Jackson Corporation sources and distributes pharmaceutical products in the United States and internationally. Its pharmaceutical distribution segment distributes brand-name and generic pharmaceuticals, over-the-counter healthcare products, home healthcare supplies, and equipment, outsourced compounded sterile preparations, and related services to various healthcare providers. The company wants to raise long-term debt of $10 million for research and development by issuing corporate bonds. The financial manager of the company, Chris Doughman, MBA is working with First Investment Bank to issue the bonds. The investment bank is providing consulting and advisory services to Jackson Corporation. Chris must make presentations to the investment banking firm to enable it to get the information needed to prepare the bond indenture.

Chris stated in the presentation that the bond would have 15 years to maturity, interest would be paid annually, and the bonds would have $1,000 par value. The coupon interest rate, according to Chris, would be determined using the following equation: rd= r* + IP + MRP + DRP + LP, where rd is quoted market interest rate, r* is the real risk-free rate, IP is inflation premium, MRP is maturity risk premium, DRP is default risk premium, and LP is liquidity premium. Chris has gathered the following data:

Characteristic

Bond

Time to maturity

15 years

Real risk-free rate

2.00%

Inflation premium

2.20%

Maturity risk premium

2.50%

Default risk premium

2.40%

Liquidity premium

0.90%

1. Calculate the quoted market interest rate for the corporate bond using the equation.

2. Using the market interest rate calculated above, determine the coupon payment i.e., the dollar amount to be paid every year to bondholders.

3. First Investment Bank is using the answers presented in questions 1 and 2 to value the bond. Calculate the present value of the bond if the yield to maturity is 10%.

4. Suppose that three years later Jackson Corporation’s bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 9%. Calculate the current market price of the bond.

5. Another company, Charter Corporation has issued 2,500 debentures with a face value of $1,000. The bonds have 10 years to maturity. The bonds have a coupon interest rate of 8% that is paid semiannually. What dollar amount of interest per bond can an investor expect to receive every 6 months?

6. Charter Corporation bonds have 10 years remaining to maturity. The bonds have a face value of $1,000 and a yield to maturity of 9%. The coupon rate is 8% that is paid semiannually.

i. Calculate the selling price of this debenture

ii. Calculate the current yield of this debenture.

7. Kahiki’s Foods Inc. corporate bonds have 10 years remaining to maturity. The bonds have a face value of $1,000, and a coupon rate of 10%. The company pays $100 interest per bond annually. The present value of the bond is $900. The bond is a callable bond. Calculate the yield to maturity of the bond (note: PV is negative because it is a cash outflow, i.e., it costs $900 to purchase the bond).

8. Some bondholders of Kahiki Foods do not understand the difference between yield to maturity and yield to call on callable bonds. Explain to them the difference between yield to maturity and yield to call.

9. Describe the following types of bonds:

i. debentures

ii. convertible bonds

iii. junk bonds

iv. callable bonds

10. Jackson’s corporate bonds are being reviewed by some credit rating agencies. Rating agencies do a good job of measuring the average credit risk of bonds and providing information to lenders whenever there is a significant change in the credit quality of bonds. One of the credit rating agencies, Moody’s Investor Services has downgraded Jackson’s bonds rating from Aa to Baa. Identify three factors that might have contributed to the low ratings of Jackson’s bonds.

Answer rating: 100% (QA)

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