Problem 1

In May 2011, Apache issued a 10-year, $263M bond paying 8.0% annually in two equal coupons each May and November. It is now May 2015 and Apache just paid the May coupon on its existing bond. Rates have come down so it is thinking of buying back the bond and issuing a 5-year, $330M bond. This bond matures in May 2020 and will pay 3.0% per year in equal coupons each May and November.

a. What is the price that Apache must pay the current bond holders to buy back the bond? (Hint - the present value of the coupon payments and the final face value)

b. What are the cash flows associated with the new bond?

c. What are the cash flow differentials to Apache? In other words, what are the net cash flows in or out for Apache each May and November when comparing both bonds?

d. What is the present value of these cash flow differentials?

e. What does the answer to d tell you?

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