Question

1. Consider a corporation who recently filed Chapter 11 bankruptcy (reorganization). Under the reorganization, the company has been allowed to reorganize their debt structure with a consolidated new deferral bond issue with more favorable terms. The new issue will be a 40- year, 12% coupon rate bond with semiannual coupons. However, under the bond indenture, the company is relieved of making interest payments (deferred interest) for the first 10 years. For the remaining 30 years, the regular interest payments would resume. The reorganization calls for the deferred interest to be paid in 3 equal installments: one payment occurring at the end of year 20, one at the end of year 25, and one at maturity.

   Calculate the value of a new $1,000 par value bond assuming a yield to maturity of 7%.

Answer 1

To calculate Price of a $1000 Par value bond, present value of all interest payments, deferred interest payments and maturity amount shall be calculated. Present value of all payments shall be value of bond.

All interest coupon and maturity amount shall get discounted with YTM to calculate Present Value of all interest payment and maturity amount.

Annual Coupon = 12 % coupon rate paid semi annually

Interest per 6 months = 12*6/12 = 6%

Interest paid (1000*6%) = $60

Yield to Maturity = 7%

Semi-annual payment made. So YTM will also be for 6 months = 7*6/12 = 3.5%

Time period shall also double. As payment is semi-annual.

Interest is deferred for 10 Years

Total interest deferred = 1000* 12/100*10 years = 1200

Deferred Interest will be paid in 3 instalments.

Per Instalment interest paid (1200/3) = 400

Now, we calculate present value of all payments.

Calculation of Present Value of Bond

Regular interest payments resume from 11th year

Interest paid per semi-annual coupon - 60

((For, first 20 periods (10 years * 2 semi-annual) Interest payment is nil.),

So, Present Value is 0.

Interest is semi-annual. So interest paid - 60

Cumulative P.V.F. @ 3.5% for 21st to 80th periods = 12.5364

Present value of regular interest payments (60 * 12.5364) = $ 752.18

At year 20, deferred interest instalment paid - 400

P.V.F. @ 3.5 % for 40th period - 0.2526

Present value of payment (400*0.2526) = $101.04

At year 25, deferred interest instalment paid - 400

P.V.F. @ 3.5 % for 50th period - 0.1791

Present value of payment (400*0.1791) = $71.64

At maturity means at 40 years, deferred interest instalment paid – 400

P.V.F. @ 3.5 % for 80th period - 0.0638

Present value of payment (400*0.0638) = $25.52

Total present value of payments = Value of bond = $950.38

So, Value of bond is $950.38.