Final answer:
To set the coupon rate for new bonds to sell at par, BDJ Co. must calculate the yield to maturity of its current bonds that sell for $1,134, and use this as the coupon rate for the new bonds. The coupon rate must be set so that it reflects the market's required return, accounting for bond pricing's reaction to changes in market interest rates.
Step-by-step explanation:
To determine the coupon rate BDJ Co. should set on its new bonds to ensure they sell at par, we need to calculate the yield to maturity (YTM) on the company's current bonds that are selling for $1,134. Since these bonds have an 18-year maturity and a 9.4% coupon rate with semiannual payments, we can solve for YTM, which represents the discount rate at which the present value of all future payments would equal the current price of the bond. This YTM would then be the coupon rate for the new bonds to sell at par because investors would be indifferent between the bonds if they provide the same return.
Likewise, it’s important to understand how bond pricing works. When market interest rates rise, existing bonds with lower coupon rates become less attractive, and their prices drop below face value to yield a comparable return to the newer, higher-interest bonds being issued. Conversely, when market interest rates fall, existing bonds with higher coupon rates are more attractive, and they sell for more than their face value.
In summary, the coupon rate for the new bonds that would allow them to sell at par would be equal to the YTM of the current bonds that are priced above par, indicating a coupon rate that is higher than the prevailing market interest rates.