Prob Set 1 #15 pt 2

background data

14. You have an opportunity to purchase a corporate bond issued by Ford Motor Company with a face value of $1,000. It has 6 years left to maturity and has an 8% coupon rate, with interest paid semi-annually. If the current market interest rate for bonds with equivalent risk is 7.25%, what should you pay for the Ford bond?

Answer to Question 14:

Face Value = $1,000

Annual Coupon Rate = 8% Semiannual Coupon Rate = 4% Semiannual Coupon = 4% * $1,000 Semiannual Coupon = $40

Time to Maturity = 6 years Semiannual Period to Maturity = 12

Annual Interest Rate = 7.25% Semiannual Interest Rate = 3.625%

Current Price = $40 * PVIFA(3.625%, 12) + $1,000 * PVIF(3.625%, 12) Current Price = $40 * (1 - (1/1.03625)^12) / 0.03625 + $1,000 / 1.03625^12 Current Price = $40 * 9.59263 + $1,000 * 0.65227 Current Price = $1,035.98

So, maximum amount paid for Ford bond is $1,035.98

Question 15

15. Suppose that Fords credit rating has declined due to poor earnings and increased concerns among investors about Fords future profitability. The required return for bonds with Fords risk is now 19.5%. How much should you pay for the Ford bond?