Wednesday 30 January 2013
ASSIGNMENT
Mr. Prudent has recently graduated from Business Finance School with major in portfolio management. In this regard, the area of his interest is “Fixed Securities”. Last Friday, on his 23rd birthday, his father gifted him a bank transfer of Rs. 30,000 to his name. Now, to his interest Mr. Prudent is planning to invest in the bonds of Limited Liability Company (LLC).
In 2008, LLC issued 8% bonds with face value of Rs. 1,000 to be redeemed in 2038. Moreover, these bonds bear the feature of being called upon by the company after the 5 years of their issuance at any time at a call price of Rs. 1,150 each. Bond Rating Agency (BRA) has rated this bond at A+.
State’s Central Bank has recently disclosed rate of inflation at 5% but an Independent Economist is of the view that this rate would certainly be increased by 1% at the end of this year as money supply is crossing over its demand. Mr. prudent, though interested in buying LLC’s bonds but also fears due to expected rise in the inflation which may cause damage to his investment. Another risk he feels is the maturity risk as the bond has still more than 2 decades to mature.
REQUIRED
While considering all of the above mentioned information, Mr. Prudent is encouraging you to answer the following questions to help him make buy decision:
a) What would be the bond’s value if Mr. Prudent desires a required return of 6%, 8%, and 10%? Would each of these computations carry any discount, premium or the face value? (6+3)
b) In which of the above cases, Mr. Prudent should buy this bond and why? (3)
c) Analyze the relationship between required rate of return and bond’s intrinsic value as per the following graph relating to a 6% bond issued by the company 7 years earlier keeping in view the maturity risk. (3)
d) What would be the capital gain or loss, if Mr. Prudent purchases the bond at call price while taking into account 1% increase in inflation and sells this bond after 5 years from now? (5)
e) What would be his yield to maturity on this bond at today’s purchase price of Rs. 980 and holding it till its maturity? (5)
Mr. Prudent has recently graduated from Business Finance School with major in portfolio management. In this regard, the area of his interest is “Fixed Securities”. Last Friday, on his 23rd birthday, his father gifted him a bank transfer of Rs. 30,000 to his name. Now, to his interest Mr. Prudent is planning to invest in the bonds of Limited Liability Company (LLC).
In 2008, LLC issued 8% bonds with face value of Rs. 1,000 to be redeemed in 2038. Moreover, these bonds bear the feature of being called upon by the company after the 5 years of their issuance at any time at a call price of Rs. 1,150 each. Bond Rating Agency (BRA) has rated this bond at A+.
State’s Central Bank has recently disclosed rate of inflation at 5% but an Independent Economist is of the view that this rate would certainly be increased by 1% at the end of this year as money supply is crossing over its demand. Mr. prudent, though interested in buying LLC’s bonds but also fears due to expected rise in the inflation which may cause damage to his investment. Another risk he feels is the maturity risk as the bond has still more than 2 decades to mature.
REQUIRED
While considering all of the above mentioned information, Mr. Prudent is encouraging you to answer the following questions to help him make buy decision:
a) What would be the bond’s value if Mr. Prudent desires a required return of 6%, 8%, and 10%? Would each of these computations carry any discount, premium or the face value? (6+3)
b) In which of the above cases, Mr. Prudent should buy this bond and why? (3)
c) Analyze the relationship between required rate of return and bond’s intrinsic value as per the following graph relating to a 6% bond issued by the company 7 years earlier keeping in view the maturity risk. (3)
d) What would be the capital gain or loss, if Mr. Prudent purchases the bond at call price while taking into account 1% increase in inflation and sells this bond after 5 years from now? (5)
e) What would be his yield to maturity on this bond at today’s purchase price of Rs. 980 and holding it till its maturity? (5)
