James Crowl
Colorado Technical University
FIN390-1201B-03
Phase Five Individual Project
Instructor: Professor Galloway
March 16, 2012

Part One: Vanilla Bonds

Abstract

Understanding how to properly value a vanilla bond is essential for finance (ctuonline.edu). In theory, the present value relationship determines the value of a bond, but in practice the actual price is (typically) determined by suggestions from other, more liquid mechanisms. The purpose of this work will be to research bonds offered by Safeway (SWY), analyze them, and then decide in what situation these bonds would be beneficial for the investor.

More often than not, a company that is successful will have retained some of its earnings. The company may do one of two things: disperse part of the cash out in the form of dividends, or simply hang onto it to create a competitive advantage. Eventually, they realize that the monies could be working for them also. Stocks may carry the lure of a larger return, but that comes with the volatility and risk of the market. Bonds, however, may offer a steady income (larger than dividends) that may be used to provide its investors with consistent revenues. Safeway offers a bond that matures in 2031, with a coupon rate of 7.25% and a discount rate of 5.88%. This will make the payment $72.50. The following calculation reveals the bond price: 1000Par

72.5Payment
19NPER
0.0588YTM
($1,154.31)Value
This bond is currently selling above its face value, which makes it a premium bond. Intel Corporation (INTC) offers a bond that matures in 2041 with a coupon rate of 4.8% and a discount rate of 4.51%. This will make the payment $48. The following calculation reveals the bond price: 1000Par

48Payment
29NPER
0.0451YTM
($1,046.41)Value

Both bonds are selling above the face value, but the Safeway bond is selling for a higher price than is Intel. This makes the Safeway bond a more attractive bond. The bond that matures in less time has...

...perpetual bond is currently selling for RS. 95/-. The coupon rate of interest is 13.5%. The approximate discount rate is 15%. The value of the bond and the YTM is:
(a) Rs. 90/- and 14.2% Value is (13.5*15%=90) and YTM is ((13.5/95)*100=14.21%)
(b) Rs. 100/- and 13.5%
(c) Rs. 90 and 15%
(d) Rs. 90/- and 13.5%
902. In 2001, Meridian Ltd. has issued bonds of Rs. 10,000/-each due in 2011 with a 14% per annum coupon rate payable at the end of each year during the life of the bond. If the required rate of interest is 8%, find the present value of the bond. Tick the nearest option.
(a) 10,000
(b) 7302
(c) 2,700
(d) 14,026 (9394.11+4631.93=14026.05)
903. The present market value of an equity share is Rs. 80/-; and the exercisable price of the warrant is Rs. 60/- per share. An investor is holding a warrant entitling him to purchase 50 equity shares. The minimum value of the warrant is:
(a) 1,000/- (80-60=20*50=1000)
(b) 4,000/-
(c) 3,000/-
(d) None of these
904. A bond with a coupon rate of 8% is available at its face value of Rs. 1,000/-. The market rate of return on an instrument with similar risk goes down to 6%. The bond price will become:
(a) 1,000/-
(b) 750/-
(c) 1,333/- (800/6%)
(d) None of these
905. A bond with a coupon rate of 10% is available at Rs. 1,250/-. The face value of the bond is Rs. 1,000/-. The...

...BONDSBonds pay fixed coupon (interest) payments at fixed intervals (usually every six months) and pay the par value at maturity.
Par value = $1,000
Coupon = 6.5% or par value per year,
or $65 per year ($32.50 every six months).
Maturity = 28 years (matures in 2032).
Issued by AT&T.
Types of Bonds
Debentures - unsecured bonds.
Subordinated debentures - unsecured “junior” debt.
Mortgage bonds - securedbonds.
Zeros - bonds that pay only par value at maturity; no coupons.
Junk bonds - speculative or below-investment grade bonds; rated BB and below. High-yield bonds.
Eurobonds - bonds denominated in one currency and sold in another country. (Borrowing overseas).
example - suppose Disney decides to sell $1,000 bonds in France. These are U.S. denominated bonds trading in a foreign country. Why do this?
If borrowing rates are lower in France.
To avoid SEC regulations.
The Bond Indenture
The bond contract between the firm and the trustee representing the bondholders.
Lists all of the bond’s features:
coupon, par value, maturity, etc.
Lists restrictive provisions which are designed to protect bondholders.
Describes repayment provisions.
VALUE
Book value: value of an asset as shown on a firm’s balance sheet; historical cost.
Liquidation value: amount that could be...

...Lecture 03: Applying the Time Value of Money to Security Valuation – Valuation of Bonds and Debt Securities
A bond or a debenture is a long term debt instrument carrying a fixed rate of interest which is known to investors. A bond is redeemable after a specified period.
Bonds are also called gilt edged securities or gilt when issued by the government since it is free of default risk.
Features of a Bond or Debenture
• Face Value – Face value is called par value. A bond / debenture is generally issued at a par value and interest is paid on the par value.
• Interest Rate – Interest rate is fixed and known to the bondholders / debenture holders. Interest paid on a bond is tax deductible. The interest rate is also called the coupon rate.
• Maturity – A bond is issued for a specified period of time. It is repaid on maturity.
• Redemption Value – The value which a bondholder will get on maturity is called redemption value.
• Market Value – A bond / debenture may be traded on the stock exchange. The price at which it is currently sold or bought is called the market value of the bond / debenture.
A bond is a long-term promissory note that promises to pay the bondholder a predetermined, fixed amount of interest each year until maturity. At maturity, the principal will be paid to the bondholder....

...Week 3 Time Value of Money and Valuing Bonds
Chapter 6
55. Amortization with Equal Payments Prepare an amortization schedule for a five-year loan of $36,000. The interest rate is 9 percent per year, and the loan calls for equal annual payments. How much interest is paid in the third year?
Answer: $2,108.52
56. Amortization with Equal Principal Payments Rework Problem 55 assuming that the loan agreement calls for a principal reduction of $7,200 every year instead of equal annual payments.
Answer: $1,944.00
57. Calculating Annuity Values Bilbo Baggins wants to save money to meet three objectives. First, he would like to be able to retire 30 years from now with retirement income of $20,000 per month for 20 years, with the first payment received 30 years and 1 month from now. Second, he would like to purchase a cabin in Rivendell in 10 years at an estimated cost of $325,000. Third, after he passes on at the end of the 20 years of withdrawals, he would like to leave an inheritance of $750,000 to his nephew Frodo. He can afford to save $2,000 per month for the next 10 years. If he can earn an 11 percent EAR before he retires and an 8 percent EAR after he retires, how much will he have to save each month in years 11 through 30?
Answer: $2,259.65
58. Calculating Annuity Values After deciding to buy a new car, you can either lease the car or purchase it on a three-year loan. The car you wish to buy costs $28,000. The dealer has a special leasing arrangement...

...features of a bond?
answer: 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 k on the day the bond is issued. To illustrate, the required rate of return on one of southern bell's bonds was 11 percent when they were issued, so the coupon rate was set at 11 percent. If the company were to float a new issue today, the coupon rate would be set at the going rate today (october 1998), which would be about 7.4%.
3. Maturity. This is the number of years until the bond matures and the issuer must repay the loan (return the par value). The southern bell...

...answer.
4. This question is composed of 3 independent multiple choice questions. To be awarded marks for these questions you must give a brief explanation of why your choice is correct. Use no numerical examples in your answer.
A. (4 marks) The yield to maturity on a bond is:
(a) based on the assumption that any payments received are reinvested at the coupon rate of return.
(b) based on the assumption that any payments received are reinvested at the current yield.
(c) below the coupon rate when the bond sells at a discount, and above the coupon rate when the bond sells at a premium.
(d) none of the above.
B. (2 marks) In which one of the following cases is the bond selling at a premium?
(a) Coupon rate is greater than current yield which is greater than yield to maturity.
(b) Coupon rate, current yield and yield to maturity are all the same.
(c) Coupon rate is less than current yield which is less than yield to maturity.
(d) Coupon rate is less than current yield which is greater than yield to maturity.
C. (4 marks) If interest rates decrease and then stabilize after the purchase of a bond, the annualized holding period rate of return for a bond which is held to maturity is:
(a) between the original yield to maturity and the new interest rate.
(b) greater than the original yield to maturity.
(c) lower than the new interest...

...
FINC 501
Case Study # (3)
Bond Valuation
Sami & Sara are vice-presidents of Manama Insurance Company and co-directors of the company's pension fund management division. A major new client, the Northwestern Municipal Alliance, has requested that Manama Co. presents an investment seminar to the mayors of the represented cities, and Sami and Sara, who will make the actual presentation, have asked you to help them by answering the following questions.
a. What are the key features of a bond?
b. What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
c. How is the value of any asset whose value is based on expected future cash flows determined?
d. How is the value of a bond determined? What is the value of a 10-year, $1,000 par value bond with a 10 percent annual coupon if its required rate of return is 10 percent?
e.1 What would be the value of the bond described in part d if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13 percent return? Would we now have a discount or a premium bond?
e.2 What would happen to the bonds' value if inflation fell, and rd declined to 7 percent? Would we now have a premium or a discount bond?
e.3 What would happen to the value of the 10‑year bond over time if the required...

...Bond Case
Sam Strother and Shawna Tibbs are vice presidents of Mutual of Seattle Insurance Company and co-directors of the company’s pension fund management division. An important new client, The North-Western Municipal Alliance, has requested that Mutual of Seattle present an investment seminar to the mayors of the represented cities, and Strother and Tibbs, who will make the actual presentation, have asked you to help them by answering the following questions.
1) What are the key features of a bond?
2) What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
3) How does one determine the value of any asset whose value is based on expected future cash flows?
4) How is the value of a bond determined? What is the value of a 10-year, $1,000 par value bond with a 10% annual coupon if its required rate of return is 10%?
5) What would be the value of the bond described in part 4 if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13% return? Would we now have a discount or a premium bond?
a. What would happen to the bond’s value if inflation fell and the rd declined to 7%? Would we now have a premium or a discount bond?
b. What would happen to the value of the 10-year bond over time if the required rate of return remained...