Jackson Corporation sources and distributes pharmaceutical products in the United States and internationally. Its pharma

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Jackson Corporation sources and distributes pharmaceutical
products in the United States and internationally. Its
pharmaceutical distribution segment distributes brand-name and
generic pharmaceuticals, over-the-counter healthcare products, home
healthcare supplies and equipment, outsourced compounded sterile
preparations, and related services to various healthcare providers.
The company wants to raise long-term debt of $10 million for
research and development by issuing corporate bonds. The financial
manager of the company, Chris Doughman, MBA is working with First
Investment Bank to issue the bonds. The investment bank is
providing consulting and advisory services to Jackson Corporation.
Chris must make presentations to the investment banking firm to
enable it to get the information needed to prepare the bond
indenture.
Chris stated in the presentation that the bond would have 15
years to maturity, interest would be paid annually, and the bonds
would have $1,000 par value. The coupon interest rate, according to
Chris, would be determined using the following equation:
rd= r* + IP + MRP + DRP + LP, where
rd is quoted market interest rate, r* is real
risk-free rate, IP is inflation premium, MRP is maturity risk
premium, DRP is default risk premium, and LP is liquidity premium.
Chris has gathered the following data:
Characteristic
Bond
Time to maturity
15 years
Real risk-free rate
2.00%
Inflation premium
2.20%
Maturity risk premium
2.50%
Default risk premium
2.40%
Liquidity premium
0.90%
1. Calculate the quoted market interest rate for the corporate
bond using the equation.
2. Using the market interest rate calculated above, determine
the coupon payment i.e., the dollar amount to be paid every year to
bondholders.
3. First Investment Bank is using the answers presented in
questions 1 and 2 to value the bond. Calculate the present value of
the bond if the yield to maturity is 10%.
4. Suppose that three years later Jackson
Corporation’s bonds have 12 years remaining to maturity. Interest
is paid annually, the bonds have $1,000 par value, and the coupon
interest rate is 8%. The bonds have a yield to maturity of 9%.
Calculate the current market price of the bond.
5. Another company, Charter Corporation has issued
2,500 debentures with a face value of $1,000.
The bonds have 10 years to maturity. The bonds have a coupon
interest rate of 8% that is paid semiannually. What dollar amount
of interest per bond can an investor expect to receive every 6
months?
6. Charter Corporation bonds have 10 years remaining to
maturity. The bonds have a face value of $1,000 and a yield to
maturity of 9%. The coupon rate is 8% that is paid
semiannually.
i. Calculate the selling price of this debenture
ii. Calculate the current yield of this debenture.
7. Kahiki’s Foods Inc. corporate bonds have 10 years remaining
to maturity. The bonds have a face value of $1,000, and a coupon
rate of 10%. The company pays $100 interest per bond annually. The
present value of the bond is $900. The bond is a callable bond.
Calculate the yield to maturity of the bond (note: PV is negative
because it is a cash outflow, i.e., it costs $900 to purchase the
bond).
8. Some bondholders of Kahiki Foods do not understand the
difference between yield to maturity and yield to call on callable
bonds. Explain to them the difference between yield to
maturity and yield to call.
9. Describe the following types of bonds:
i. debentures
ii. convertible bonds
iii. junk bonds
iv. callable bonds
10. Jackson’s corporate bonds are being reviewed by some credit
rating agencies. Rating agencies do a good job of measuring the
average credit risk of bonds and providing information to lenders
whenever there is a significant change in credit quality of bonds.
One of the credit rating agencies, Moody’s Investor Services has
downgraded Jackson’s bonds rating from Aa to Baa.
Identify three factors that
might have contributed to the low ratings of Jackson’s bonds.