Question

A Ford bond carries a coupon rate of 10%, payable semi-annually and has 15 years until maturity. It has a yield to maturity (YTM /yield rate) of 8%.

a. What price does the bond sell for?

b. What will the price be if the bond yield rises to 10%?

c. If Ford significantly reduced the amount of debt on its balance sheet, what would likely happen to the price of the bond? Explain.

d. If Ford incurred a considerable amount of debt what would happen to the coupon rate? Explain.

e. Give two reasons that could cause the yield rate to increase on a bond.

f. As a bond trader what is your strategy when purchasing bonds—what are you ‘betting’ on?

g. Would Ford want to have a higher or lower yield on its bond when it issues the bond? Explain (like you are talking to your dim-witted uncle).

h. The yield on Ford bonds increased 0.5% the day before they were to be sold to the market. Would the CFO be happy or sad? Explain

Answer 1

a). FV (par value) = 1,000; PMT (semi-annual coupon) = coupon rate*par value/2 = 10%*1,000/2 = 50; N (number of payments) = 15*2 = 30; rate = 8%/2 = 4%, solve for PV.

Current price = 1,172.92 (Since par value is not mentioned, it is assumed to be 1,000. If it is 100 then price wil be 117.29)

b). If yield becomes 10% then it equals the coupon rate so bond price will be same as the par value i.e. 1,000 (or 100).

c). If amount of debt on the balance sheet is significantly reduced then risk of the company decreases. This will lead to lower yield which means bond price will increase.

d). If debt amount is considerably increased, then company risk increases so potential debtholders will require higher return. This will result in an increase in coupon rates.

e). Yield rate can rise if the credit rating agency downgrades the bond. This indicates the bond has become riskier and consequently, yield will rise. Yield will also rise as inflation increases because market interest rates will increase.