A 10-year bond of a firm in severe financial distress has a coupon rate of 10% a

Question

A 10-year bond of a firm in severe financial distress has a coupon rate of 10% and sells for $880. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to reduce coupon payments on the bond to one-half the originally contracted amount. The firm can handle these lower payments. What are the stated and expected yield to maturity of the bonds? The bond makes its coupon payments annually.

A 10-year bond of a firm in severe financial distress has a coupon rate of 10% and sells for $880. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to reduce coupon payments on the bond to one-half the originally contracted amount. The firm can handle these lower payments. What are the stated and expected yield to maturity of the bonds? The bond makes its coupon payments annually.

Explanation / Answer

Solution :

Price = Coupon*Annuity Factor + Face Value/(1+YTM)^10

880 = 100*Annuity Factor + 1000/(1+YTM)^10

We can use a financial calculator to find the YTM:PV = -880, FV =1000, PMT =100, N = 10I = 16.0%Now find the expected yield to maturity.

This is the yield that equates the price to bond payments. Expected coupon rate = 0.5*10% = 5%

Resolve for I, using the new inputs:PV = -880, FV = 1000, PMT = 50, N = 10

I= 8.53%

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