Question

Carolina issued a 15-year semi-annual non-callable bond five years ago. Bond has a $1,000 face value, coupon rate of 5% and it currently sells for $925. Carolina needs to issue 10-year semi-annual note. Note will be non-callable and is expected to get the same credit rating as outstanding bond issue. If Carolina wants to issue and sell new note at par, find approximate coupon rate that needs to be assigned to the note. (Hint: similar bonds/notes should be providing approximately same returns).

Answer 1

Yield of issued bond should be equal to coupon of new bond as they share same credit rating.

i.e. Yield of old bond = Coupon of new bond

The old bonds always trade on basis on present rate of return or current rate. The new bonds give current market to the investors so that new bonds give fair interest income to investors.

Old bond’s remaining payment life is 10 years as 5 years always gone passed. The coupon payment will be for 20 times for next 10 years as this is semiannual coupon.

Using financial calculator BA II Plus - Input details:	#
FV = Future Value =	$1,000
PV = Present Value =	-$925
N = Total number of remaining payment periods =	20
PMT = Payment = 5%/2 x 1000	$25
CPT > I/Y = Rate =	3.0043
Convert Yield in annual and percentage form = Yield x 2 x 100	6.0086%

Yield of old bond = 6.0086% (approximately)

Hence, Coupon of new bond should be 6.0086%

@ 6.0086% coupon the bonds can be issued at par value as Yield = Coupon !

(Note: Please apply rounding as per your requirement since it is not mentioned in question)