Question

Use the following information for this question:

Rating Yield

AAA 4.50%

AA   5.00%

BBB 7.00%

Your company is rated “AA” and has 5 year bonds with semi-annual coupons. If the coupon on your bonds is 6.0%, what price must they trade at if par value is $100?

Answer 1

Since the yield for AA rated corporate bonds is 5%, the YTM to be applied
for bond valuation is 5%
Tenor of bonds = 5 years
Interest paid semi-annually, hence no. of periods = 5 years x 2 = 10 periods
Interest per period = 6%/2 = 3%		Interest amt = 100 * 3% = 3
DF @ 5% per year = 5%/2 = 2.5% per period

To arrive at the Market value of the bond, discount the cash flows from the bond at the YTM (which is 5% p.a.)

Cash flows of the bond will be interest received based on the coupon rate on the par value of the bond plus the par value of the bond at the end of 5 years

Calculations below :

Compounding period	Cash Flow	DF @ 2.5%	Cash flow x PV
1	3	0.976	2.93
2	3	0.952	2.86
3	3	0.929	2.79
4	3	0.906	2.72
5	3	0.884	2.65
6	3	0.862	2.59
7	3	0.841	2.52
8	3	0.821	2.46
9	3	0.801	2.40
10	3	0.781	2.34
10	100	0.781	78.12
Total PV of cashflows or MV of the bond	104.38

The bond should be trading at $104.38