Exactly 2 years ago your company issued a series of 5-year, 9% bonds, with coupon payments...

Exactly 2 years ago your company issued a series of 5-year, 9% bonds, with coupon payments made semi- annually. The bonds have a face value of $1000. The bonds also have a call feature attached to them which allows your company to call the bonds three years after the issuing date (i.e. After the 6th coupon payment) at a premium of 10% above the face value. Investors currently require an annual return of 12% on their investment in your company’s bonds. a. Should your company call the bonds? Please explain your answer in no more than two sentences. Please show the basis of calculation b. What is the current value of a single bond? Tip: The response depends on your answer in part

Expert Solution

Time value of money refers to the concept in which it is dominantly stated that the present value of money which is to be received in future will be low after removing the effect of interest factor.

Following is the formula table for computation of required return of investor at the time of issue of bonds:

Following is the computation of required return of investor at the time of issue of bonds:

The solution has been highlighted in the yellow cell. The current required rate of return at the time issue of bond has been computed on a assumption that only face value has been paid to acquire the bond. Thus the required rate of return shall be 9% which is equal to coupon rate.

a. The company should not call bonds, as the investor's expectations from bonds has risen from 9% to 12% because, the company could carry on paying the coupon rate of 9% irrespective of required return and also it is not obliged to call them.

b.

Following is the formula table for computation of current price of bond at the given required rate of return of 12%:

Following is the computation of current price of bond at the given required rate of return of 12%:

Thus the current price of bond has been computed as $948.02 taking the 12% as required rate of return for the investor. Also, 10% of premium has not been taken into account as the company will not call these bonds after 3 years, thus no need of considering premium of 10%.

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jeff jeffy answered 9 months ago

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