Question

Your firm has a credit rating of A. You notice that the credit spread for five-year maturity A debt is 85 basis points (0.85%). Your firm’s five-year debt has a coupon rate of 6%. You see that new five-year Treasury notes are being issued at par with a coupon rate of 2.0%. What should the price of your outstanding five-year bonds be per $100 of face value?

Answer 1

The market price should be: $114.67

Step-by-step explanation:

the risk free rate is 2.00%

this firm has a spread of 0.85%

firm cost of debt 2.85%

The market will adjust the bond price so the yield ofthe bonds relfect this rate.

So we will calculate the present value of a coupon 100 with a 6% rate

We use the ordinary annuity for the coupon payment:

`C * (1-(1+r)^(-time) )/(rate) = PV\\`

Coupon payment: 100 face value x 3% bond rate = 3

time 10 (5 years with 2 payment per year)

market rate: 0.01425 (2.85%/2)

`3 * (1-(1+0.01425)^(-10) )/(0.01425) = PV\\`

PV $27.7768

and lump sum present value for the maturity:

`(Maturity)/((1 + rate)^(time) ) = PV`

Maturity 100

time 5

rate 0.0285

`(100)/((1 + 0.0285)^(5) ) = PV`

PV 86.89

Last, we add them to get the market price:

PV c $27.7768

PV m $86.8917

Total $114.6685