Discuss the relationship between the coupon rate (original interest rate at time of issue) on a bond and its security provisions.© BrainMass Inc. brainmass.com October 16, 2018, 7:35 pm ad1c9bdddf
The higher the security provisions (such as A), the lower is the coupon rate. This is because people with ...
The solution discusses the relationship between the coupon rate (original interest rate at time of issue) on a bond and its security provisions.
Finance: Cash flow, payback method, IRR, secured debt, bond yields, zero coupon
Also see attached file for problems
Text Questions and Exercises - WEEK 3
Prepare answers to the following questions and exercises from the text: Foundations of Financial Management -
Chapter 12: 1, 4, 8, 9
Chapter 16: 4, 5, 10
1. Assume a corporation has earnings before depreciation and taxes of $90,000, depreciation of $40,000, and that it is in a 30 percent tax bracket. Compute its cash flow using the format below.
Earnings before depreciation and taxes ___
Earnings before taxes ___
Taxes @ 30% ___
Earnings after taxes ___
Cash flow ___
1. Assume a $40,000 investment and the following cash flows for two alternatives.
Year Investment X Investment Y
1 $ 6,000 $15,000
2 8,000 20,000
3 9,000 10,000
4 17,000 ?
5 20,000 ?
Which of the alternatives would you select under the payback method?
Internal Rate of return
8. You buy a new piece of equipment for $16,980, and you receive a cash inflow of $3,000 per year for 12 years. What is the internal rate of return?
Internal Rate of Return
9. Warner Business Products is considering the purchase of a new machine at a cost of $11,070. The machine will provide $2,000 per year in cash flow for eight years. Warner's cost of capital is 13 percent. Using the internal rate of return method, evaluate this project and indicate whether it should be undertaken.
Secured vs. unsecured debt
2. Match the yield to maturity in column 2 with the security provisions (or lack thereof) in column 1. Higher returns tend to go with greater risk.
1. Security Provision 2. Yield to Maturity
a. Debenture a. 6.85%
b. Secured debt b. 8.20%
c. Subordinated debenture c. 7.76%
3. The Southeast Investment Fund buys 70 bonds of the Hillary Bakery Corporation through its broker. The bonds pay 9 percent annual interest. The yield to maturity (market rate of interest) is 12 percent. The bonds have a 25-year maturity. Using an assumption of semiannual interest payments:
1. Compute the price of a bond (refer to "semiannual interest and bond prices" in Chapter 10 for review if necessary).
2. Compute the total value of the 70 bonds.
Zero coupon bond values
A 15-year, $1,000 par value zero-coupon rate bond is to be issued to yield 10 percent.
1. What should be the initial price of the bond? (Take the present value of $1,000 to be received after 15 years at 10 percent, using Appendix B at the back of the text.)
2. If immediately upon issue, interest rates dropped to 8 percent, what would be the value of the zero-coupon rate bond?
3. If immediately upon issue, interest rates increased to 12 percent, what would be the value of the zero-coupon rate bond?