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16-6. Solution:
Florida Investment Company
a. Present value of interest payments
Present value of principal payment at maturity
Total present value
× 58
(a)
N I/Y PV PMT FV
Answer: 885.30
7. Bond value (LO16-2) Cox Media Corporation pays an 11 percent coupon rate on
debentures that are due in 10 years. The current yield to maturity on bonds of similar risk is
8 percent. The bonds are currently callable at $1,110. The theoretical value of the bonds
will be equal to the present value of the expected cash flow from the bonds.
a. Find the market value of the bonds using semiannual analysis.
b. Do you think the bonds will sell for the price you arrived at in part a? Why?
16-7. Solution:
Cox Media Corporation
a. Present value of interest payments
Present value of principal payment at maturity
Total present value
b. No. The call price of $1,110 will keep the bonds from getting
much over $1,110. Since the bonds are currently callable,
(a)
N I/Y PV PMT FV
Answer: 1,203.85
8. Effect of bond rating change (LO16-2) The yield to maturity for 10-year bonds is as
follows for four different bond rating categories:
Aaa 9.40%........................... Aa2 10.00%
Aal 9.60%........................... Aa3 10.60%
The bonds of Falter Corporation were rated as Aaa and issued at par a few weeks ago.
The bonds have just been downgraded to Aa2. Determine the new price of the bonds,
assuming a 10-year maturity and semiannual interest payments. (Refer to “Semiannual
Interest and Bond Prices” in Chapter 10 for a review if necessary.)
16-8. Solution:
With a Aaa rating at issue, the coupon rate is 9.4 percent annually
Present value of interest payments
Present value of principal payment at maturity
Total present value
Total present value or price of the bond $962.71
N I/Y PV PMT FV
Answer: 962.61
9. Interest rates and bond ratings (LO16-2) Twenty-five-year B-rated bonds of Parker
Optical Company were initially issued at a 12 percent yield. After 10 years, the bonds have
been upgraded to Aa2. Such bonds are currently yielding 10 percent to maturity. Use Table
16-3 to determine the price of the bonds with 15 years remaining to maturity. (You do not
need the bond ratings to enter the table. just use the basic facts of the problem.)
16-9. Solution:
Parker Optical Company
Using Table 16-3:
10. Interest rates and bond ratings (LO16-2) A previously issued A2, 15-year industrial
bond provides a return three-fourths higher than the prime interest rate of 11 percent.
Previously issued A2 public utility bonds provide a yield of three-fourths of a percentage
point higher than previously issued A2 industrial bonds of equal quality. Finally, new
issues of A2 public utility bonds pay three-fourths of a percentage point more than
previously issued A2 public utility bonds.
What should be the interest rate on a newly issued A2 public utility bond?
16-10. Solution:
Interest rate on previously issued
11. Zero-coupon rate bond (LO16-2) A 17-year, $1,000 par value zero-coupon rate bond is to
be issued to yield 7 percent.
a. What should be the initial price of the bond? (Take the present value of $1,000 for 17
years at 7 percent, using Appendix B.)
b. If immediately upon issue, interest rates dropped to 6 percent, what would be the
value of the zero-coupon rate bond?
c. If immediately upon issue, interest rates increased to 9 percent, what would be the
value of the zero-coupon rate bond?
16-11. Solution:
a. PV of $1,000 for n = 17, i = 7%, PVIF = .317
c. PV of $1,000 for n = 17, i = 9%, PVIF = .231
(a)
N I/Y PV PMT FV
Answer: $317
(b)
N I/Y PV PMT FV
Answer: $371
(c)
N I/Y PV PMT FV
Answer: $231
12. Zero-coupon bond Yield (LO16-2) Assume a zero-coupon bond that sells for $403 and
will mature in 10 years at $1,250. What is the effective yield to maturity? (Compute PVIF
and go to Appendix B for the 10-year figure to find the answer, or compute FVIF and go to
Appendix A for the 10-year figure to find the answer. Either approach will work.)
16-12. Solution:
Using Appendix A for n = 10, the yield is approximately
12 percent.
N I/Y PV PMT FV
Answer: 12
13. Floating rate bond (LO16-2) You buy an 8 percent, 25-year, $1,000-par-value floating
rate bond in 1999. By the year 2004, rates on bonds of similar risk are up to 11 percent.
What is your one best guess as to the value of the bond?
16-13. Solution:
With a floating rate bond, the rate the bond pays changes with
14 Effect of inflation on purchasing power of bond (LO16-2) Seventeen years ago, the
Archer Corporation borrowed $6,500,000. Since then, cumulative inflation has been 65
percent (a compound rate of approximately 3 percent per year).
a. When the firm repays the original $6,500,000 loan this year, what will be the effective
purchasing power of the $6,500,000? (Hint: Divide the loan amount by one plus
cumulative inflation.)
b. To maintain the original $6,500,000 purchasing power, how much should the lender be
repaid? (Hint: Multiply the loan amount by one plus cumulative inflation.)
c. If the lender knows he will receive only $6,500,000 in payment after 17 years, how
might he be compensated for the loss in purchasing power? A descriptive answer is
acceptable.
16-14. Solution:
Archer Corporation
a. Loan amount/(1 + Cumulative inflation) =
c. Charge a high enough interest rate to not only provide an
A $10,725,000 loan repayment in a 65 percent cumulative
15. Profit potential associated with margin (LO16-2) A $1,000 par value bond was issued 25
years ago at a 12 percent coupon rate. It currently has 15 years remaining to maturity.
Interest rates on similar obligations are now 8 percent.
a. What is the current price of the bond? (Look up the answer in Table 16-3.)
b. Assume Ms. Bright bought the bond three years ago when it had a price of $1,050.
What is her dollar profit based on the bond’s current price?
c. Further assume Ms. Bright paid 30 percent of the purchase price in cash and borrowed
the rest (known as buying on margin). She used the interest payments from the bond
to cover the interest costs on the loan. How much of the purchase price of $1,050 did
Ms. Bright pay in cash?
d. What is Ms. Bright’s percentage return on her cash investment? Divide the answer to
part b by the answer to part c.
e. Explain why her return is so high.
16-15. Solution:
Ms. Bright
a. The original bond was issued at 12 percent.
b. $1,345.52 Current price
c. Purchase price $1,050.00
d.
Dollar profit $295.52
Purchase price paid in cash $315.00
93.82%
e. Ms. Bright has not only benefited from an increase in the
price of the bond (due to lower interest rates), but she also
16. Loss exposure and profit potential (LO16-2) A $1,000 par value bond was issued 20
years ago at a 9 percent coupon rate. It currently has five years remaining to maturity.
Interest rates on similar debt obligations are now 10 percent.
a. Compute the current price of the bond using an assumption of semiannual payments.
b. If Mr. Robinson initially bought the bond at par value, what is his percentage loss
(or gain)?
c. Now assume Mrs. Pinson buys the bond at its current market value and holds it to
maturity, what will her percentage return be?
d. Although the same dollar amounts are involved in part b and c, explain why the
percentage gain is larger than the percentage loss.
