HMK Enterprises would like to raise $10 million to invest in capital expenditures. The company plans to issue five-year bonds with a face value of $1000 and a coupon rate of 6.5% (annual payments). The following table summarizes the yield to maturity for five-year (annual-pay) coupon corporate bonds of various ratings:
Rating |
AAA |
AA |
A |
BBB |
BB |
YTM |
6.20% |
6.30% |
6.50% |
6.90% |
7.50% |
(a) Bond Rating: AA, Corresponding Bond Yield to Maturity(YTM) = 6.3 %, Face Value = $ 1000, Coupon Rate = 6.5 % with annual payments, Bond Tenure = 5 years
Bond Coupon = 0.065 x 1000 = $ 65
Bond Price = Total Present Value of All Coupons + Face Value redeemed at maturity = 65 x (1/0.063) x [1-{1/(1.063)^(5)}] + 1000/(1.063)^(5) = $ 1008.36
(b) Target Fund = $ 10000000 and Price per Bond = $ 1008.36
Number of Bonds to be Issued = 10000000 / 1008.36 = 9917.093 ~ 9917
(c) If bond sells at par then YTM should equal the bond's annual coupon of 6,5 %. Bond YTM = 6,5 % corresponds to a rating of A
(d) Let the bond YTM be R and Bond Price = $ 959.54
Therefore, 959.54 = 65 x (1/R) x [1-{1/(1+R)^(5)}] + 1000 / (1+R)^(5)
Using hit and trial method/EXCEL's Goal Seek Function to solve the above equation, we get:
R = 0.075 or 7.5 %
A YTM of 7.5 % corresponds to a rating of BB
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