THX, Inc. has been manufacturing high-end sound systems for 35 years. 19 years ago, they issued 10,000 20-year bonds, each with a face value of $1,000. The bonds promise a 9% annual coupon. The face value and final coupon payment are due in exactly one year. The bonds have a beta of 0.10 and information from the credit rating agencies indicates that the bonds have a 3% chance of defaulting. In the event of default, investors are expected to recover 56% of the amount due to them (i.e., 56% of the coupon payment and face value due to them). The market risk premium and risk-free rate are both 5%. a. What is the opportunity cost of debt (i.e., discount rate) for these bonds? b. What price should these bonds sell for in the market? c. What should the YTM be on these bonds? d. Is the expected return on these bonds equal to their YTM? Why or why not? e. Your colleague at work looks at this bond and says that a 9% coupon rate is unheard of these days. She says this means that investors get 9% annual return from an investment in these bonds. Is she correct? Why or why not?

Answer rating: 100% (QA)

a The opportunity cost of debt or the discount rate for these bonds can be calculated using the Capital Asset Pricing Model CAPM The formula for CAPM ... View the full answer