Tangential is a AA+ rated company that is looking to issue bonds with a five yea
ID: 2763355 • Letter: T
Question
Tangential is a AA+ rated company that is looking to issue bonds with a five year maturity. Their investment bank adviser has suggested that they issue a Yen 1 billion ‘high’ coupon bond which will be an attractive investment for Japanese pension funds which must pay their pension obligations from income.
The investment bank has suggested that a high coupon and redemption price of 90% of the face value will be a suitable bond structure. The following information is relevant. The current average yield on a AA+ bond is 5.7%. The maximum coupon payment could be 8%.
Show the possible cash flows for the bond and estimate the issue price. You can assume there are no issue costs. (20 marks)
Explain and analyse what the investment bank adviser means if he says that such a bond will allow the investor to convert capital to income (10 marks)
Discuss any significant disadvantages that you would expect in issuing a high coupon bond (10 marks)
If Tangential wishes to pay US dollars and not Japanese Yen, what can the company do? Illustrate and analyse your answer with diagrams showing the cash flows (10 marks)
Explanation / Answer
Assume Face Value of Bond =$1000
Annual Interest = $1000*8% =$80
Current Yield on AA+ Rated Bond= 5.70%
Current Yield= Annual Interest/Current Market Price
5.70% = $80/Market Price
Market Price= $80/.0570 = $1403.51
Company can issue Bond at Price of Similar AA+ Rated Bond $1403.51
Alternatively We can find fair Price of bon by discountin Interest and Redemption Value
Redemption Value = 1000*90% =$900
Price of Bond at current Yield 5.70% = ($80*4.2470)+($900*.7579) =$1021.87
Cash flow per Bond will be issue price $1403.51 as there is no issue cost.
As Advisor suggested that it will be attractive investment for Japanese pension funds which must pay their pension obligations from income. It means that person who have to pay for pension fund can pay by earning of Long term bond and such fension fund will become capital for Investor.
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