Kramerica, Inc. wants to finance its acquisition of Vandalay Industries, Inc. with debt, so the company issues bonds with the face value of $1,000 each, which will mature in 12 years and pay 7% interest coupon. Answer the questions below based on this information.
What price would the company’s bonds sell for in the market given that the similar bonds have 9% yield to maturity?
What price would the company’s bonds sell for if the coupon payments were to be made semiannually and what would be their effective annual yield given that the similar bonds have 9% yield to maturity?
What price would the company’s bonds sell for after two years if the market interest rates drop to 5% provided that the bond coupons are paid semiannually?
Suppose that Mr. Kramer has a choice whether to invest his money in Kramerica’s bonds or New York City municipal bonds of comparable risk and rating, which are non-taxable and yield 4.9% annual rate. If he was in 35% tax bracket, then which investment would be more attractive for him and what would be the tax rate that would make him indifferent between these two?
Extra Credit Section.
Suppose that Mr. Kramer’s broker quotes him the price of $814 for a thirty-year bond with the face value of $1,000 that pays 13% annual coupon rate. Based on this information, what is this bond’s YTM and the current yield?