Question

Could this be solved without excel?

Acme Chemical, Inc. is a major manufacturer of chemical products for the agricultural industry, including pesticides, herbicides and other compounds. Due to a number of law suits related to toxic wastes, Acme Chemical has recently experienced a market re-evaluation of its common stock. The firm also has a bond issue outstanding with 10 years to maturity and an annual coupon rate of 5 percent, with interest paid semi annually. The required nominal market annual interest rate on this bond has now risen to 10 percent due to the high risk level associated with this firm. The bonds have a par or face value of $1,000.

1. Label each of the variables that you would use to determine the value of this bond in the market today:

N (time periods until maturity) =

PMT (periodic interest payment) =

I per (periodic market interest rate) =

FV (future value to be received when the bond matures) =

2. Based on the variables that you have identified in Question #1, what is the market value today (the present value or PV) of one of Acme Chemical’s bonds?

3. After five years of judicial appeals, Acme Chemical emerges victorious in the toxic waste law suits. This provides a positive signal to the market and the market rate of interest (r d ) applicable to Acme Chemical’s bonds declines to 6 percent. Assume that there are now 5 years remaining until maturity.

a. Label each of the variables that you would use to determine the new value of this bond in the market:

N (time periods until maturity) =

PMT (periodic interest payment) =

I per (periodic market interest rate) =

FV (future value to be received when the bond’s mature) =

b. Based on the variables that you have identified in Question #3.a., what is the new market value (the present value or PV) of one of Acme Chemical’s bonds, following their victory in appeals court?

4. Why do you suppose that the market value of Acme Chemical’s bonds has risen following the firm’s victory in appeals court?

Answer 1

1.

N (time periods until maturity) = 10 years * 2 time per year (every six months) = 20

PMT (periodic interest payment) = Annual coupon/2 = $1000*5%/2 = $25

I per (periodic market interest rate) = 10%/2 = 5% =0.05

FV (future value to be received when the bond matures) = $1000

2. PV of the bond = PMT/I*(1-1/(1+I)^N)+ FV/(1+I)^N

=25/0.05*(1-1/1.05^20)+1000/1.05^20

=$688.44

3 a)

N (time periods until maturity) = 5 years * 2 time per year (every six months) = 10

PMT (periodic interest payment) =Annual coupon/2 = $1000*5%/2 = $25

I per (periodic market interest rate) =6%/2 = 3% =0.03

FV (future value to be received when the bond’s mature) = $1000

b) New market value or

PV of the bond = PMT/I*(1-1/(1+I)^N)+ FV/(1+I)^N

=25/0.03*(1-1/1.03^10)+1000/1.03^10

=$957.349

4. The market price of the bond has increased following the victory because the bond has become more attractive leading to a decline in the market interest rate demanded from this bond . This attractiveness has also caused an increase in the bond price

It may be noted that the bond price will keep on increasing slowly to $1000 (face value) with time as the bond matures. However, due to decline in the interest rates , the bond prices have increased drastically.