To help ease a continuing need for financing, the Consolidated Chemical Company is considering borrowing from insurance companies through a so-called "private placement" of bonds in addition to issuing bonds in public debt markets. The company must choose between transactions suggested by two different insurance companies. In both transactions, Consolidated Chemical would receive $10,000,000 up front in exchange for issuing a bond promising a single (larger) maturity payment from Consolidated Chemical in 15 years at a promised interest rate. The two options open to Consolidated Chemical are as follows: 4.  A.   A. A 15-year bond to Pru-Johntower Life Insurance Company, promising an annual rate of interest of 10%; A 15-year bond to Tom Paine Mutual Life Insurance Company, promising a rate of interest of 9.72% per year, compounded monthly. 

A- What is the effective annual yield to maturity on each of the bonds? 

B-What is the future required payment that Consolidated Chemical will make 15 years later on each bond? The Treasurer of Consolidated Chemical also explored with each insurance company the possibility of selling an identical dollar amount of 15-year bonds that would make regular semi-annual coupon payments each year and $10 million principal repayment at maturity rather than a single lump-sum payment. It was discovered in each case that the insurance company would require an effective annual yield on ordinary coupon bonds of equivalent default risk that was 50 basis points (i.e., 0.50%) higher than the effective annual yields on the bonds with no coupons. 

C-What might explain why the insurance companies would require a slightly higher effective annual yield on the coupon bonds compared to the bonds with no coupons. 

Answer rating: 100% (QA)

Effective Annual Yield and Future Payment A Effective Annual Yield PruJohntower Life Insurance Compa... View the full answer