Question

Chamberlain Co. wants to issue new 20-year bonds for some much-needed expansion projects. The company currently has 6 percent coupon bonds on the market that sell for $1,083, make semiannual payments, and mature in 20 years. What coupon rate should the company set on its new bonds if it wants them to sell at par?

Answer 1

Answer:

5.36%

Explanation:

We would need to calculate the yield to maturity of the current bonds:

YTM = {coupon + [(face value - market value)/n]} / [(face value + market value)/2]

• coupon = $1,000 x 6% x 1/2 = $30
• face value = $1,000
• market value = $1,083
• n = 20 x 2 = 40

YTM = {$30 + [($1,000 - $1,083)/40]} / [($1,000 + $1,083)/2] = $27.925 / $1,041.50 = 0.026812 x 2 = 0.05362 = 5.36%

Since the bond's coupon rate is higher than the market rate, the bonds are sold at a premium. In order to sell bonds at the par value, you must lower the coupon rate.