Question

The fry company has a credit rating of B and 10 year semi annual 5% coupon bonds. Current market yield until maturity on the bond is 7%.

1) What is the expected price of the bond?

2) What happens if it drops to a B rating?

3) Why did the price change with the credit rating of Fry company?

  

Answer 1

The price of bond can be calculated by use of discounting of cash flow method as

value of bond =

Maturity value Ci 1+YTM)'(1+YTM)"

or by use of PV( ) function in excel.

Face Value	$        100
Annual Coupon Rate	5.000%= 2.5% (semi annual)
Annual Required Return	7.000%
Years to Maturity	10.00
Payment Frequency	2
Coupon	5% * 100 = $ 5 , $ 2.5(semi annual)
Value of Bond	$     85.79 = -PV(3.5%,20,2.5,100)

answer 1) Expected price of Bond = 85.79 % of face value

Answer 2) it drops to a B rating,

There will be no change in price of bond as the above calculation in based on rating of 'B" .

Answer 3) The price of bond varies according to involvement of risk in bond. The price of bond change with change in credit rating ,  as the amount default risk changes with change in credit rating