Question

Jalal, Inc. needs to raise $50,000,000 by selling bonds. The bonds have a par value of $1,000, pay coupon interest semi-annually, have an annual coupon rate of 6%, and mature in 20 years. The bond’s default risk-premium (DRP) is 2%, its maturity risk-premium (MRP) is 1%, and its liquidity risk-premium (LRP) is 2%. Further, the risk-free rate of return is 3%

What is the required rate of return on Jalal’s debt?

a. 5%

b. 9%

c. 8%

d. 3%

e. None of the above

How many bonds will Jalal, Inc. have to sell to raise the needed funds (round to the nearest whole number)? [Hint: Compute the price of each bond first. For simplicity, assume that the required rate of return you computed in Question 4 is a stated annual rate compounded semiannually. The number of bonds Jalal, Inc. will need to issue will then equal the amount of capital it wants to raise divided by the price it expects to get for each bond that it sells.]

a. 44,424 bonds

b. 69,063 bonds

c. 123,833 bonds

d. 62,339 bonds

e. None of the above

Answer 1

required rate of return = risk free rate +MRP + LRP +DRP = 3+2+2+1 = 8%

K = Nx2

Bond Price =∑ [(1000 Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =20x2

Bond Price =∑ [(6*1000/200)/(1 + 8/200)^k]     +   1000/(1 + 8/200)^20x2

k=1

Bond Price = 802.07

Number of bonds to issue = capital to be raised/(bond price)

Number of bonds to issue = 50000000/(802.07) =62339