Question

6. ) Bondigo Beverage Inc. is planning to issue two types of 20-year, noncallable bonds to raise a total of $8 million, $4 million from each type of bond. First, 4,000 bonds with a 10% semiannual coupon will be sold at their $1,000 par value to raise $4,000,000. These are called "par" bonds.

Second, Original Issue Discount (OID) bonds, also with a 20-year maturity and a $1,000 par value, will be sold, but these bonds will have a semiannual coupon of only 7.05%. The OID bonds must be offered at below par in order to provide investors with the same effective yield as the par bonds. How many OID bonds must Bondigo issue to raise $4,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.

Answer 1

Original Issue Discount (OID) bonds is similar to zero coupon bond.

Interest is not paid periodically, but is accrued.

OID bonds should provide investors with the same effective yield as the par bonds.

Therefore effective yield on OID bonds = 7.05% compounded semi-annually

Tenure (N) = 20 years = 40 half years

Par value = $1000

Therefore present value per bond = Par Value / (1 + 7.05%/2)⁴⁰ = $ 250.14

Therefore number of  bonds to be issued to raise $ 4,000,000 = 4,000,000 / 250.14 = 15991 bonds