A Decision of Uncertainty
University of Phoenix
Pam Campbell, Facilitator
This scenario is an investment decision; this paper will present an assumption that my organization is faced with a decision of investing in bonds based on market availability. The two chosen municipal bonds with highest yields were obtained from yahoo finance (2011) the highest yield maturity bonds were Invesco Van Kapen,Oppenheimer . A discussion will be given in this paper as to how the decisions will be made, this will be based on the requirements that the firm seeks to be inclusive in the bond investments.
They are seeking higher return yields, low risk level bonds; also the level of risk will be rated as indicated by the bond rating.
The firms interest lies in investing in a five year municipal bond, the choice has to be made based on research retrieved from Yahoo finance. Research form this website will give a wide range to choose municipal bonds that are available, and provide summaries of the ratings and positions in the market.
Retrieved information summary:
The value for the Invesco bond (ACTHX) is 9.265% the rates for the coupon are paid every six months, the value is at 5% which gives a final price of $88.75, Oppenheimer is a 5 year bond with a value of 3.877% the coupon rates are also paid every six months the given value is 6.00% which gives a final price of $105.70.
Bond ratings (5 year default)
Investo (A) =0.00%
Oppenheimer (Baa) =1.93%
Investo High Income (AA, YTM) =0.23%
( Default Rates of Municipal Bonds, 2011).
The above information is evidence that a bond with an A rating in 5 years will default at 0.00%,the Investo High Income both ratings as seen will default at 0.23% over 5 years, Oppenheimer has a default in pay of 1.93%.
Construction of a decision can now be done by the firm the decision will entail the yields, prices of the bond , the most appropriate formula to construct the data will be the Bayer’s theorem for probability calculations. The probabilities are known; therefore this will provide the correct default pay information for the decision makers.
Based on the above calculations the returns on the bonds are similar, however the pricing and rates of default has a significant difference. The next portion will present a summary of probability if the firm decides to invest in the two given bonds.
Probability of the firm investing in Investo bond (A-rated) is 0.5, the second bond probability is:
Also 0.5 Openheimer bond has a rating of (Baa).
Defaults-Does not default
The probability that the firm chooses Investo is 0.5, and the same probability would be they will also invest in Openheimer. The investment probability values are:
Investment made in Investo and firm defaults=0.5*0.05=0.025
Investment made in Openheimer and firm defaults=0.5*0.46=0.23
Calculations from the probability shows that if the firm chooses to make an investment in both bonds, the payment in full from the bond is 99.745% the return will be paid in full.
The above calculations will help the firm to choose Investo , and Openheimer for their investments. There is only a 0.255 probability the return will not be paid in full. However, the report given for Openheimer gives a 1.93% default in full payment so the firm has to make the decision if the bond may default. A variable was developed to analyze the probability the bond will default: