Question

Absalom Motors's 8.90% coupon rate, semiannual payment, $1,000 par value bonds that mature in 25 years are callable 10 years from now at a price of $1,089. The bonds sell at a price of $1,250, and the yield curve is flat. Assuming that interest rates in the economy are expected to remain at their current level, what is the best estimate of the nominal interest rate on new bonds? 03.08% 8.90% 6.81% 3.40% 06.17%

Answer 1

Calculation of nominal interest rate is shown below

DE F H 1 2 3 In this case the bond are selling at higher price then its par value and thus they are likely to be called by company. Thus, the nominal interest rate earned would be Yield to Call (YTC) 5 We can calculate Yield to call using the rate function in excel 6 No of payments (NPER) 7 Coupon amount (PMT) $45 8 Price of bond (PV) $1,250.00 9 Call value (FV) $1,089 10 Yield to call (Semi-Annual) 3.085% 11 Yield to call (Annual) 6.17% 13 Thus, nominal interest rate on new bonds would be 6.17%.

Following shows the working

2 In this case the bond are selling at higher price then its par value and thus they are likely to be called by company 3 Thus, the nominal interest rate earned would be Yield to Call (YTC) 4 5 We can calculate Yield to call using the rate function in excel 6 No of payments (NPER) 7 Coupon amount (PMT) 8 Price of bond (PV) 9 Call value (FV) 10 Yield to call (Semi-Annual) 11 Yield to call (Annual) =10*2 =1000*(8.9%/2) 1250 1089 (RATE(B6,-B7 B8,-B9)) =B102 12 13 Thus, nominal interest rate on new bonds would be 6.17%.