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A bond's credit rating provides a guide to its risk. Long-term bonds rated Aa currently offer yields to maturity of 8.2%. A-rated bonds sell at yields of 8.5%. Assume a 10-year bond with a coupon rate of 7.7% is downgraded by Moody's from Aa to A rating.

a. Calculate the initial price. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Initial price \$

b. Calculate the new price. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

New price \$

#### Solution Preview

(a) You can PV function in Excel to compute the initial price...

Assume face value ...

#### Solution Summary

The solution uses excel function to compute bond price after a downgrade from Moody's.

\$2.19
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## Price of bonds, purchasing power & revised lease payments

1. The yield to maturity for 15 year bonds is as follows for four different bond rating categories.
Aaa 9.4%...........................Aa2 10.0%
Aa1 9.6%..........................Aa3 10.2%
The bonds of Falter Corporation were rated as Aa1 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 15-year maturity and semiannual interest payments.

2. Twelve years ago, the Archer Corporation borrowed \$6,000,000. Since then, cumulative inflation has been 80 percent (a compound rate of approximately 5 percent per year).
a) When the firm repays the original \$6,000,000 loan this year, what will be the effective purchasing power of the \$6,000,000? (Hint: Divide the loan amount by one plus cumulative inflation.)
b) To maintain the original \$6,000,000 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 \$6,000,000 in payment after 12 years, how might he be compensated for the loss in purchasing power? A descriptive answer is acceptable.

3. The Hardaway Corporation plans to lease a \$900,000 asset to the O'Neill Corporation. The lease will be for 10 years.
a) If the Hardaway Corporation desires a 12 percent return on its investment, how much should the lease payments be?
b) If the Hardaway Corporation is able to take a 10 percent deduction from the purchase price of \$900,000 and will pass the benefits along to the O'Neil Corporation in the form of lower lease payments (related to the Hardaway Corporation lower initial net cost), how much should the revised lease payments be? Continue to assume the Hardaway Corporation desires a 12 percent return on the 10 year lease.

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