CASE 3: Your uncle is retired and lives on state pension and the interest he gets...

Transcribed Image Text:

CASE 3: Your uncle is retired and lives on state pension and the interest he gets from his savings. As interest rates have been falling con- tinuously, his income from interest on his savings has dwindled to a mere 3 percent a year on his savings of 120,000. He has approached you as a student of finance to advise him on how he can invest a portion of his savings in some corporate bonds as a way of increasing his interest income. You have conducted a basic survey and have identified three corporate bonds for your uncle to consider. The first is an issue from Waves Plc, which pays annual interest based on a 7 percent coupon rate and matures in 10 years. The second bond is from Swallow Properties Plc, and it pays 7.5 percent annual interest and has 15 years until it matures. The final bond issue is by Thomas Media Plc, and it pays an annual coupon interest payment at 8 percent and has four years until it matures. All three bonds have a 1,000 par value. You have collected data for the bonds' default risk and credit ratings. After your analysis you have very different yields to maturity in mind for the three bond issues, as noted below. Swallow Properties Thomas Media 7.5% 8% Coupon interest rate Years to maturity Waves 7% 10 15 4 Current market price 1,100 980 1,010 Par value 1,000 ,1000 1,000 Bond rating B BBB Before recommending any of the three bonds to your uncle, you perform a number of analyses. Specifically, you want to ad- dress each of the following issues: 1. Estimate an appropriate market's required yield to maturity for each of the bond issues using credit spreads reported in Table 9.4. 2. Consider the selling price for each of the bond issues as given in the table above. Calculate the yield to maturity for each bond. 3. Given your estimate of the proper discount rate, what is your estimate of the value of each of the bonds? In light of the prices recorded above, which issue do you think is most attractively priced? 4. How would the value of the bonds change if the market's required yield to maturity on a comparable-risk bond (i) in- creases 3 percentage points or (ii) decreases 3 percentage points? Which of the bond issues is the most sensitive to changes in the rate of interest? 5. What are some of the things you can conclude from these computations? 6. Which of the bonds (if any) would you recommend to your uncle? Explain. CASE 3: Your uncle is retired and lives on state pension and the interest he gets from his savings. As interest rates have been falling con- tinuously, his income from interest on his savings has dwindled to a mere 3 percent a year on his savings of 120,000. He has approached you as a student of finance to advise him on how he can invest a portion of his savings in some corporate bonds as a way of increasing his interest income. You have conducted a basic survey and have identified three corporate bonds for your uncle to consider. The first is an issue from Waves Plc, which pays annual interest based on a 7 percent coupon rate and matures in 10 years. The second bond is from Swallow Properties Plc, and it pays 7.5 percent annual interest and has 15 years until it matures. The final bond issue is by Thomas Media Plc, and it pays an annual coupon interest payment at 8 percent and has four years until it matures. All three bonds have a 1,000 par value. You have collected data for the bonds' default risk and credit ratings. After your analysis you have very different yields to maturity in mind for the three bond issues, as noted below. Swallow Properties Thomas Media 7.5% 8% Coupon interest rate Years to maturity Waves 7% 10 15 4 Current market price 1,100 980 1,010 Par value 1,000 ,1000 1,000 Bond rating B BBB Before recommending any of the three bonds to your uncle, you perform a number of analyses. Specifically, you want to ad- dress each of the following issues: 1. Estimate an appropriate market's required yield to maturity for each of the bond issues using credit spreads reported in Table 9.4. 2. Consider the selling price for each of the bond issues as given in the table above. Calculate the yield to maturity for each bond. 3. Given your estimate of the proper discount rate, what is your estimate of the value of each of the bonds? In light of the prices recorded above, which issue do you think is most attractively priced? 4. How would the value of the bonds change if the market's required yield to maturity on a comparable-risk bond (i) in- creases 3 percentage points or (ii) decreases 3 percentage points? Which of the bond issues is the most sensitive to changes in the rate of interest? 5. What are some of the things you can conclude from these computations? 6. Which of the bonds (if any) would you recommend to your uncle? Explain.