Cccx.Doc

BOND VALUATION: PRACTICE QUESTION

QUESTION 1

The Vancouver Development Company has just sold a $100 million, 10-year, 12 percent bond issue. A sinking fund will retire the issue over its life. Sinking fund payments are of equal amounts and will be made semi-annually, and the proceeds will be used to retire bonds as the payments are made. Bonds can be called at par for sinking fund purposes, or the funds paid into the sinking fund can be used to buy bonds in the open market.

Required

a. How large must each semi-annual sinking fund payment be?

b. What will happen, under the conditions of the problem thus far, to the company’s debt service requirements per year for this issue over time?

c. Now suppose Vancouver Development set up its sinking fund so that equal annual amounts, payable at the end of each year, are paid into a sinking fund trust held by a bank, with the proceeds being used to buy government bonds that pay 9 percent interest. The payments, plus accumulated interest, must total $100 million at the end of 10 years, and the proceeds will be used to retire the bonds at that time. How large must the annual sinking fund payment be now?

d. What are the annual cash requirements for covering bond service costs under the trusteeship arrangement described in part c? (Note: Interest must be paid on Vancouver’s outstanding bonds but not on bonds that have been retired.)

e. What would have to happen to interest rates to cause the company to buy bonds on the open market rather than call them under the original sinking fund plan?

QUESTION 2

The Pennington Corporation issued a new series of bonds on January 1, 1978. The bonds were sold at par ($1,000), have a 12 percent coupon, and mature in 30 years, on December 31, 2007. Coupon payments are made semi-annually (on June 30 and December 31).

Required

a. What was the YTM of Pennington’s bond on January 1, 1978?

b. What was the price of the bond on January 1,...