1. Before maturity, a bond may be selling at the face value or at a price greater or lesser than the face value.The terms “premium” and “discount” refer to the difference that exists from the face value of the bond. Bonds selling at a price greater than the face value are said to be at a premium and the bonds selling at a price lesser than the face value are said to be at a discount.
Premium or discount occurs when nominal interest rate(or coupon rate) of the bond differs from the current market rate of interest demanded by lenders.Regardless of the required yield, the bond price will reach face value as its approaches the maturity date.
The bond with a face value of $1000 is …show more content…
In order to refund the old bonds entirely by issue of new bonds, Lyons has to issue 11,542 bonds with 6% coupon rate paid annually.
3. Taking into account the time value of money, the present value of the 2 options (issuing new bonds or continuing with existing bonds) is the same. It is up to Rene Cook or the firm’s ideology to decide which option to go for.
Decision to issue new bonds at 6%
Also the number of bonds issued does make any difference on increasing the savings of the firm.(assuming the interest rate to remain at 6% p.a. from 2008 to 2019)
Option a Option b No. of Bonds Issued | 10000 | Interest Payment | $ 4,463,242.46 | Principal | $ 5,536,757.54 | Total | $ 10,000,000.00 | No. of Bonds Issued | 11542 | Interest Payment | $ 5,151,474.45 | Principal | $ 6,390,525.55 | Total | $ 11,542,000.00 |
Under option a:
The firm issues 10,000 bonds worth $10mn.at 6% and retires bonds worth $11.54mn, thereby having to incur immediate loss worth $1.54mn. However this is recouped over the 10 year period by savings incurred on interest rate payments. Hence net effect of this is zero.
Under option b:
The firm issues 11,542 bonds worth $11.54mn at 6%and uses the proceeds to retire bonds worth $11.54, thereby incurring no profit or loss. However it doesn’t make any savings on interest payment after issuing bonds at 6%, since the number of bonds issued (11,542) is greater