Question

Tesco PLC is planning to issue a 9-year maturity bond with 20 warrants attached and a bond yield to maturity of 4%. Each warrant is expected to worth $2.5.

(a) If the coupon rate for this 9-year maturity bond is at 3%, how much capital would Tesco PLC be able to raise for every bond with 25 warrants attached to each share of bond? (1 point)

(b) Suppose Tesco PLC plans to sell each share of this 9-year bond with only 20 warrants attached at par value ($1,000) today. What is the coupon rate for this Tesco bond? (1 point)

Answer 1

Given, 1 warrant = $2.5, Maturity rate = 4%, Number of period = 9 years.

For question (a),

Given, Number of period = 9 years, Maturity rate = 3%, 1 warrant = $2.5

To Calculate; Capital price for 25 warrants.

The formula for calculating Capital Price is P(T0) = PMT(TN) + FV / (1+ R)^N

P(T0) = Price at Time 0, i.e., $2.5

PMT(TN) = Coupon Payment at Time N, i.e., 25 warrants

FV = Future Value/ Principal Value, i.e., $2.5

R = Market Interest Rate, i.e., 3%

N = Number of Periods, i.e., 9 years

P(T0) = (2.5x25) + 2.5 / (1+3%)9

P(T0) = 62.5 + 2.5 / (1+ 0.03)9

P(T0) = 65 / (1.03)9

P(T0) = 65 / 1.3048

P(T0) = 49.8 (or) 50

Hence, Tesco PLC can raise their capital upto $50 for every bond.

For question (b),

Given, Number of Period = 9 years

Number of warrants = 20

Par Value = $1000

Each warrant price = $2.5

To calculate Coupon Rate, the formula is Coupon Rate = (Total Annual Coupon Payment / Par Value) x 100%

Total Annual Coupon Payment = Periodic Payment x Number of Payments in years

Periodic Payment :

Payment for 1 month = 20 warrants x $2.5 = 50, hence Payment for 1 year = 50 x 12 = 600

Total Annual Coupon Payment = 600 x 9

Total Annual Coupon Payment = 5400

Coupon Rate = 5400 / 1000 x 100%

Coupon Rate = 5.4%