Final answer:
Valuing a proposed new issuance of corporate bonds involves calculating the present value of future cash flows, which includes interest payments and the principal, using a discount rate that reflects the market's required return. An increase in interest rates reduces the present value of a bond, aligning with investors' need for higher returns.
Step-by-step explanation:
Corporate Bond Valuation Model
To value a proposed new issuance of corporate bonds with a face value of 70 million dollars, we can use a valuation model based on the present value of future cash flows. This approach will consider both interest payments and the repayment of the principal. Take, for example, a simple two-year bond issued for $3,000 at an 8% interest rate. This bond will pay $240 in interest annually and the $3,000 principal at the end of the second year. If we consider a discount rate identical to the interest rate, the bond's present value would be equal to its face value.
However, if market interest rates rise to 11%, the same bond's present value must be recalculated using the new discount rate. In this situation, the future cash flows of the bond are discounted at a higher rate, which reduces the bond's present value. This shift reflects the higher return investors now require in the market due to changes in the interest rate environment. To find the present value, each future payment is divided by (1 + r)^n, where 'r' is the discount rate and 'n' is the number of periods until the payment will be received.
For the $70 million bond issue being considered, we can extend this present value calculation to a series of cash flows over the bond's lifetime. If the bond pays semi-annual or annual interest, each of these payments, as well as the final return of principal, must be discounted back to their present value at the market's current discount rate. The sum of these present values represents the bond's current market value.