RST PLC is a stock exchange listed manufacturing company. Following a decision made by the board to expand its manufacturing faclilties, the company needs to raise additional finance amounting to $75 million by way of a five year corporate bond issue. The proposed corporate bond will have a par value of $k100 and will be remeeded a par value at the end of year five.

The issue will significantly change the companys capital structure and as such, the credit rating will fall from the current AAA to A. The companys treasurer has been advised that this is still within the investment grade.

The government bond yield curve shows the following spot rates

Year 1	Year 2	Year 3	Year 4	Year 5
4.52%	4.85%	5.25%	5.85%	6.02%

In addition, the following table showing the credit spreads applicable to the sector in the RST PLC operates have been obtained from a credit rating agency.

CREDIT SPREADS IN BASIS POINTS

Credit rating	Year 1	Year 2	Year 3	Year 4	Year 5
AAA	20	30	40	50	60
AA	45	55	64	76	82
A	52	62	73	85	96

The following proposals have been made in respect of the proposed bond issue

Proposal 1: issue the proposed corporate bond with a fixed annual coupon rate of 6%, with the first payment being made at the end of year 1.

Proposal 2: issue the proposed corporate bond with a fixed annual coupon rate of 4%, from year 1 to year 3 and a fixed annual coupon rate of 7% from year 4 to year 5.

Proposal 3: issue the proposed corporate bond with a fixed annual coupon rate but such that the issue price will be equal to the bonds par value of $ 100.

Proposal 4: issue the proposed corporate bond with a variable annual coupon rate based on the bank base rate so that the annual coupons will be bank rate + 40 basis points.

Required

1. Calculate whether the proposed bond would be issued at a discount or at a premium if terms of issue were

1. Those in proposal 1
2. Those in proposal 2

2. Calculate what the fixed annual coupon rate would be if the proposed bond was issued based on the terms of proposal 3
3. Explain why a company may consider issuing a bond based on terms stated under proposal 2
4. Discuss the problems that are likely to be faced by a company if the proposed bond was issued based on the terms of proposal 4
5. Explain and discuss the relationship between the coupon rate, the yield to maturity and the price of redeemable bonds

RST PLC is a stock exchange listed manufacturing company. Following a decision made by the board to expand its manufacturing faclilties, the company needs to raise additional finance amounting to $75 million by way of a five year corporate bond issue. The proposed corporate bond will have a par value of $k100 and will be remeeded a par value at the end of year five.

The issue will significantly change the companys capital structure and as such, the credit rating will fall from the current AAA to A. The companys treasurer has been advised that this is still within the investment grade.

The government bond yield curve shows the following spot rates

Year 1	Year 2	Year 3	Year 4	Year 5
4.52%	4.85%	5.25%	5.85%	6.02%

In addition, the following table showing the credit spreads applicable to the sector in the RST PLC operates have been obtained from a credit rating agency.

CREDIT SPREADS IN BASIS POINTS

Credit rating	Year 1	Year 2	Year 3	Year 4	Year 5
AAA	20	30	40	50	60
AA	45	55	64	76	82
A	52	62	73	85	96

The following proposals have been made in respect of the proposed bond issue

Proposal 1: issue the proposed corporate bond with a fixed annual coupon rate of 6%, with the first payment being made at the end of year 1.

Proposal 2: issue the proposed corporate bond with a fixed annual coupon rate of 4%, from year 1 to year 3 and a fixed annual coupon rate of 7% from year 4 to year 5.

Proposal 3: issue the proposed corporate bond with a fixed annual coupon rate but such that the issue price will be equal to the bonds par value of $ 100.

Proposal 4: issue the proposed corporate bond with a variable annual coupon rate based on the bank base rate so that the annual coupons will be bank rate + 40 basis points.

Required

1. Calculate whether the proposed bond would be issued at a discount or at a premium if terms of issue were

1. Those in proposal 1
2. Those in proposal 2

2. Calculate what the fixed annual coupon rate would be if the proposed bond was issued based on the terms of proposal 3
3. Explain why a company may consider issuing a bond based on terms stated under proposal 2
4. Discuss the problems that are likely to be faced by a company if the proposed bond was issued based on the terms of proposal 4
5. Explain and discuss the relationship between the coupon rate, the yield to maturity and the price of redeemable bonds