Consider a hypothetical Payment in Kind (PIK) bond of XYZ Corporation. The bond

Question

Consider a hypothetical Payment in Kind (PIK) bond of XYZ Corporation. The bond has 2 years to maturity, a face value of $1000, and has an annual coupon rate of 10%. Coupons are paid annually. XYZ has the right to pay the first coupon either in cash or in additional PIK bonds - i.e., the bond holder may get either S100 in cash or 10 additional PIK bonds for every 100 bonds she has. (If additional PIK bonds were paid as the first coupon, in year 2 the bond holder would receive the 1 year coupon as well as the corresponding principal, according to the amount of additional PIK bonds paid.) The second year coupon must however be paid in cash along with the face value, and everything clears at the end of two years.

Explanation / Answer

Solution:

- To find out the price of bond, we need to discount all interest cash flows and principal amount at maturity by the YTM rate (In this case, the assumptions is that YTM rate = Coupon Rate of 10%; in case YTM is seperately givern then please use that to discount cash flows)

- Interest cash flows will be $100 each for the given two years if both coupons are paid in cash (it is given in Question @) that first coupon is paid in cash - Also, as per the question, 2nd coupon is always paid in cash)

- Prinicpal payment to be received is $1000

Under the given assumptions and assuming YTM = 10%

Therefore, Price of the Bond = $1000

(This is because YTM is assumed to be the coupon rate; had the YTM been different, the price of the bond too would be different - In such a case you need to use the relvant rate in discounting cash flows instead of 10% used here)

Year 1 2 Interest Received 100.00 100.00 P.V Formula 100/(1+10%)^1 100/(1+10%)^2 P.V of Interest 90.91 82.64 Total P.V of Interests 173.55 Principal Received 1000 1000/(1+10%)^2 P.V of Principal 826.45 Sum of P.Vs 826.45 + 173.55 1000.00

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.