An investor is considering purchasing an Allstate bond. The bond is rated BBB. The bond has a $1,000 face value, an 8.5% coupon rate and matures in 5 years. The bond is currently quoted at 95.
a) If the investor decides to buy the bond today, how much will she pay, in dollars?
b) If the investor has a discount rate of 4.0%, what is the most she should be willing to pay for the bond today? Make relevant calculations using Excel formulas so I can see all of your work.
c) Based on your calculations, should the investor buy the bond or not? Explain your reasoning briefly.
d) On the same day, an IBM bond that will mature in 5 years and a 2.0% coupon rate is quoted at 94. The IBM bond is rated AAA. (The investor discount rate remains 4.0%) Why would a rational investor pay more for an Allstate bond than for the IBM bond?
I am looking for a few sentences of explanation here.