Page 294 - AFM Integrated Workbook STUDENT S18-J19

Chapter 13

Illustration 2

Names Co is an A-rated, listed company, with some 5% coupon bonds in
issue.

The bonds have a nominal value of $100, and they are redeemable at a 7%
premium in four years’ time.

The risk free rate of interest is 3%, and the four year credit spread on A-rated
bonds is 50 basis points.

Required:

Estimate the value of each Names Co bond.

Solution

Yield on these bonds is 3% + 50 basis points = 3.50%

Therefore, bond value = PV of future receipts to the lender discounted at 3.50%

= ($5 × 4-year annuity factor at 3.50%) + ($107 × 4-year discount factor at 3.50%)

= ($5 × 3.674*) + ($107 × 0.872*)

= $111.67

* Note that these annuity/discount factors have been taken from tables as the
mid-point between the 3 year and 4 year figures. Calculating the factors from first
principles would have given a very similar answer.

Illustrations and further practice

Now try Illustrations 2, 3 and 4 in Chapter 13

282