Discussion:
Items 1 through 3 are based on the following information:
Watco, Inc. issued $1,000,000 in 8% bonds, maturing in ten years and paying interest semiannually. The bonds were issued at face value.
What can you assume about the interest rates at the time the bonds were issued?
1. The market rate for this bond was about 8%.
2. The nominal rate of interest was about 8%.
3. The coupon rate on the bond includes no premium for credit risk.
4. The risk-free interest rate is about 6%
If the market rate of interest for this type of bond increases to 9%, which of the following is true?
1. The market value of Watco's bond will increase.
2. The market value of Watco's bond will decrease.
3. The effect will depend on the change in the LIBOR rate.
4. The effect cannot be predicted.
Assume that one of Watco's bonds with $1,000 face is currently selling for $950. What is the current yield on the bond?
1. 8.00%
2. 9.00%
3. 7.56%
4. 8.42%