Lisa Crawfall started to work as an intern in the fixed-income department of the AAA Mutual Funds
Question:
Lisa Crawfall started to work as an intern in the fixed-income department of the AAA Mutual Funds on January 2, 2018. Her supervisor, Janet Zemo, assigned her to analyze interest rate risk associated with investment in bonds issued by Superior Energy. Ms. Zemo provided Lisa with the information about four bonds issued by Superior Energy. The four bonds are named as AB, CD, EF, and GH.
Bond AB | Bond CD | Bond EF | Bond GH | |
Price on January 1, 2018 | 110 | 115 | 96.5 | 103 |
Annual coupon rate | 7.0 | 7.0% | 1% | 5.9% |
Maturity date | 12/31/2040 | 12/31/2036 | 12/31/2018 | 12/31/2018 |
Par value | $1,000 | $1,000 | $1,000 | $1,000 |
Coupon payment frequency | Semiannual | Semiannual | Semiannual | Semiannual |
Rating | A | A | A | A |
Then, Ms. Zemo assigned Lisa to do the following research jobs based on the information:
- Calculate the yield to maturity for the four bonds on January 2, 2018, respectively.
- Based on the macroeconomic data released by the National Bureau of Economic Research, Ms. Zemo expected that inflation rate will increase by 1%. Hence, she expected that yield to maturity for the four bonds will increase by 1% too. She asked Lisa to calculate prices of the four bonds if the yield to maturity increases by 1%, respectively.
- List the bond prices of the four bonds on January 1, 2018 and the bond prices of the four bonds calculated in 2) when the yield to maturity increases by 1% in a table. Lisa next calculated the percentage price change of the four bonds.
- Since Bond AB and Bond CD have the same coupon rates, Ms. Zemo asked Lisa to compare which bond price will drop more when the yield to maturity increases by 1%? Since Bond EF and Bond GH have the same maturity date, Ms. Zemo asked Lisa to compare which bond price will drop more when the yield to maturity increases by 1%?
- Based on the results in 1) through 4), Lisa needed to report to Ms. Zemo about which bonds have higher interest rate risk and why.
Suppose that you are Lisa Crawfall. Please write a short memo to address 1) through 5). The calculation results are attached to the memo.
Note: Each group turns in one copy of group exercise on Canvas. Please write down your group’s name and the names of the group members who participate in the exercise on your turned-in assignment. You are required to use the Excel Spreadsheet to do quantitative analysis and write a memo in Word. Please turn in a hard copy of your work on 3/26.
Financial Accounting
ISBN: 978-1259105692
6th Canadian edition
Authors: Robert Libby, Patricia Libby, Daniel G Short, George Kanaan, Maureen Sterling