Lopez Information Systems management is planning to issue 10-year bonds. The goi

Question

Lopez Information Systems management is planning to issue 10-year bonds. The going market yield for such bonds is 8.125 percent. Assume that coupon payments will be made semiannually. Management is trying to decide between issuing an 8 percent coupon bond or a zero coupon bond. Lopez needs to raise R1 million.
a. What will be the price of an 8 percent coupon bond?
b. How many 8 percent coupon bonds would have to be issued?
c. What will be the price of a zero coupon bond?
d. How many zero coupon bonds will have to be issued?

Explanation / Answer

Assuming face value of 1000,

Price of 8% coupon bond=40/1.040625+40/1.040625^2..........40/1.040625^20+1000/1.040625^20

=40/0.040625*(1-1/1.040625^20)+1000/1.040625^20

=991.5529

So, 8% coupon bonds to be issued=1 million/991.5529=0.001009 million=1009 bonds

Price of zero coupon bond=1000/1.08125^10=457.8664

Number of zero coupon bonds to be issued=1 million/457.8664=0.002184 million=2184 bonds

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