Question

Five Star Co. wants to issue new 20-year bonds for an expansion project. The company currently has 5% (annual coupon rate) coupon bonds on the market. This existing bond was issued 5 years ago and the original term to maturity was 25 years. Currently, this bond is selling at par and makes semiannual payments. The par value of bonds is $1,000. If the company wants to sell its new bonds for 120% of the par value, what should the coupon rate be for new bonds? Suppose that the par value of new bonds is also $1,000.

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

B 20 Existing Bond Years until maturity Annula coupon rate Par value Current price when Bond sells at par then YTM = Coupon rate Thus, YTM 5% $1,000.00 $1,000.00 $1,000.00 20 $1,200.00 5% New Bond Par value Years until maturity Sell Price YTM New Bond should have same YTM as existing Bond because both have same years until maturity and credit rating (same company) Coupon frequency in a year Coupon amount in each period $32.97 Thus, 20 Annual Coupon rate 6.59%

Cell reference -

в Existing Bond Years until maturity Annula coupon rate Par value Current price when Bond sells at par then YTM = Coupon rate Thus, YTM 20 0.05 1000 1000 0.05 1000 20 14 =C12*120% =C4 15 New Bond Par value Years until maturity Sell Price YTM New Bond should have same YTM as existing Bond because both have same years until maturity and credit rating (same company) Coupon frequency in a year Coupon amount in each period Thus, Annual Coupon rate 17 =PMT(C15/2, C13*2,-C14,C12,0) 20 =(C18*2)/012 23

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.