Building on its reputation for manufacturing no-thrills, efficient and affordable automobiles, the Indian car manufacturer Indy Cars Ltd. Is ready to launch an international marketing campaign, specifically targeting low- to medium- income customers in Asia and Europe. In preparation for the expected demand increase, a new production facility will be added in the state of Andhra Pradesh near Hyderabad to complement the already existing plants in Mumbai and New Delhi. The companys CFO, Raja Jain, is planning to raise the required funds of Indian Rupees (Rs.) 10 billion ($222.4 million) in the form of a 20-year, annual coupon paying corporate bond. The companys current debt rating with Standard & Poors is A with a positive outlook, indicating the likelihood of a rating upgrade to AA in the near future. In that case, the markets required rate of return could drop by as much as 75 basis points from 6.80 percent to 6.05 percent. Mr. Jain is wondering if the bond should be issued at a premium or a discount and if the company should offer a fixed or floating rate or, instead of making explicit interest payments, issue a zero-coupon bond instead. Each bond will have a normal value of Rs. 1,000. The intended issue date is 1 July 2023. Your job is to:

QUESTIONS:

2. Compute the expected issue price based on a required rate of return of 6.8 percent for

a. a fixed annual interest payment of Rs. 64 per bond

b. a fixed annual interest rate of Rs. 72 per bond.

c. Does your answer to a and b change if semi-annual interest payments of Rs. 32 is made? If so, why?

d. A zero-coupon bond

Annual Interest = Rs.64 will be paid per bond of Rs.1000 face value (coupon rate of 6.4%)

So, price of bond with a YTM of 6.8% for 20 years

P = 64/0.068*(1-1/1.068^20)+1000/1.068^20

=Rs.956.96

So, the issue price of the bond will be Rs.956.96 per bond of Rs.1000 face value

Annual Interest = Rs.72 will be paid per bond of Rs.1000 face value (coupon rate of 7.2%)

So, price of bond with a YTM of 6.8% for 20 years

P = 72/0.068*(1-1/1.068^20)+1000/1.068^20

=Rs.1043.04

So, the issue price of the bond will be Rs. 1043.04 per bond of Rs.1000 face value

If semiannual interest of Rs.32 is paid , no of payments = 40

Semiannual YTM = 6.8%/2 =3.4%

So, Price of bond = 32/0.034*(1-1/1.034^40)+1000/1.034^40

=Rs.956.62

If semiannual interest of Rs.36 is paid , no of payments = 40

Semiannual YTM = 6.8%/2 =3.4%

So, Price of bond = 36/0.034*(1-1/1.034^40)+1000/1.034^40

=Rs.1043.38

The answer has changed because both the Coupon rate and YTM are now semiannually compounded instead of annually compounded as assumed earlier

Price of a zero-coupon bond = Rs.1000/1.068^20

= Rs.268.27

So, the issue price of the Zero coupon bond will be Rs. 268.27 per bond of Rs.1000 face value

3. Recompute your results of 2 a, b and c assuming an upgrade in the companys credit rating and determine the impact on the expected issue price