of 7%, and a face value of $1000. Wyatt Oil believes it can get a BBB rating from Standard and Poor's for this bond issue. If Wyatt Oil is successful in getting a BBB rating, what is the issue price for these bonds?

B)Wyatt Oil is contemplating issuing a 20-year bond with semiannual coupons, a coupon rate of 5%, and a face value of $1000. Wyatt Oil believes it can get a AAA rating from Standard and Poor's for this bond issue. what is the difference in the price the company will receive if the BBB instead of AAA

Answer 1

a)

Wyatt oil will use yield of 8%

Rate = 8 / 2 = 4% ( since it is a semi annual bond, we divide by 2)

Coupon payment = 0.07 * 1000 = 70 / 2 = 35

Maturity = 20 * 2 = 40

Face value = 1000

Bond price = C * [ 1 - 1 / ( 1 + r)ⁿ]] / r + face value / ( 1 + r)ⁿ

Bond price = 35 * [ 1 - 1 / ( 1 + 0.04)⁴⁰]] / 0.04 + 1000/ ( 1 + 0.04)⁴⁰

Bond price = 35 * [ 0.791711 / 0.04 ] + 208.289

Bond price = 692.747125 + 208.289

Bond price = $901.036

b)

Wyatt oil will use yield of 7%

Rate = 7 / 2 = 3.5% ( since it is a semi annual bond, we divide by 2)

Coupon payment = 0.05 * 1000 = 50 / 2 = 25

Maturity = 20 * 2 = 40

Face value = 1000

Bond price = C * [ 1 - 1 / ( 1 + r)ⁿ]] / r + face value / ( 1 + r)ⁿ

Bond price = 25 * [ 1 - 1 / ( 1 + 0.035)⁴⁰]] / 0.035 + 1000/ ( 1 + 0.035)⁴⁰

Bond price = $786.449

Difference = 901.036 - 786.449 = 114.587