Module $4$ Assignment: Bond Valuation

CASE $13$: PACIFIC HEALTHCARE $($A$)$

Directions: Fully answer each question regarding Case $13$: Pacific Healthcare.

$1.$ To prepare for the meeting, create a summary of the yields of each bond by completing the table shown in exhibit $13\mathrm{.}2.$ Remember that the YTM of each bond is assumed to be the required rate of return of each bond and that the semiannual YTM must be multiplied by two to get the stated $($nominal$)$ YTM$.$

$2.$ At the meeting, a committee member asks, $$The two $25-$year bonds have the same maturity date, so why do the current yields and capital gain yields of these bonds differ?$$ How do you reply to the committee member? $($Hint: No additional calculations are required.$)$

$3.$ Next, the committee member notices that there is an expected capital gain on one of the $25-$year bonds and a capital loss on the other and so asks, $$assuming current interest rates don$$t change, will these gains and losses continue over the life of the bond?$($Hint: In one figure, graph the expected value of each bond over the $25$ years to maturity.$)$

$4.$ The committee chair states that interest rates change over time, which causes interest rate risk. She asks you to identify the bond that has the most price risk. $($Hint: For each bond, compare the values at interest rates of $6,8,10,12,$ and $14$ percent.$)$

$5.$ The chair then asks you to identify the bond that has the greatest reinvestment rate risk for an investor who has an investment horizon $($or expected holding period$)$ of $25$ years. Is there a type of bond the investor could buy to eliminate reinvestment rate risk? $($Hint: No additional calculations are required.$)$