Please review the Word Doc and pdf.Jackson Corporation sources and distributes pharmaceutical products in the United States and internationally. Its pharmaceutical distribution segment distributes brand-name and generic pharmaceuticals, over-the-counter healthcare products, home healthcare supplies and equipment, outsourced compounded sterile preparations, and related services to various healthcare providers. The company wants to raise long-term debt of $10 million for research and development by issuing corporate bonds. The financial manager of the company, Chris Doughman, MBA is working with First Investment Bank to issue the bonds. The investment bank is providing consulting and advisory services to Jackson Corporation. Chris must make presentations to the investment banking firm to enable it to get the information needed to prepare the bond indenture.
Chris stated in the presentation that the bond would have 15 years to maturity, interest would be paid annually, and the bonds would have $1,000 par value. The coupon interest rate, according to Chris, would be determined using the following equation: rd= r* + IP + MRP + DRP + LP, where rd is quoted market interest rate, r* is real risk-free rate, IP is inflation premium, MRP is maturity risk premium, DRP is default risk premium, and LP is liquidity premium. Chris has gathered the following data:
Characteristic
Bond
Time to maturity
15 years
Real risk-free rate
2.00%
Inflation premium
2.20%
Maturity risk premium
2.50%
Default risk premium
2.40%
Liquidity premium
0.90%
1. Calculate the quoted market interest rate for the corporate bond using the equation.
2. Using the market interest rate calculated above, determine the coupon payment i.e., the dollar amount to be paid every year to bondholders.
3. First Investment Bank is using the answers presented in questions 1 and 2 to value the bond. Calculate the present value of the bond if the yield to maturity is 10%.
4.
Suppose that three years later Jackson Corporation’s bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 9%. Calculate the current market price of the bond.
5. Another company, Charter Corporation has issued 2,500
debentures with a face value of $1,000. The bonds have 10 years to maturity. The bonds have a coupon interest rate of 8% that is paid semiannually. What dollar amount of interest per bond can an investor expect to receive every 6 months?
6. Charter Corporation bonds have 10 years remaining to maturity. The bonds have a face value of $1,000 and a yield to maturity of 9%. The coupon rate is 8% that is paid semiannually.
i. Calculate the selling price of this debenture
ii. Calculate the current yield of this debenture.
7. Kahiki’s Foods Inc. corporate bonds have 10 years remaining to maturity. The bonds have a face value of $1,000, and a coupon Bonds, Bond Valuation, and Interest Rates
CHAPTER 5
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Topics in Chapter
Key features of bonds
Bond valuation
Measuring yield
Assessing risk
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Determinants of Intrinsic Value: The Cost of Debt
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Key Features of a Bond (1 of 2)
Par value: Face amount; paid at maturity. Assume $1,000.
Coupon interest rate: Stated interest rate. Multiply by par value to get dollars of interest. Generally fixed.
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Key Features of a Bond (2 of 2)
Maturity: Years until bond must be repaid. Declines.
Issue date: Date when bond was issued.
Default risk: Risk that issuer will not make interest or principal payments.
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Call Provision
Issuer can refund if rates decline. That helps the issuer but hurts the investor.
Therefore, borrowers are willing to pay more, and lenders require more, on callable bonds.
Most bonds have a deferred call and a declining call premium.
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What’s a sinking fund?
Provision to pay off a loan over its life rather than all at maturity.
Similar to amortization on a term loan.
Reduces risk to investor, shortens average maturity.
But not good for investors if rates decline after issuance.
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Sinking funds are generally handled in 2 ways
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