Solution to Minicase 5
Bond Yields for Johnson & Johnson
The case enables the student to gain insight into the financing activities of large corporations and to practice calculating bond prices and yields. Computations are carried out for annual and semiannual interest periods, and for fractional periods.
Johnson & Johnson is one of the leading pharmaceutical firms in the world. It is large and financially sophisticated. When it needs to borrow money, it sells bonds where it can get the best deal. Sometimes that means selling bonds to U.S. investors. Other times it means issuing Eurodollar bonds to investors outside the United States. (The text discusses the Eurobond market in more depth in Chapters 20 and 27.)
The student is asked in this case to use the techniques developed in Chapter 5 to calculate the yields of domestic bonds and Eurobonds. The main difference between the two is that domestic bonds pay interest semiannually, whereas Eurobonds pay annually. Due to this difference in the frequency of compounding, the student must be careful to compare the APYs of domestic and Eurobonds when trying to find the lower-cost alternative.
Exhibit S-5-1 provides information concerning five Johnson & Johnson debt issues.
Answers to Questions:
1. Calculate the APY for each of Johnson & Johnson’s bonds and identify which one has the lowest APY, assuming today is January 15, 2009.
Bond 1, calculate the APY of the 7.375s23 eurobond. There are 15 coupon payments left, and the last one was made 2 months plus 6 days ago (66 days ago). Use annual payment analysis; CPN=7.375% x 1000 = $73.75. Solve the equation using a spreadsheet with N=15, and f=(66/360)=0.183333 to find the APY = 7.3001%:
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Bond 2, calculate the APY of the 7.375s22 domestic bond. There...
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