1. Bond Valuation & Refunding Britterby Ltd has an outstanding perpetual bond with a 7 percent coupon rate. The (a) bonds make semi-annual coupon payments. There is a 50 percent chance that the interest rate in one year will be 9 percent, a 30 percent chance that the interest rate will be 5 percent and a 20 percent chance that the interest rate will be 3 percent. If the one-year interest rate is, at present, 6 percent: Required: (i) What is the current price of the bond if there is no call provision? (ii) What is the current price of the bond if it can be called in one year and the call premium is set at $120 over par value? (b) The total principal value of Clatterbridge Ltd bonds is $165 million, and the bonds have an annual coupon rate of 6 percent. The total cost of refunding would be 8 percent of the principal amount raised. The appropriate tax rate for the company is 30 percent. Assume the bonds were issued at par value and that coupons are paid annually. Required: How low does the market interest rate need to drop to justify refunding with a new bond issue?
1. Bond Valuation & Refunding Britterby Ltd has an outstanding perpetual bond with a 7 percent coupon rate. The (a) bonds make semi-annual coupon payments. There is a 50 percent chance that the interest rate in one year will be 9 percent, a 30 percent chance that the interest rate will be 5 percent and a 20 percent chance that the interest rate will be 3 percent. If the one-year interest rate is, at present, 6 percent: Required: (i) What is the current price of the bond if there is no call provision? (ii) What is the current price of the bond if it can be called in one year and the call premium is set at $120 over par value? (b) The total principal value of Clatterbridge Ltd bonds is $165 million, and the bonds have an annual coupon rate of 6 percent. The total cost of refunding would be 8 percent of the principal amount raised. The appropriate tax rate for the company is 30 percent. Assume the bonds were issued at par value and that coupons are paid annually. Required: How low does the market interest rate need to drop to justify refunding with a new bond issue?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:1. Bond Valuation & Refunding
(а)
Britterky Ltd has an outstanding perpetual bond with a 7 percent coupon rate. The
bonds make semi-annual coupon payments. There is a 50 percent chance that the
interest rate in one year will be 9 percent, a 30 percent chance that the interest rate
will be 5 percent and a 20 percent chance that the interest rate will be 3 percent.
If the one-year interest rate is, at present, 6 percent:
Required:
(i)
What is the current price of the bond if there is no call provision?
(ii)
What is the current price of the bond if it can be called in one year and the
call premium is set at $120 over par value?
(b) The total principal value of Clatterbridge Ltd bonds is $165 million, and the bonds
have an annual coupon rate of 6 percent. The total cost of refunding would be 8
percent of the principal amount raised. The appropriate tax rate for the company
is 30 percent. Assume the bonds were issued at par value and that coupons are
paid annually.
Required:
How low does the market interest rate need to drop to justify refunding with a new
bond issue?
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