Question

A 7-year bond of a firm in severe financial distress has a coupon rate of 12% and sells for $960. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to reduce coupon payments on the bond to one-half the originally contracted amount. The firm can handle these lower payments. What are the stated and expected yields to maturity of the bonds? The bond makes its coupon payments annually. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Answer 1

State Yield 12.9%

Expected Yield 8.8%

Step-by-step explanation:

Yield to maturity is the annual rate of return that an investor receives if a bond bond is held until the maturity. It is the long term yield which is expressed in annual term.

Use Following Formula to calculate YTM

P = C×(1 + r) -1 + C×(1 + r) -2 + . . . + C×(1 + r) -Y + B×(1 + r) -Y

As per given data

Face value = B = $1,000

Coupon payment = C = $1,000 x 12% = $120

Selling price = P = $960

Number of periods = Y = 7 years

Stated Yield

$960 = $120 × (1 + r) -1 + $120 × (1 + r) -2 + $120 × (1 + r) -3 + $120 × (1 + r) -4 + $120 × (1 + r) -5 + $120 × (1 + r) -6 + $120 × (1 + r) -7 + $1,000 × (1 + r) -7

$950,39 = [ $120 ( × (1 + r) -28 ] + [ $1,000 × (1 + r) -7]

r = 12.9%

Expected Yield

Revised Coupon Rate = 12% / 1.5 = 8%

Coupon Payment = $1,000 x 8% = $80

P = C×(1 + r) -1 + C×(1 + r) -2 + . . . + C×(1 + r) -Y + B×(1 + r) -Y

$960 = $80 × (1 + r) -1 + $80 × (1 + r) -2 + $80 × (1 + r) -3 + $80 × (1 + r) -4 + $80 × (1 + r)-5 + $80 × (1 + r) -6 + $80 × (1 + r) -7 + $1,000 × (1 + r) -7

$950,39 = [ $80 ( × (1 + r) -28 ] + [ $1,000 × (1 + r) -7]

r = 8.79%