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- May 9, 2017 at 10:52 am #385482
i study this topic and i reached to some conclusions:
1) Bond yield is the expected required rate of return of an investor and it is calculated by adding risk free rate and credit spread of a company..
2)Yield to maturity is the average return earned by an investor till bond’s maturity and it is calculated via IRR and gross amount of interest will be use.
3)YTM will not equal to company’s cost of debt i.e. Kd 1-t
4) if coupon rate is equal to bond yield then MV of bond = Par value and company’s cost of debt can be calculated as follows bond yield x 1-t, if coupon is less than bond yield then bond will be issue at discount and kd 1-t will the IRR and after tax interest will be use, if coupon rate is higher than bond yield than bond will be issue at premium and again kd 1-t will be the IRR and after tax interest amount will be use.
5) MV of a bond = PV of all future cashflows discounted at bond yield.
if i am not wrong then my question is,
In D-12 Sigra co. question
method 3 of payment is issuing bonds to dentro co’s shareholders and the coupon rate of the bond is 2% having par value of 100 and will redeem after 3 years and sigra co have some issued bonds which are currently trading at 104 having coupon rate 6% and will redeem after 3 years.
Now it is very much clear that bond yield is less than 6% but greater than 2%. so the MV of new bond will be less than its par value.
MV of bond should be calculate on bond yield and bond yield is not mention in the question the examiner use the YTM of 6% bond as discount factor for new bonds. why??May 9, 2017 at 4:04 pm #385509Debt investors are currently requiring a return of 4.55% on the existing bonds if they were to buy them on the stock exchange.
Therefore it is reasonable to assume that they will require a return of 4.55% on any new bonds about to be issued.
Obviously it is an assumption (and you would state your assumption) but it is a very sensible assumption to make 🙂
May 10, 2017 at 2:51 am #385549okay. and plz tell me my concepts are correct?
May 10, 2017 at 6:51 am #385568Yes – they all seem correct 🙂
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