Question

• Develop and present a valuation model for corporate debt with a face value of $100 million dollars. The model should use hypothetical assumptions for the coupon rate and other characteristics as well as a hypothetical market interest rate. You must also select a maturity for the bonds and the frequency of the coupon payments. The market rate should be justifiable/reasonable given current market conditions. Explain why the model will be important for the issuance process that is being considered.

Answer 1

Face value = $100 million

Assumptions are as below :

Coupon rate = 5%

Coupon frequency = semiannual

Maturity = 15 years

Rating = AAA

Yield on AAA corporate bonds (Moody's) is 3.31%

The current market value of the bond issue can be calculated as the present value of all the cash flows of the bond, discounted at the yield on corporate bonds (3.31%). The cash flows of the bond are :

• the semiannual coupon payments. Semiannual coupon payment = face value * coupon rate / 2 = $100 million * 5% / 2 = $2.5 million
• face value receivable by bondholder on maturity. This is $100 million

The current market value of the bond issue is calculated using PV function in Excel :

rate = 3.31% (converting annual yield into semiannual yield)

nper = 15 * 2 (number of semiannual payments = years to maturity * 2)

pmt = 2,500,000 (semiannual coupon payment)

fv = 100,000,000 (face value receivable on maturity)

PV is calculated to be $119,854,400

The current market value of the issue is $119,854,400. This is the amount that can be raised by the bond issue.

The model is important for the issuance process because the model determines the net proceeds of the bond issue. The bond is being issued at a premium (issue price > face value). Hence the net proceeds of the issue are higher than the face value.