Factors That Affect the Bond Issue Price BENTWORTH CORP. is considering the issu

Question

Factors That Affect the Bond Issue Price

BENTWORTH CORP. is considering the issue of $102,000 face value, ten-year term bonds. The bonds will pay 6% interest each December 31. The current market rate is 6%; therefore, the bonds will be issued at face value.

Required:

1. For each of the following situations, indicate whether you believe the company will receive a premium on the bonds or will issue them at a discount or at face value.

a. Interest is paid semiannually instead of annually.
- Select your answer -DiscountFace valuePremiumItem 1

b. Assume instead that the market rate of interest is 7%; the nominal rate is still 6%.
- Select your answer -DiscountFace valuePremiumItem 2

2. For each situation in part (1), prove your statement by determining the issue price of the bonds given the changes in (a) and (b). Do not round intermediate computation and round your final answer to the nearest dollar.

Here are some time value of money factors:
Present value of an annuity, n=10, i=7%, PV=7.02358
Present value of an annuity, n=20, i=3%, PV=14.87747
Present value of a single amount, n=10, i=7%, PV=0.50835
Present value of a single amount, n=20, i=3%, PV=0.55368

Explanation / Answer

Bond Price -Bond price is the present value of coupon payments and maturity value received over the life of bond.

Bond Price and market rate of interest – When market interest rate is higher than coupon rate , bond will be issued at discount. It is because bond holder is going to receive fixed coupon over the life of bond in which market is paying more return compare to bond. Hence to offset that bond price will do down and bond will be issued at discount.

Coupon arte and market interest rate is the main factor in bond issue price. Issue price is summarised as under.

Market Interest rate = Coupon rate ( bond will be issue at par)

Market interest rate > Coupon rate ( Bond will be issued at discount)

Market interest rate < Coupon rate ( Bond will be issued at premium)

(‘1) (a) When interest is paid semi-annually, but the market rate and coupon rate is same

Bond will be issued at Par.

(‘b) Market rate = 7 %, Nominal rate = 6 %,

Hence bond will be issued at discount.

(‘2) Calculation of issue price of bond-

Price of Bond = (Present Value of Coupon Payments )+ (Present Value of Face Value)

(‘a) Market interest rate = 6 %, Number of payment = 20

Coupon rate = 6 %, Face Value = 102,000

Present Value of Coupon Payment =

Face Value x Coupon Rate x Present Value of Annuity for 20 year at 3 %

Present Value of Coupon = 102,000 x 0.03 x 14.87747

PV of Coupon = 45,525.07

PV of face Value = Face Value x (PV of single amount for n=20, i=3 %)

PV of face value = 102,000 x 0.55368

PV of face value = 56,474.93

Issue price = $102,000

(‘b) = Market rate = 7 %, n= 10

PV of Coupon = (102,000 x 0.06)x 7.02358

PV of coupon = $42984.32

PV of face value = $102000 x 0.50358

PF of face value = $51851.63

Price of bond = 42984.32+51851.63

Price of bond = $94836

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