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Sir i am confused in part b option 2
Issue the new bond at a coupon rate where the issue price of the new bond will be $100 per unit and equal to its par value
Please explain this requirement and how to approach this part
what i understand is we want a coupon rate which gives valuation of the new bond as $100 please provide easy calculations along with explanation thanks for ur time and helpThe market value is always the PV of the future receipts to the investor (interest and repayment) discounted at the investors required rate of return (the YTM).
So if the YTM is 6% and the market value is to be $100, then the coupon rate will have to be 6%.Sorry – I didn’t explain well enough 🙂
We know from part (i) that if the 5% coupon bonds are issued, then the value will be $95.72.
So we then need to calculate the YTM of the 5% coupon bonds. The answer tried 5.5% but that give a value of $97.86 which is too high. So the answer then tried 6% and that gives a MV of $95.78, which is almost the same as $95.72.
So…..the YTM for the 5% bonds is 6% and we assume therefore that investors in the other bonds (being issued at $100) will require a YTM of 6% as well.
Given that they are being issued at $100 and are being redeemed at $100, this means the coupon rate will have to be 6% (and the answer then goes on to prove that at 6% then the market value will indeed be $100).
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