1) Why do lower rated bonds trade at a higher yield to maturity?

2) What is the price of a bond, such as Air Canada, if the coupon rate is exactly the same as the yield to maturity (market required rate of return)?

3) Tech Edge Inc. (TEI), once known as the global leader in wireless innovation, has lost its darling status after the introduction of the latest Apple iPhone. Recently, TEIs stock price declined by approximately 75% and its bond ratings have been downgraded to CCC. Now management believes they might have to raise capital this year (2022) by issuing debt. You work for an investment bank in Toronto that has been hired by TEI to advise them on the debt issue.

Based on your research and market conditions, you feel TEI will have raise $10 million (market value) by issuing a four-year bond that has a 9.0% coupon rate (coupons will be paid semi-annually). Assume a face value of $1000. If TEI uses a 9% coupon, you have advised the company that should be able to get the bonds sold at par value ($1000).

a) If TEI decides to issue this bond, what will be the bonds yield to maturity?

b) How many $1000 face bonds would have to be issued to raise the $10 million needed?

c) Assume market interest rates for all bonds go up 2% as the Bank of Canada raises rates over the next year to combat inflation. What would be the price of the TEI bond in one year if the required return (YTM) on TEI bonds increases to 11%?

d) What is the rate of return that an investor would earn if they bought TEI 9% bonds today and sold them in one year, when its YTM has increased to 11%? Hint: Use the formula below.

Rate of Return =

e) Why should you be concerned if an investment advisor tells you (or your parents) that bonds are a safe investment?