To calculate the price of the bond if Andrew maintains the A rating, we can use the present value formula:
PV = (C / r) * (1 - (1 / (1 + r)^n)) + (F / (1 + r)^n)
Where:
PV = Present value of the bond
C = Coupon payment per period ($70 since the coupon rate is 7% and the face value is $1,000)
r = Yield to maturity rate (0.065 since the bond is rated A)
n = Number of periods (30 years)
Plugging in the values into the formula, we get:
PV = (70 / 0.065) * (1 - (1 / (1 + 0.065)^30)) + (1000 / (1 + 0.065)^30)
PV = $1,129.47
Therefore, the price of the bond if Andrew maintains the A rating would be $1,129.47.
If the bond is downgraded to BBB, we would use the yield to maturity rate for BBB-rated bonds, which is 6.9%. Plugging in the new value for r into the formula, we get:
PV = (70 / 0.069) * (1 - (1 / (1 + 0.069)^30)) + (1000 / (1 + 0.069)^30)
PV = $1,103.52
Therefore, if the bond is downgraded to BBB, the price of the bond would be $1,103.52.
Andrew Industries is contemplating issuing a 30-year bond with a coupon rate of 7% (annual coupon payments) and a face value of $1,000. Andrew believes it can get a rating of A from Standard and Poor’s. However, due to recent financial difficulties at the companies, Standard and Poors is warning that it may downgrade Andrew Industries bonds to BBB. Yields on A-rated long term bonds are currently 6.5% and yields on BBB rated bonds are 6.9%
What is the price of the bond if Andrew maintains the A rating for the bond issue?
What will the price of the bond be if its downgraded?
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