A 7-year bond of a firm in severe financial distress has a coupon rate of 12% an

Question

A 7-year bond of a firm in severe financial distress has a coupon rate of 12% and sells for $960. 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 yields to maturity of the bonds? The bond makes its coupon payments annually. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Stated yield to maturity

Explanation / Answer

Financial distress A: Stated yield to maturity: what is the yield to maturity according the terms of the contract? Price = Coupon*Annuity Factor + Face Value/(1+YTM)^7 960 = 120*Annuity Factor + 1000/(1+YTM)^7 We can use a financial calculator to find the YTM: PV = -960, FV =1000, PMT =120, N = 7 Rate 12.90% RATE(7,120,-960,1000) Now find the expected yield to maturity. This is the yield that equates the price to bond payments we expect to get Expected coupon rate = 0.5*14% = 7% Resolve for I, using the new inputs: PV = -960, FV = 1000, PMT = 60 , N = 7 Rate 6.74% RATE(7,60,-960,1000)

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