Question: Following a substantial earthquake, a major West Coast university suffered $100 million in property damage. Suppose that this loss enabled the university to borrow an additional $100 million worth of tax-exempt bonds. The university issues 20-year zero-coupon bonds yielding 7% to maturity-that is, the university will pay bondholders $100 million × 1.0720, or $386.97 million, at maturity. Any gift money raised from friends of the university can be invested to earn 10% in riskless taxable bonds.
a. How much must the university raise in gifts to pay off its bond obligation at maturity?
b. How would your answer change if the bonds matured in 30 years rather than in 20 years?