QUESTION 15

KIC Inc. plans to issue $5 million of bonds with a coupon rate of 8 percent and 30 years to maturity. The coupons are paid semiannually and the current market interest rate on these bonds is 7 percent. In one year, the interest rate on the bonds will be either 10 percent or 6 percent with equal probability. Assume investors are risk neutral. If the bonds are non-callable, what is the price of the bonds today? If the bonds are callable one year from today at $1, 080, will their price be greater than or less than the price you computed in (a)? Why? Margret Kimberly, CFO of Georgia Strait Associates, is considering whether or not to refund the two currently outstanding corporate bonds of the firm. The first one is a 7 percent perpetual bond with a $1,000 face value with $125 million outstanding. The second one is an 8 percent perpetual bond with the same face value with $132 million outstanding. The call premiums for the two bonds are 7.5 percent and 8.5 percent of the face value, respectively. The transaction costs of the refundings are $11.5 million and $13 million, respectively. The current interest rates for the two bonds are 6.25 percent and 7.1 percent, respectively. The tax rate is 35 percent. Which, if either, bond should Margret recommend be refunded? What is the NPV of the refunding? Some Different Types of Bonds What is a junk bond? What are some of the controversies created by junk-bond financing? Describe the following types of bonds