Question

A firm with an AA-rating plans to issue one million units of a 10 year-4% bond with face value $100. After the financial crisis this firm is downgraded to a B-rating. The yield curve increases 0.2% per year. The yield for year 1 is yı=1%, for year 2 is y2=1.2%, y3=1.4% and so on and y10=2.8%. The default spreads are given in the table below. (a) What is the initial amount (before downgrading) the firm wants to raise? [2p] How much can this now B-rated firm raise? [2pl mo If the firm wants to raise the planned amount, how many more bonds does it issue? [3p] 1) What is the additional interest payment per year the firm has to pay? [3p] What Rating Default spread AAA AA A+ A- BBB BB+ BB 0.20% 0.40% 0.60% 0.80% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.50% 8.00% 10.00% 12.00% 20.00% B+ B- CCC

Answer 1

SOLUTION:-

1.80% 2.00% 2.20% 2.40% 2.60% 2.80% 10 104 4 4 4 4 Yield 1% 1.20% 1.40% 1.60% Year 0 1 2 3 4 Payments 4 4 4 4 Before Downgrade Credit spread 0.40% Effective rates 1.4% 1.6% 1.8% 2.0% PV 3.94 3.88 3.79 3.70 Sum 107.88 One million units issued, so the initial amount raised is 2.2% 3.59 2.4% 3.47 2.6% 3.34 2.8% 3.21 3.0% 3.07 3.2% 75.90 107,877,780.8 After downgrade 5.5% Credit spread 3.50% Effective rates 4.5% 4.7% 4.9% PV 3.83 3.65 3.47 Sum 84.26 One million units issued, so the company can raise 5.1% 3.28 5.3% 3.09 5.7% 2.71 5.9% 2.53 6.1% 2.35 6.3% 56.45 2.90 84,255,498.2 To raise 107,877,780.8, the company will have to issue 1,280,364.88 bonds, which is 280,364.88 more than the planned amount Additional interest payment per year will be 1,121,459.52

(a) What is the initial amount ( before downgrading) the firm wants to raise = 107,877,780.8

(b) How much can this now B-rated firm praise. = 84,255,498.2

(c) If the firm wants to raise the planned amount,how many more bonds does it true? = 280,364.88

(d) What is the additional interest payment per year the firm as to pay? = 1,121,459.52