Question

The Churchill Company issued a 25-year bond five years ago with a face value of $1,000. The bond pays interest semiannually at a 10% annual rate.

Questions: Show all calculations

1. What is the bond's price today if the coupon rate on comparable new issues is 12%?

2. What is the price today if the coupon rate on comparable bonds declines to 8%?

3. Explain the results of parts a) and b) in terms of opportunities available to

investors. Specifically, comment on the relationship between coupon rates on newly issued bonds and the coupon of the existing bond

Answer 1

Answer a)

Value of Bond =

Where r is the discounting rate of a compounding period i.e. 12%/2 = 6%

And n is the no of Compounding periods 20 years * 2 = 40

Coupon 10% / 2 = 5%

=

= 849.54

Answer b)

Value of Bond =

Where r is the discounting rate of a compounding period i.e. 8%/2 = 4%

And n is the no of Compounding periods 20 years * 2 = 40

Coupon 10% / 2 = 5%

=

= 1197.93

Answer c)

When YTM > Coupon, the Value of Bond is less than the Par value.

Also, YTM < Coupon, the Value of Bond is more than the Par value.