Question

Your firm has a credit rating of A. You notice that the credit spread for​ five-year maturity A debt is 8383 basis points left parenthesis 0.83 % right parenthesis(0.83%). Your​ firm's five-year debt has an annual coupon rate of 5.5 %5.5%. You see that new​ five-year Treasury notes are being issued at par with an annual coupon rate of 1.5 %1.5%. What should be the price of your outstanding​ five-year bonds?

Answer 1

Yield of bonds = Treasury-note yield + credit spread

Treasury-note yield = coupon rate of Treasury-note (since they are issued at par, their yield equals their coupon rate)

Yield of bonds = 1.5% + 0.83% = 2.33%

Price of a bond is the present value of its cash flows. The cash flows are the coupon payments and the face value receivable on maturity

Price of bond at issue is calculated using PV function in Excel :

rate = 2.33% (Yield of bonds)

nper = 5 (Years remaining until maturity with 1 coupon payment each year)

pmt = 1000 * 5.5% (annual coupon payment = face value * coupon rate)

fv = 1000 (face value receivable on maturity)

PV is calculated to be $1,148.00

Price of bonds is $1,148.00