Financial Management-Chapter 7 Solution- Gitman
Financial Management-chapter 7 solution- Gitman
7-21
Western Money Management Inc.
Bond Valuation
Robert Black and Carol Alvarez are vice presidents of Western Money Management and codirectors of the company’s pension fund management division. A major new client, the California League of Cities, has requested that Western present an investment seminar to the mayors of the represented cities. Black and Alvarez, who will make the presentation, have asked you to help them by answering the following questions. A. Answer: What are a bond’s key features? [Show S7-1 through S7-4 here.] If possible, begin this lecture by showing students an actual bond certificate. We show a real coupon bond with physical coupons. These can no longer be issued—it is too easy to evade taxes, especially estate taxes, with bearer bonds. All bonds today must be registered, and registered bonds don’t have physical coupons. 1. Par or face value. We generally assume a $1,000 par value, but par can be anything, and often $5,000 or more is used. With registered bonds, which is what are issued today, if you bought $50,000 worth, that amount would appear on the certificate. 2. Coupon rate. The dollar coupon is the “rent” on the money borrowed, which is generally the par value of the bond. The coupon rate is the annual interest payment divided by the par value, and it is generally set at the value of rd on the day the
Chapter 7: Bonds and Their Valuation
Integrated Case
1
bond is issued. To illustrate, from Table 7-4 the required rate of return on Sprint Capital’s 2028 bonds was 6.875% when they were issued, so the coupon rate was set at 6.875%. If the company were to float a new issue today, the coupon rate would be set at the going rate today (March 2008), which would be around 10.05%—the YTM on these outstanding bonds. 3. Maturity. This is the number of years until the bond matures and the issuer must repay the loan (return the par value). 4. Call provision. Most bonds
7-21
Western Money Management Inc.
Bond Valuation
Robert Black and Carol Alvarez are vice presidents of Western Money Management and codirectors of the company’s pension fund management division. A major new client, the California League of Cities, has requested that Western present an investment seminar to the mayors of the represented cities. Black and Alvarez, who will make the presentation, have asked you to help them by answering the following questions. A. Answer: What are a bond’s key features? [Show S7-1 through S7-4 here.] If possible, begin this lecture by showing students an actual bond certificate. We show a real coupon bond with physical coupons. These can no longer be issued—it is too easy to evade taxes, especially estate taxes, with bearer bonds. All bonds today must be registered, and registered bonds don’t have physical coupons. 1. Par or face value. We generally assume a $1,000 par value, but par can be anything, and often $5,000 or more is used. With registered bonds, which is what are issued today, if you bought $50,000 worth, that amount would appear on the certificate. 2. Coupon rate. The dollar coupon is the “rent” on the money borrowed, which is generally the par value of the bond. The coupon rate is the annual interest payment divided by the par value, and it is generally set at the value of rd on the day the
Chapter 7: Bonds and Their Valuation
Integrated Case
1
bond is issued. To illustrate, from Table 7-4 the required rate of return on Sprint Capital’s 2028 bonds was 6.875% when they were issued, so the coupon rate was set at 6.875%. If the company were to float a new issue today, the coupon rate would be set at the going rate today (March 2008), which would be around 10.05%—the YTM on these outstanding bonds. 3. Maturity. This is the number of years until the bond matures and the issuer must repay the loan (return the par value). 4. Call provision. Most bonds