Question

Suzy owns a corporate bond that matures in five years. She has determined that by investing all of the future proceeds from the coupon payments at her current required return, she will have exactly enough money to purchase a $1,200 vacation package at the end of five years. Due to the COVID-19 outbreak, the company announces that all coupon payments will be delayed by one year so that the bond will mature in six years. All else equal, if her payments are delayed by one year, will Suzy be able to afford the $1,200 vacation in six years and how much money will she have accumulated? Yes, Suzy will have even more than $1,200 when the bond matures No, Suzy will have less than $1,200 in present value terms No, Suzy will have less than $1,200 when the bond matures Yes, Suzy will still have exactly $1,200 when the bond matures

Answer 1

As per original bond features, bond had 5 coupons and a principal at end of 5th year to receive the principal. The future value of cashflows which are reinvested at the current rate will give a benefit of 1200.

1200 C+P 3 4

However due to the outbreak, all the coupons are moved ahead by 1 year.

Hence first coupon will be received at end of 2 years for 5 years (till 6 th year) and principal payment at end of 6 th year. We observe that just the timeline is moved ahead by 1 year, and rest there is no change. Reinvestement of 1st instalment will still be for 4 years and so on.

1200 C+P 1 1 2 3 4 5 6

Correct option d), Suzy will still have exactly 1200 when bond matures.