Suppose Ford Motor Company issues a five year bond with a...

Suppose Ford Motor Company issues a five year bond with a face value of $5,000 that pays an annual coupon payment of $150. a. What is the interest rate Ford is paying on the borrowed funds? b. Suppose the market interest rate rises from 3% to 4% a year after Ford issues the bonds. Will the value of the bond increase or decrease?

Suppose Ford Motor Company issues a five year bond with a face value of $5,000 that pays an annual
coupon payment of $150.
a. What is the interest rate Ford is paying on the borrowed funds?
b. Suppose the market interest rate rises from 3% to 4% a year after Ford issues the bonds. Will the value of the bond increase or decrease?

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Key Concepts

Coupon Rate

The coupon rate is the fixed annual interest payment a bond issuer promises to pay based on the bond's face value. It represents the rate of interest that the borrower effectively pays on the borrowed funds and is calculated by dividing the annual coupon payment by the face value of the bond.

Market Interest Rate and Bond Value

Market interest rates play a crucial role in bond valuation. There is an inverse relationship between market interest rates and the price of a bond; when market interest rates rise, the present value of a bond's future cash flows (coupon payments and face value) falls, leading to a decrease in the bond's market value.

Bond Pricing

Bond pricing involves discounting the bond's future cash flows (both periodic coupon payments and the face value at maturity) by an appropriate discount rate, often linked to prevailing market interest rates. This calculation helps determine the current market price of the bond relative to its promised payments.

Transcript

00:01 Hey everyone, today we're solving problem number 38 on chapter 17 of the textbook.

00:07 This is a two -part problem.

00:09 And we're given this scenario.

00:11 Suppose ford motor company issues a five -year bond with a face value of $5 ,000 that pays an annual coupon payment of $150.

00:22 What is the interest rate that ford is paying on the borrowed funds? and then in part b, we're asked, suppose the market interest rate raises from 3 % to 4 % a year after 4th issues the bonds, will the value the bond increase or decrease? so let's start off with part a.

00:40 We're trying to figure out what the annual interest rate is.

00:44 So we're going to use the initial value of $150, and we're going to end up dividing by the $5 ,000 base value.

01:08 And this is all in parentheses.

01:12 And that's also going to be divided by 5.

01:18 And all this needs to be multiplied by 100 because we're looking for percentage.

01:24 So that's the formula.

01:26 So i can do this actually pretty easily without a calculator.

01:30 I have 150 over 5 ,000 divided by 5 is simply 1 ,000.

01:38 And then i'm going to multiply this number by 100.

01:42 And 100 is the same thing as 100 over 1.

01:45 I can cross multiply.

01:48 100 goes into 1 ,000, 10 times.