Question

You own 100 bonds that have 8 years remaining to maturity, an annual coupon payment of $80, and a par value of $1,000. Unfortunately, the issuer is on the brink of bankruptcy. The creditors, including yourself, have agreed to postpone the next 4 interest payments (otherwise, the next interest payment would have been due in 1 year). The remaining interest payments, for Years 5 through 8, will be made as scheduled. The postponed payments will accrue interest at an annual rate of 6%, and they will then be paid as a lump sum at maturity (8 years from now). The required rate of return on these bonds, considering their substantial risk, is now 28%. What is the present value of each bond?

Answer 1

Year	CF	Deferred	FV(Def)	Total CF
1	$             -	$   80.00	$ 120.29	$             -
2	$             -	$   80.00	$ 113.48	$             -
3	$             -	$   80.00	$ 107.06	$             -
4	$             -	$   80.00	$ 101.00	$             -
5	$      80.00	$          -	$          -	$      80.00
6	$      80.00	$          -	$          -	$      80.00
7	$      80.00	$          -	$          -	$      80.00
8	$ 1,080.00	$          -	$ 441.83	$ 1,521.83
			PV	$266.88

Calculate the future value of deferred coupons and sum it up to calculate the lump sum of deferred coupon payment at maturity.

Total Payment in year 8 = 1080 + 441.83 = $1,521.83

PV of each bond = 80 / (1 + 28%)^5 + 80 / (1 + 28%)^6 + 80 / (1 + 28%)^7 + 1521.83 / (1 + 28%)^8 = $266.88