On October 14, 2016 Mercury Motors issued $1 billion of “step-up” bonds having 20 years to maturity. The step-up bonds, having a par value of $1000, make semiannual coupon payments on April 15 and October 15. Although the initial coupon rate is 2.5 percent, beginning with the coupon payment to be received on April 15, 2027 (after twenty semiannual coupon payments) the coupon rate will be “stepped-up” to 6 percent until the bond matures on October 15, 2036. Assuming the required yield to maturity for Mercury Motors bonds is currently 3.6 percent, determine:
a. the price for Mercury Motors step-up bonds on October 15, 2016.
b. assuming coupon payments from Mercury Motors’ step-up bond can be reinvested at a semiannually compounded rate of 4.2 percent, determine the reinvested rate of return from buying the Mercury Motors step-up bonds on October 15, 2016 and holding the bonds to their maturity on October 15, 2036.