a) A bond of 10 years maturity is left with 8 years to maturity today. Its...

a) A bond of 10 years maturity is left with 8 years to maturity today. Its coupon rate is 10%, paying annual coupon with par value of $1,000. What is the price of the bond today if the yield to maturity is 8%? Is it a premium bond or discount bond?
b) Recently, a 30-year corporate bond issued by Liz Co. has been downgraded by a credit rating agency from AAA to B. Other things being constant, what would you expect to happen to the price and yield of the bond as a consequence of the downgrade?

Solutions

Expert Solution

a) Price of the Bond = $1,114.93
The bond is a premium bond as the market price of the bond > face value of the bond

b) I expect the price of the bond to decrease as well as the yield on the bond to increase as the price of the bond is inversely related to the yield of the bond
The financials of Liz Co. would have deteriorated and that is why its credit rating would have been downgraded. Since the company would face difficulties in obliging its debt (due to financial deterioration) and there would be a risk of default also. Hence, on the secondary market, there would be very less number of buyers of the bond and many of the bondholders would want to sell off this bond. Since the supply is more than the demand, therefore, the price of the bond will fall down and hence the yield will also increase.
Also, to compensate for the credit default risk, the new buyers of the bond will demand for yield as a compensation for taking this risk and hence this will lead to decrease in the price of the bond.

jeff jeffy answered 1 year ago

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