1. Explain the difference between Bond Yield (Yield to Maturity) and Coupon Interest Rate.
2. What factors determine a bond’s rating and why is the rating important to the firm’s manager?
3. Waco Industries, Inc. likes to open a branch in Houston and need to raise capital to do so. Waco management decides to issue 20 year corporate bond, at coupon rate of 8%, a par value of $1,000 to raise the needed funds for this project. As an investor, if your required rate of return is 7% (to compensate you for your cost of borrowing from elsewhere), what price would you be willing to pay for Waco’s bond? What happens if you pay more for the bond? What happens if you pay less for the bond? Now if your required rate of return is 12% (rather than 7%), what is the price you will be willing to pay for the bond? (show your calculations)
4. From the calculated result of Q3, we can see how market price of a bond differ from its par value when the coupon interest rate does not equal the bondholder’s required rate of return. What kind of relationship is there between interest rate (a bond investor’s required rate of return) and a bond’s market price?
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