Take the 2-minute tour ×
Quantitative Finance Stack Exchange is a question and answer site for finance professionals and academics. It's 100% free, no registration required.

This is a simple problem but I'm not sure about one aspect of it.

A company has 15 year bonds outstanding, with a 5% annual coupon, a face value of \$1000, and a current market value of \$1100. What is the company's pre-tax cost of debt?

I'm tempted to think it's just 5%, as when the company originally sold the bonds it received $1000 and is paying 5% coupons on that original face value, but the inclusion of the current market value is confusing me. I'd appreciate any help you can give me.

share|improve this question
1  
Wild guess: CFA Level I question? –  SRKX Dec 12 '12 at 23:19
    
@SRKX Exactly what ran through my head when I read it - that's why I included the accounting bit. –  jeff m Dec 13 '12 at 4:12
add comment

1 Answer

up vote 1 down vote accepted

It's a simple TVM problem - solve for the interest rate. The "current" cost of debt would be market determined, so that's why you use the market value. It ties into how bond accounting works - the premium of the bond is amortized until maturity. The amortization amount would be the difference between the coupon and the interest expense(market rate at issuance)

share|improve this answer
    
So I'm just calculating the YTM? –  Cooper Royce Dec 7 '12 at 20:33
    
@CooperRoyce Unless I misunderstood the question, yes. –  jeff m Dec 8 '12 at 21:41
    
Thanks for your help. –  Cooper Royce Dec 8 '12 at 22:04
add comment

Your Answer

 
discard

By posting your answer, you agree to the privacy policy and terms of service.

Not the answer you're looking for? Browse other questions tagged or ask your own question.