Question

Worldwide Widget Manufacturing, Inc., is doing so well it decides it’s time to become an international company. As the chief financial officer (CFO), you’re tasked with raising $340 million of new capital to open offices around the world. In researching the matter, you learn that if bonds due in 20 years are used for raising the capital, they’ll be rated AA and will need to offer a yield of 6.5 percent. How many bonds will it be necessary to issue to raise the needed capital? What will Worldwide Widget Manufacturing have to make as a semiannual interest rate payment?

Answer 1

Key features of the bond are the following:

Face Value or Par value: This is the denomination of the bond on which interest is calculated. Unless otherwise specified, the bond will be redeemed at face value on maturity. Let us treat the par value of this bond at $1,000.

Maturity: It is the tenure of the bond. In the given case, the term to maturity is stated as 20 years.

Coupon rate: This is the rate of interest paid on the bond per year. Coupon rate is usually stated on yearly basis.

Payment frequency: Coupon (interest) may be paid at the pre-determined frequency of number of times a year. The frequency could be usually annual (one in a year) or semi annual (twice a year). In the given case, frequency is stated as semi annual.

Yield to maturity (YTM): It is the rate of interest (discount rate) at which present values of future cash inflows become equal to the present market value (price) of the bond.YTM is the expected rate of income (interest) that the investor receives out of this investment and it is dependant on the risk involved, in addition to the other factors. It is stated that yield on this bond is 6.5%.

Issue price and premium/discount: If the coupon rate and yield are equal, the bond price is equal to par value (face value). If the yield is higher than coupon rate, price will be less than face value (discount) and if the yield is lower than coupon rate, price will be higher (premium).

Since the yield offered is 6.5%, the bond can be issued at par (issue price $1,000) if the coupon rate is also 6.5%. Assuming issue at par and face value of $1,000 per bond, number of bonds that Wordwide Widget shall issue is as follows:

Amount to be raised: $340 million

Issue price per bond= $1,000

Number of bonds= $340,000,000/$1,000 = 340,000.

Semi annual interest payment= Number of bonds*Issue price per bond*Coupon Rate/2

=340,000*1,000*6.5%/2 = $11,050,000