# FINC 501 Bond Valuation Case Study 3 2015

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Topics: Bond, Bonds, Investment
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 rate of return remained at 13 percent, or if it remained at
7 percent? (Hint: with a financial calculator, enter PMT, I/YR, FV, and N, and then change (override) n to see what happens to the PV as the bond approaches maturity.)

f.1 What is the yield to maturity on a 10-year, 9 percent annual coupon, \$1,000 par value bond that sells for \$887.00? That sells for \$1,134.20? What does the fact that a bond sells at a discount or at a premium tell you about the relationship between rd and the bond's coupon rate?

f.2 What are the total return, the current yield, and the capital gains yield for the discount bond? (Assume the bond is

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