Question

1. What would be the yield to maturity for a bond with a $70 coupon, interest paid semiannually, $1000 maturity value, 12 years to maturity and a quoted price of 104.50 (Actual price of $1045)? Remember we are taking the view of the investor, so the price needs to be entered with a negative sign because if we buy the bond, that is cash out of our account

2. If the quoted price fell to 99 (actual price $990), what would be the pretax yield to maturity? How about if the quoted price instead rose to 110.5 (actual price $1105)? What do you conclude from this about the relationship between the bond price and the market rate of interest?

3. A further complication related to bonds is that interest is deductible for tax purposes, so to arrive at an after-tax cost of debt for the firm, rather than a return for investors, it is necessary to multiply the yield by (1- tax rate) to get the after-tax cost of debt. For the first example with a quoted price of 104.5 (actual price of $1045), assuming that the tax rate is 20%, what would be the after-tax cost of debt?

4. To sum up the cost of debt, we only really have three variables to work with - the market rate of interest, the bond price and the firm's tax rate. The coupon payment, time to maturity and the maturity value for a specific bond are effectively fixed. As those first three variables (market interest, bond price and firm's tax rate) change, up or down, how does that affect the firm's after-tax cost of debt?

Answer 1

1. Yield to maturity = YTM = 0.06455 = 6.46%

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