Answer to Question #259913 in Financial Math for JAMES

Question

Upendo ltd wishes to take advantage of the new commercial paper now popular. It

wishes to issue two debenture papers. Both bear coupons of 12% and the effective yield

required on each is 20%. Paper A has a maturity of 10 years and paper B a maturity of

20 years. Both will be paying interest annually and Kshs. 100,000 at maturity. What is

the price of each paper? If the effective yield on each paper rises to 24%, what is the

price of each paper?

Answer 1

Cost of Debentures=Interest(1-t) + (Par Value - Market Value)/0.5(Par Value-Market Value)
         Ke={D0(1+g)/(Market Price per share)}+g
                ={12(1+24)/20}+24
                     15+24=39

Cost of debentures(A)={12(1-0)+(24-12)^1/10}/{1/2(24+12)}

                        =(12+1.82)/18
                               =0.7678
                               =76.78%

Cost of debenture(B)={12(1-0)+(24-12)^1/20}/{0.5(24+12)}

                         =1.132/18
                           =0.0628
                             =62.8%