Question

In: Finance

The fry company has a credit rating of B and 10 year semi annual 5% coupon...

The fry company has a credit rating of B and 10 year semi annual 5% coupon bonds. Current market yield until maturity on the bond is 7%.

1) What is the expected price of the bond?

2) What happens if it drops to a B rating?

3) Why did the price change with the credit rating of Fry company?

  

Solutions

Expert Solution

The price of bond can be calculated by use of discounting of cash flow method as

value of bond =

or by use of PV( ) function in excel.

Face Value $        100
Annual Coupon Rate 5.000%= 2.5% (semi annual)
Annual Required Return 7.000%
Years to Maturity 10.00
Payment Frequency               2
Coupon 5% * 100 = $ 5 , $ 2.5(semi annual)
Value of Bond $     85.79 = -PV(3.5%,20,2.5,100)

answer 1) Expected price of Bond = 85.79 % of face value

Answer 2) it drops to a B rating,

There will be no change in price of bond as the above calculation in based on rating of 'B" .

Answer 3) The price of bond varies according to involvement of risk in bond. The price of bond change with change in credit rating ,  as the amount default risk changes with change in credit rating


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