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Klondike Adventure, Inc., has outstanding $100 million bonds that pay an annual coupon rate of interest of 11 percent. The par value of each bond is $1,000. The bonds are scheduled to mature in 10 years. Because of Dooley’s increased risk, investors now require a 13 percent rate of return on bonds of similar quality. The bonds are callable at 110 percent of par at the end of 5 years.

1. What price would the bonds sell for assuming investors do not expect them to be called?
2. What price would the bonds sell for assuming investors expected them to be called at the end of 5 years?

Excel hints:
- Review the timeline and cash flow amount for the regular and callable bond.
- PV(rate = discount rate for each period, nper = # of coupons, pmt = coupon, fv = par, type = 0)

According to the call features, what is the terminal value at the call date?

A. 900
B. 1200
C. 1000
D. 1100

Answer :

Final answer:

The terminal value at the call date for the callable bonds is $1,100.

Explanation:

To calculate the terminal value at the call date, we need to determine the call price, which is 110 percent of the par value. The par value of each bond is $1,000, so the call price would be $1,000 * 110% = $1,100.

If the bonds are called at the end of 5 years, investors would receive $1,100 for each bond. This would be the terminal value at the call date.

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Rewritten by : Barada

The bond Valuation is the present value of its future cash flows, including annual coupon payments and the face or call value at maturity. The bond price can change depending on whether investors expect the bonds to be called. The terminal value at the call date is 110% of the par value. So, the correct option is $1100.

The bond value, or price, is determined by the present value of its future cash flows, which are the annual coupon payments and the face value or call value at maturity. In this case, the annual coupon payment is 11% of the $1000 par value, or $110. The discount rate is the rate required by investors, which is 13%.

The formula for the present value of an annuity (PV) is used to calculate the present value of the coupon payments:[tex]PV = PMT * [1 - (1 + r)^ -n] / r[/tex] , where PMT is the annual payment, r is the discount rate, and n is the number of periods. The face value at maturity or call value is discounted using the formula: [tex]FV / (1 + r)^ n.[/tex]

Therefore, if investors do not expect the bonds to be called, the bond price is calculated using a 10-year maturity: Bond price = PV of coupon payments + PV of face value at maturity. The correct option is $1100.

If investors expect the bonds to be called, the bond price is calculated using a 5-year maturity and the call value: Bond price = PV of coupon payments + PV of call value. According to the call features, the terminal value at the call date is 110% of par, or $1100.

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