Question

Prob set 1.4

13. For the project above, calculate its internal rate of return (IRR).

14. You have an opportunity to purchase a corporate bond issued by Ford Motor Company with a face value of $1,000. It has 6 years left to maturity and has an 8% coupon rate, with interest paid semi-annually. If the current market interest rate for bonds with equivalent risk is 7.25%, what should you pay for the Ford bond?  

15. Suppose that Ford’s credit rating has declined due to poor earnings and increased concerns among investors about Ford’s future profitability. The required return for bonds with Ford’s risk is now 19.5%. How much should you pay for the Ford bond?

16. What is the annual Yield to Maturity (YTM) of a 6-year bond with semi-annual coupon payments if the coupon rate is 6.5%, it is selling for $975.84 and the face value is $1,000?

Answer 1

Answer to Question 14:

Face Value = $1,000

Annual Coupon Rate = 8%
Semiannual Coupon Rate = 4%
Semiannual Coupon = 4% * $1,000
Semiannual Coupon = $40

Time to Maturity = 6 years
Semiannual Period to Maturity = 12

Annual Interest Rate = 7.25%
Semiannual Interest Rate = 3.625%

Current Price = $40 * PVIFA(3.625%, 12) + $1,000 * PVIF(3.625%, 12)
Current Price = $40 * (1 - (1/1.03625)^12) / 0.03625 + $1,000 / 1.03625^12
Current Price = $40 * 9.59263 + $1,000 * 0.65227
Current Price = $1,035.98

So, maximum amount paid for Ford bond is $1,035.98