Question

Kebt Corporation's Class Semi bonds have a 12-year maturity and an 8.50% coupon paid semiannually (4.25% each 6 months), and those bonds sell at their $1,000 par value. The firm's Class Ann bonds have the same risk, maturity, nominal interest rate, and par value, but these bonds pay interest annually. Neither bond is callable. At what price should the annual payment bond sell?

Answer 1

Since the bond is selling at par, the its nominal yield to maturity is equal to its coupon rate, which is 8.50%. Since, this bond pays semiannual coupons the effective market rate of interest can be calculated as follows: ( Nominal rate Effective annual rate = 1+- -1 2 -1 ( 8.5% =11+- 2 = 8.6806% Therefore, the effective annual market yield is current 8.6806%. Use this yield to compute the price of the annual coupon bond as follows: A 1 Nominal annual yield 2 Effective annual yield 3 Face value 4 Coupon rate 5 Maturity (years) 6 Price 8.50% 8.68% $1,000 8.50% 12 $986.86 Therefore, the price of annual bond is $986.86 The formula sheet is shown below: A B 1 Nominal annual yield 2 Effective annual yield Face value 4 Coupon rate 5 Maturity (years) 6 Price 8.50% =(1+B1/2)^2-1 $1,000 8.50% 12 --PV(B2,B5, B4%B3,B3)