Saturday, 4 May 2013
Case
A&N Corporation is currently deciding to expand its operations as forecasted sales figure for next year
is showing a significant increase ascompare to last year. Company has to import new plant to meet its
production demand that requires finances, although company is generating profits from last many
years but still external finance is needed for the import of plant. There are two options available for
company to generate finances through external source (either through issuance of shares or through
bond issuance). Keeping in mind advantage of debt financing (tax shield affect) management has
decided to issue bonds of two different maturities; information about two bonds is given below:
Bond A:5-year bond with par value of Rs. 1,000 and 16% annual coupon payments.
Bond B:12-years bond with par value of Rs. 1,000 and 16% annual coupon payments.
Moreover required rate of return for such types of investment is 18 %
One of your friends (Mr. A) is thinking to invest in the bonds of A & N Corporations and wants to
know the current price of bond and the impact of interest rate volatility on the price of bonds. Being a
student of Corporate Finance you have to help your friend inextracting following required
information.
1. Calculate current market price of both bonds. (6 marks)
2. If required rate of return increases by 2%, which component ofterm structure of interest rate
will be affected by increase in required rate of return and how? Discuss with respect to both
bonds. (4 marks)
3. Suppose your friend has invested in bond A. A month after purchase, country’s political
situation has become uncertain that has affectedthe financial markets as well as investor’s
return. Your friend is worried that how this adverse economic situation will affect his yield to
maturity. Mr. A has asked you to help him out incalculating the yield tomaturity; if current
market price of Bond A is Rs. 850?
(10 marks)
Important Instruction:
