SHOW ALL WORK STEPS Now Michelle asked you to help her invest in bonds market. Y

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SHOW ALL WORK STEPS

Now Michelle asked you to help her invest in bonds market. You have the following three bonds good for investment. Assume all coupons are paid annually and END mode, can you please find the best option for Michelle? Option One: Treasury bond has 4% annual coupon, matures in 10 years, and has a $10,000 face value. Its price is $9,550 Option Two: Corporate Bond A has a 9% annual coupon, matures in 5 years, and has a $10,000 face value. Its price is $10,500 Option Three: Corporate Bond B has a 10% annual coupon, matures in 8 years, and has a $10,000 face value. Its price is $9,950

5.Calculate YTM for each bond (3%)?

6.Compare YTM with coupon rate, indicate whether each bond is trading at a premium, at a discount, or almost at par. (3%)

7. Which one do you recommend Michelle to buy and why, assume Michelle has high risk tolerance and the current market interest rate is around 6%, Corporate Bond A is rated as BB bond and Corporate Bond B is a high-yield risky bond? (4%)

8. Assume Michelle also told you her expected residual savings from 2019 to 2023 will be: $15,000, $20,000, $25,000, $30,000, $35,000. She wants to know the present values of these savings at an 8% discount rate. Calculate PVs of the streams. (10%)

Explanation / Answer

5)

Treasury bond:

Coupon payment = 0.04 * 10,000 = 400

Face value = 10,000

Number of periods = 10

price = 9,550

YTM using a financial calculator = 4.57%

Keys to use in a financial calculator: N = 10, PV = -9550, FV = 10000, PMT = 400, CPT I/Y

Corporate A :

Coupon payment = 0.09 * 10,000 = 900

Face value = 10,000

Number of periods = 5

price = 10,500

YTM using a financial calculator = 7.76%

Keys to use in a financial calculator: N = 5, PV = -10500, FV = 10000, PMT = 900, CPT I/Y

Corporate B :

Coupon payment = 0.1 * 10,000 = 1000

Face value = 10,000

Number of periods = 8

price = 9,950

YTM using a financial calculator = 10.1%

Keys to use in a financial calculator: N = 8, PV = -9950, FV = 10000, PMT = 1000, CPT I/Y

6)

Treasury bond is seeling at a discount as the YTM is more than the coupon rate

Corporate A bond is selling at a premium as YTM is less than the coupon rate

Corporate B is selling at a discount as YTM is more than the coupon rate

7)

If Micelle has the highest risk tolerance, we would recommend to buy Corporate bond B as it has the highest yield to maturity

8)

Present value of cash flow streams = 15,000 / ( 1 + 0.08)1 + 20,000/ ( 1 + 0.08)2 + 25,000/ ( 1 + 0.08)3 + 30,000 / ( 1 + 0.08)4 + 35,000 / ( 1 + 0.08)5

Present value of cash flow streams = 13,888.9 + 17,146.8 + 19,845.8 + 22,050.9 + 23,820.4

Present value of cash flow streams = $96,752.8

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