a) A 10-year, RM1,000 par value bond pays an 8% coupon with quarterly payments during its first five years (you receive RM20 a quarter for the first 20 quarters). During the remaining five years the security has a 10% quarterly coupon (you receive RM25 a quarter for the second 20 quarters). After 10 years (40 quarters) you receive the par value.
Another 10-year bond has an 8% semiannual coupon. This bond is selling at its par value, RM1,000. This bond has the same risk as the security you are thinking of purchasing.
Given this information, what should be the price of the security you are considering purchasing? Calculate and justify your answer.
b) Recently, SMJC Hospital Inc. filed for bankruptcy. The firm was reorganized as American Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue to be put into effect. The issue has 10 years to maturity and an annual coupon rate of 10%. The new agreement allows the firm to pay no interest for 5 years. Then, interest payments will be resumed for the next 5 years. Finally, at maturity (Year 10), the principal plus the interest that was not paid during the first 5 years will be paid. However, no interest will be paid on the deferred interest. If the required annual return is 20%, what should the bonds sell for in the market today? Calculate and discuss your answer.