JCPenny Company once issued bonds for 33.24 (percent of face value), with a face
ID: 2742715 • Letter: J
Question
JCPenny Company once issued bonds for 33.24 (percent of face value), with a face value of $200 million and a stated interest rate of zero, which matured eight years later. That same yar, Martin Marietta, Northwest Industries, and Alcoa also issued bonds with stated interest rates of zero. A. Why would an investor purchase a bond with a stated interest rate of zero? B. Compute the effective interest rate on the bond issuance. C. In terms of its cash flows, explain why a company might wish to issue bonds with a stated interest rate of zero. D. At what price would the bonds have been issued if the stated interest rate had been 5%? 18%? Assume that interest payments would be made annually.
Explanation / Answer
1. Zero coupon bonds are fixed income securities, which are sold at high discount to their face value. Both the interest and face value are paid at maturity. So investors buy zero coupon bonds
2.
Effective interest rate is the yield of the bond
Yield to Maturity = (Face Value / Current Price of Bond) ^ (1 / Years to Maturity) - 1
Yield = (200/0.3324*200)(1/8) - 1 = 14.76%
3.
There are two reasons why companies issue zero coupon bonds
1. When the maturity of bonds is short, there is no time until maturity to make payments
2. Zero coupon bonds can be issued when the company do not have revenues to repay until maturity
4.
Compute the present value. Bond is issued at the present value of the cashflows.
a. interest rate = 0.05
10 is the coupon payment = 200*0.05
Interest rate = 0.18
36 is the coupon payment = 200*0.18
Rate 0.05 Year (n) Cashflow (x) Discount rate = 1/(1+0.05)^n Present Value = x*discount rate 1 10 0.95238095 9.523809524 2 10 0.90702948 9.070294785 3 10 0.8638376 8.638375985 4 10 0.82270247 8.227024748 5 10 0.78352617 7.835261665 6 10 0.7462154 7.462153966 7 10 0.71068133 7.106813301 8 210 0.67683936 142.136266 Present value 207.1068133Related Questions
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