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Dear tutor!
In revision kit BPP q.33 Levante Co (12/11) part a) we need to calculate market value of bond in case of fall to grade A from AA. In answer it is said that we should calculate spot yields based on A rating for each of 3 yrs and apply them in calculation of market value:
1yr 4/1.0385=3.852
2yr 4/1.0446^2=3.666
3yr 104/1.0507^3=89.66Why we should apply different rate for each year, but not rate for 3-year bonds which is 5.07%?
And why in q.32 Coeden Co (12/12) for calculation of market value of 3-year bonds we used just one rate?
Thanks for your help
In Levante, investors receive fixed interest each year (which is obviously different than the rates from the yield curve).
So we are effectively calculating how much one year bonds would be needed to get the same interest in 1 years time; how much two year bonds to be getting the same interest in 2 years time, and so on.In Coeden I guess we really should do the same, but the information is not available.
Hi sir, if a question asks on the cost of debt for the bond, eg the new bond in levante, do we simply take 6.12%*(1-t) which is the yield curve + credit spread, or do we find the cost of debt using the irr method with post tax interest cash flow after market value of the bond here has been estimated using the annual spot yield curve, of which in b(i) it is at 95.72.
i havent come across any such question but just in case such question like levante has additional question on cost of debt, and tax rate was given, i’d appreciate your advice on how to approach such question.
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