Question

On may 1, 2006, Baxter Corporation sold a $500 bond issue to finance the purchase of a new distribution facility. There bonds were issued in $1,000 denominations with a maturity data of May 1, 2026. The bonds have a coupon rate of 10.00% with interest paid semiannually.

A) Determine the value today, May 1, 2018 of one of these bonds to an investor who requires an 8 percent return on these bonds. Why is the value today different from the par value?

B) Assume that the bonds are selling for $1,352. Determine the current yield and the yield-to-maturity. Explain what these term mean.

C) Explain what layers or textures of risk play a role in the determination of the required rate of return on Baxter's bonds.

Answer 1

A) n=8*2=16
rate =0.08/2=0.04
Coupon =0.10*1000/2=$50
=PV(0.04,16,50,1000)
=$1,116.52

B)PV=-1352
rate =0.04
n=16
=RATE(16,50,-1352,1000)
YTM=4.68%
Current yield =100/1352=7.40%
Current yield is the annual coupon received as a percentage of total price paid. Yield to maturity is the yield or return achieved when a bond is held until maturity

C) The layers that play role are:
Credit risk: due to cash flows and operational efficiency these risk are mitigated. If they decrease then risk increases, required return increases and price increases
Liquidity risk: How easily the bond can be redeemed at market price
Market risk: How bond market behaves in event of systematic risk