Reference no: EM131115369
1. Valuing a Corporate Bond Issue
American Airlines is currently considering the issuance of a series of $1,000 par bonds. The coupon rate offered, based on current market interest rates and the Standard & Poor's based AMR bond rating, will be 10%. The current interest rate is coincidentally 10% as well. Interest on the bonds will be paid semi-annually. However, American cannot decide on the maturity of the new issue. The life of the bonds will be 10, 20, or 30 years.
a) Ignoring floatation costs, what will the bonds sell for today if American decides to issue the bonds with a maturity of 10 years? What will the price be if the bonds have a maturity of 20 years? 30 years?
b) If the bonds are issued with 10 years to maturity and the day after they are issued, the market interest rates increase to 12%, what will be the price of American Airline's bonds? What if interest rates drop to 8%?
c) If the bonds are issued with 20 years to maturity and the day after they are issued, the market interest rates increase to 12%, what will be the price of American Airline's bonds? What if interest rates drop to 8%?
d) If the bonds are issued with 30 years to maturity and the day after they are issued, the market interest rates increase to 12%, what will be the price of American Airline's bonds? What if interest rates drop to 8%?
e) Based on your answers to questions (b) through (d), what is the relationship between time to maturity and the price of the bond?
f) Based on your answer to question (a), what is the relationship between current interest rates, the coupon rate, and time to maturity?
2. Forward Rates Problems
Assuming in December of 2014, the term structure of Treasury securities included the following rates:
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Security
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Annualized Yield (%)
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3-month bill
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4.50
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6-month bill
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4.57
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1-year note
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4.52
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2-year note
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4.51
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3-year note
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4.48
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a) The six-month annualized yield expected in the second half of year 2015 (forward rate for 6-month bill in June 2015)
b) The one-year expected yield for year 2017 (forward rate for 1-year note in December 2016)
c) Suppose the 8-year spot interest rate is 8 percent and the 3-year spot rate is 4 percent. What is the implied forward rate on a 5-year bond originating 3 years from now?
d) Suppose the 5-year spot interest rate is 6 percent. Under the expectation hypothesis the forward rate on a 3-year bond originating 2 years from now was estimated. The estimated forward rate is 5.5 percent. What is the 2 -year bond spot rate?
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What are the potential tax consequences for the corporation
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Valuing a corporate bond issue
: American Airlines is currently considering the issuance of a series of $1,000 par bonds. The coupon rate offered, based on current market interest rates and the Standard & Poor's based AMR bond rating
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