Bond Case
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. What are the key features of a bond?
Par value - face amount, paid at maturity
Coupon interest rate - Stated interest rate
Maturity length - years until bond must be repaid
Issue date - Date when bond is issued
Default risk - Risk that issuer will not make interest payments
Call provisions - provisions that allow the original issuer to repurchase and retire the bonds, usually within a time window or on a specific date, which the bond can be called, and a specific price to be paid to bondholders.
What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
Call provisions give the issuing corporation the right to call the bonds for redemption. The call provision generally states that if the bonds are called, then the company must pay the bondholders an amount greater than the par value, or a call premium. Sinking funds are provisions to pay off a loan over its life rather than all at maturity. These provisions make bonds less risky to both the corporation and the investors.
How does one determine the value of any asset whose value is based on expected future cash flows?
The value of such an asset is determined by calculating the net present value (NPV) of all future expected cash flows. NPV measures the increase of an investment based on the present value of future expected cash flows against the cost of the initial investment. NPV is calculated by totaling the result of multiplying each year’s expected cash flow by the discount rate, and
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. What are the key features of a bond?
Par value - face amount, paid at maturity
Coupon interest rate - Stated interest rate
Maturity length - years until bond must be repaid
Issue date - Date when bond is issued
Default risk - Risk that issuer will not make interest payments
Call provisions - provisions that allow the original issuer to repurchase and retire the bonds, usually within a time window or on a specific date, which the bond can be called, and a specific price to be paid to bondholders.
What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
Call provisions give the issuing corporation the right to call the bonds for redemption. The call provision generally states that if the bonds are called, then the company must pay the bondholders an amount greater than the par value, or a call premium. Sinking funds are provisions to pay off a loan over its life rather than all at maturity. These provisions make bonds less risky to both the corporation and the investors.
How does one determine the value of any asset whose value is based on expected future cash flows?
The value of such an asset is determined by calculating the net present value (NPV) of all future expected cash flows. NPV measures the increase of an investment based on the present value of future expected cash flows against the cost of the initial investment. NPV is calculated by totaling the result of multiplying each year’s expected cash flow by the discount rate, and