Case Study

Case Study

1. To begin, assume that it is now January 1, 1993, and that each bond in Table 1 matures on December 31 of the year listed. Further, assumes that each bond has $1,000 par value, each had a 30-year maturity when it was issued, and the bonds currently have a 10 percent required nominal rate or return.

a. Why do the bonds’ coupon rates vary so widely?

It is because TECO sells bonds at par and sets the coupon rates at the market rate of interest when the bonds are issued, interest rates have risen over the last 25 years, and that explains the rising pattern of coupon rates.

b. What would be the value of each bond if they had annual coupon payments?

The value of a bond is found as the present value of interest payments plus the present value of the principal.

5-year bond:

10%,5

10%,5

V=$45(PIVFA ) +$1,000(PVIF ) = $791.51

15-year bond:

10%,15

10%,15

V=$82.50(PIVFA ) +$1,000(PVIF ) = $866.89

25-year bond:

10%,25

10%,25

V=$126.25(PIVFA ) +$1,000(PVIF ) = $1,238.27

Table    |

Maturity years    | 5    | 15    | 25    |

FV    | $1,000    | $1,000    | $1,000    |

Pmt/Yr    | 1    | 1    | 1    |

Pmt    | $45    | $82.50    | $63.125    |

Int/yr    | 10%    | 10%    | 10%    |

N    | 5    | 15    | 25    |

PV    | $791.51    | $866.89    | $1,238.27    |

c.     TECO’s bonds, like virtually all bonds, actually pay interest semiannually. What is each bond’s value under these conditions? Are the bonds currently selling at a discount or at a premium?

5-year bond:

5%,10

5%,10

V=$22.50(PIVFA ) +$1,000(PVIF )= $787.65 discount

15-year bond:

5%,30

5%,30

V=$41.25(PIVFA ) +$1,000(PVIF )= $865.49 discount

25-year bond:

5%,50

5%,50

V=$63.125(PIVFA ) +$1,000(PVIF )= $1,239.61 discount

Table    |

Maturity years    | 5    | 15    | 25    |

FV    | $1,000    | $1,000    | $1,000    |

Pmt/Yr    | 2    | 2    | 2    |

Pmt    | $22.50    | $41.25    | $63.125    |

Int/yr    | 10%    | 10%    | 10%    |

N    | 10    | 30    | 50    |...