Essay about Case Study

2183 Words Oct 5th, 2011 9 Pages
1. To begin, assume that it is now January 1, 1993, and that each bond in Table 1 matures on December 31 of the year listed. Further, assumes that each bond has $1,000 par value, each had a 30-year maturity when it was issued, and the bonds currently have a 10 percent required nominal rate or return.

a. Why do the bonds’ coupon rates vary so widely?

It is because TECO sells bonds at par and sets the coupon rates at the market rate of interest when the bonds are issued, interest rates have risen over the last 25 years, and that explains the rising pattern of coupon rates.

b. What would be the value of each bond if they had annual coupon payments?

The value of a bond is found as the present value of interest payments plus
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The effective annual rate of return implied is 10.25 percent e. If we evaluated at the same effective rate, the earlier payments would give the semiannual bond the higher value.

2. Now, regardless of your answer to Question 1, assume that the 5-year bond selling for $800.00, the 15-year bond is selling for $865.49, and the 25-year bond is selling for $1,320.00. a. The Yield to Maturity (YTM) is the nominal rate of return which investors would realize if they held the bond to maturity and the bond did not default.

b.
5-year bond: k/2,10 k/2,10
$800.00 = $22.50(PIVFA ) +$1,000(PVIF ) k/2 = 4.817% k = 9.634%

15-year bond: k/2,30 k/2,30
$865.49 = $41.25(PIVFA ) +$1,000(PVIF ) k/2 = 5.000% k = 10.000%

25-year bond: k/2,50 k/2,50
$1,320.00 = $63.125(PIVFA ) +$1,000(PVIF )= $1,239.61 K/2 = 5.091% K = 10.151%

c. Effective Annual YTM
5-year bond:
EAR = (1.04817)² – 1.0 = 9.866%

15-year bond:
EAR = (1.0500)² – 1.0 = 10.250%

25-year bond:
EAR = (1.05091)² – 1.0 = 10.441%

d. Since different securities can have different payment period (for example, bond interest is paid semiannually but stock dividends are paid quarterly), direct comparisons can only be made when all yields are expressed as effective annual rates.

3. Suppose TECO has a second bond with 25 years left to maturity (in addition to the one listed in Table 1),

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