Question

Your firm has a credit rating of BBB. You notice the credit spread for 5yr maturity BBB debt is 1.1% or 110 basis points. Your firm's 5yr debt has a coupon rate of 6% with annual payments. You see that new 5yr Treasury bonds are being issued at par with a coupon rate of 2.6%. What should the price of your outstanding 5yr bonds be per $100 face value?

a. $110.33.b. $115.75.c. $123.71.d. $112.54.

Answer 1

Bond Price = $110.3260609 rounded off to $110.33

Option A is the correct answer.

Step-by-step explanation:

To calculate the price of the bond today, we will use the formula for the price of the bond. We assume that the interest rate provided is stated in annual terms. As the bond is an annual bond, the coupon payment, number of periods and annual interest rate in the market will be,

Coupon Payment (C) = 100 * 0.06 = $6

Total periods (n) = 5'

i or market interest rate = 2.6% + 1.1% = 3.7%

We use the market interest rate for BBB rated bonds in the calculation. The market rate can be found by taking the risk free rate and adding the credit spread for BBB rating bond in this case. The market rate comes out to be 3.7%

The formula to calculate the price of the bonds today is attached.

Bond Price = 6 * [( 1 - (1+0.037)^-5) / 0.037] + 100 / (1+0.037)^5

Bond Price = $110.3260609 rounded off to $110.33