Dooley, Inc., has outstanding $100 million (par value) bonds that pay an annual

Question

Dooley, Inc., has outstanding $100 million (par value) bonds that pay an annual coupon rate of interest of 10.5 percent. Par value of each bond is $1,000. The bonds are scheduled to mature in 20 years. Because of Dooley’s increasedrisk, investors now require a 14 percent rate of return on bonds of similar quality with 20 years remaining until maturity. The bonds are callable at 110 percent of par at the end of 10 years. •a. What price would the bonds sell for assuming investors do not expect them to be called? b. What price would the bonds sell for assuming investors expect them to be called at the end of 10 years?

Explanation / Answer

Dooley Inc. All Amounts in $ a. Assuming that the bonds are not going to be called The Price for selling the bonds would be $ 768.19. b. Assuming that the bonds will be called in 10 years from now The bond's coupon rate is 10.5% or 0.105 Adding 1 to this, we get 1.105 Since the period of calling is 10 years, the indexed coupon rate will be 1.105 ^10 = 2.714081 With a face value per bond of $ 1,000, the revised face value is 2985.489 The bond's call value is $ 1,000, and hence the selling price of the bond will be $ 2,985.49 - $ 1,000 = $ 1,985.49.

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