reading 35 - part practice question 22

CFA Level I Corporate Finance
#1

Hi, I am having some issues calculating the cost of debt for the below :

Currently outstanding bonds $2.4 million five-year bonds, coupon of 12.5 percent, with a market value of $2.156 million

The solution presented in the curriculum is as follows :

For debt: FV = 2,400,000; PV = 2,156,000; n = 10; PMT = 150,000

Solve for i. i = 0.07748. YTM = 15.5%

However , I am not getting the 0.07748 but a negative rate.

please help :slight_smile:

#2

Check the signs on your inputs. You want either:

  • FV = 2,400,000
  • PV = −2,156,000
  • PMT = 150,000

or else:

  • FV = −2,400,000
  • PV = 2,156,000
  • PMT = −150,000
#3

It does indeed help, thanks s2000magician!! :slightly_smiling_face: However this has raise another question :

I thought it was only 1 variable ( FV or PV) which had to be concerned with the -ve sign.

So, when do I have to use the -ve sign for FV or PV or PMT ?

#4

The PV, FV, and PMT buttons are cash flow buttons. Which numbers are positive and which are negative depends on the point of view that you adopt.

If you look at this problem from the point of view of the company issuing the bonds, the borrower, then PV is positive (they receive money today from issuing the bonds), PMT is negative (they pay coupons), and FV is negative (they pay the par value at maturity).

If you look at this problem from the point of view of the bondholder, the lender, then PV is negative (they pay money today to purchase the bonds), PMT is positive (they receive coupons), and FV is positive (they receive the par value at maturity).

I encourage you to decide on a point of view – borrower or lender, it doesn’t matter – and always adopt that point of view when working these problems. You’ll find that you make fewer mistakes that way.

#5

Thanks a lot for your help!!

It does clarify a lot :slight_smile:

#6

My pleasure.

#7

Hi,

Could you please advise me how “n = 10” is derived in the solution as I am not sure the five-year bonds are semi-annual coupon payment. Thank you.

#8

N is the number of payments to be made in the future. You can enter it directly as 10 , or enter 5, press the 2nd N to get xP/Y, which will multiply 5 by whatever you have stored as P/Y (which should be 2 for semi-annual) and the display will change to 10. You can then press N to register 10.

#9

Thank you for your reply. My question is how come the bond is semi-annual coupon payments from the explanation below.

Currently outstanding bonds $2.4 million five-year bonds, coupon of 12.5 percent, with a market value of $2.156 million

#10

Unless otherwise specified, coupons and bond yields are quoted nominal semi-annual.

#11

Understood with many thanks.