What would you expect to be the market price of the bonds

Reference no: EM13596323

Debtors may be able to realize an economic gain by defeasing their debt "in substance".
A hospital has outstanding $100 million of bonds that mature in 20 years (40 periods). The debt was issued at par and pays interest at a rate of 6% (3%per period). Prevailing rates on comparable bonds are now 4% (2% per period)

1. What would you expect to be the market price of the bonds, assuming that they are freely traded. Is there an economic benefit for the hospital to refund the existing debt by acquiring it at market price and replacing it with new, "low-cost" debt? (Present value at 2% of $1 paid at the end of 40 periods= $.452890; present value at 2% of annuity of $1 paid at the end of each of 40 periods= $27.35548)

2. Assume the bonds contain a provision permitting the hospital to call the bonds in another five years (10 periods) at price of $105 and that any invested funds could earn a return equal to the prevailing interest rate of 4% (2% of $1 paid at the end of 10 periods= $.820348; present value at 2% of annuity of $1 paid at the end of each of 10 periods = $8.98258)

Reference no: EM13596323

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