Calculation Of Effective Yield To Maturity For A Bond

Question

Research in Motion (RIM), once known as the global leader in wireless innovation, has lost its darling status after the introduction of the Apple iPhone. In 2011, RIM’s stock price declined by approximately 75%. Now management believes they might have to raise capital this year (2012) by issuing debt. You work for an investment bank in Toronto that has been hired by RIM to advise them on the debt issue. Assume the global markets are continuing to experience stress and credit spreads are continuing to widen. Based on your research and market conditions, you feel RIM will have raise $10 million by issuing a four-year bond that has a current yield of 17.61% and a 15.0% coupon rate (coupons will be paid semi-annually).

a) If RIM decides to issue this bond, what will be the effective yield to maturity?

b) Assume an investor bought the bond (in part a) and sold it after two years. If market interest rates remained constant over this period, what was the holding period return on this investment? (Assume the coupons were not re-invested).

c) In order to be able to pay back the total face value ($10 million) in four years, RIM’s management has decided to use a sinking fund in which it will make semi-annual payments. The sinking fund pays an interest of 9.0% compounded semi-annually. How much does the company have to contribute to the sinking fund every six months to ensure it has enough funds to pay back the entire bond issue at maturity? (Assume payments will be made at the end of each six month period).

 

Summary

The question belongs to Finance and it discusses about calculating effective yield to maturity for a bond.

Total Word Count 145

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