Question

1a. The bond’s price increases.

b. The bond is downgraded by the rating agencies.

c. A change in the bankruptcy code makes it more difficult for the bondholders to receive payments in the event the firm declares bankruptcy.

d. The economy seems to be shifting from a boom to a recession.

e. Investors learn that the bonds are subordinated to another debt issue.

2. Yield to Maturity (YTM). Findlay Industries bonds have 6 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 10%. (5 points)

a. What is the YTM at a current market price of $865? (HINT: use Excel function, =RATE).

b. Would you pay $865 for this bond if you thought that the fair market interest rate was 12%? YES or NO.

Answer 1

1a. The market price of the bond will rise when the demand for bonds will rise. The demand for the bonds will rise when the economy will shift from boom to a recession as during times of recession, the bond holders will be paid a fixed amount as coupon payments.

Rest for all the other reasons the bond price would be fallen. As if debt is subordinated, the attractiveness of the bond falls, downgraded bond is more likely to default as the price would have fallen.

So, the correct option is option D.

2. The YTM of the bond can be calculated with the help of a financial calculator,

The face value of the bond (FV) = $1000

The coupon payments will be: 10% * $1000

= $100

N = 6 years

PV = ( $865)

So, the YTM of the bond is :

= 13.4163

Yes, I would have invested in these bonds. While investing in these bonds ,I would have earned a rate of return of 13.4163 while the market interest rate is 12%.

Another reson I would say yes to but this bond is : At market interest rate of 12%, the bond will would be higher at $917.77 , so as the price of the bond would be higher, the investor would perceive it as the bond is available at a discount. Hence, the investor would buy it.