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Chapter 5: 5BP (page 528)

Match the yield to maturity in column 2 with the security provisions (or lack thereof) in column 1. Higher returns tend to go with greater risk.

(1) (2)

Security Provision Yield to Maturity

a.Debenture a.6.85%

b.Secured debtb.8.20%

c.Subordinated debenture c.7.76%

Short Answer

Expert verified
  1. Debenture 鈥� 8.20%
  2. Secured debt 鈥� 6.85%
  3. Subordinated debt 鈥� 7.76%

Step by step solution

01

Concept of secured, unsecured, and yield to maturity for debt

Secured debts are those that are backed up by some class of assets. Thus they are less risky in terms of default. Because of lower risk, interest is also earned less on these debts.

On the contrary, unsecured debt does not have any security and charges higher interest for taking more risk.

02

Matching yield to maturity with security types

a. Debenture 鈥� it is the security that does not need any security for providing loans. Thus the risk is higher in this case. So, the interest earned on the debenture would be 8.20%.

b. Secured debt 鈥� Since it is the secured debt, it has been backed up by certain assets. So, the risk is lowest under this type of loan, In this case, the yield to maturity would be 6.85%.

c. Subordinate debenture 鈥� A subordinate debenture is also an unsecured loan with the difference that they are not highly ranked and subordinated debts. The yield to maturity for this loan would be 7.76%.

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Most popular questions from this chapter

Question:The yield to maturity for 10-year bonds is as follows for four different bond rating categories:

Aaa 9.40% Aa2 10.00%

Aa1 9.60% Aa3 10.60%

The bonds of Falter Corporation were rated as Aaa and issued at par a few weeks ago. The bonds have just been downgraded to Aa2. Determine the new price of the bonds, assuming a 10-year maturity and semiannual interest payments. (Refer to 鈥淪emiannual Interest and Bond Prices鈥� in Chapter 10 for a review if necessary.)

Question: The Bowman Corporation has a \(18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new \)18,000,000 issue is \(530,000, and the underwriting cost on the old issue was \)380,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.

c. Calculate the net present value.

Question:Twenty-five-year B-rated bonds of Parker Optical Company were initially issued at a 12 percent yield. After 10 years the bonds have been upgraded to Aa2. Such bonds are currently yielding 10 percent to maturity. Use Table 16-2 to determine the price of the bonds with 15 years remaining to maturity. (You do not need the bond ratings to enter the table; just use the basic facts of the problem.)

The Hamilton Corporation Company has 4 million shares of stock outstanding and will report earnings of \(6,910,000 in the current year. The company is considering the issuance of 1 million additional shares that can only be issued at \)30 per share.

a. Assume that Hamilton Corporation Company can earn 7.0 percent on the proceeds. Calculate the earnings per share.

b. Should the new issue be undertaken based on earnings per share?

Discuss the reason for the differences between underwriting spreads for stocks and bonds.

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