Question 3 (8.5 marks) Given are three bonds issued by Emaar, Etisalat and Du, e

Question

Question 3 (8.5 marks) Given are three bonds issued by Emaar, Etisalat and Du, each with a par value of AED 1,000 Emaar 8.1% Etisalat 3.9% 6.7% Coupon Years to maturity Question A (3 marks) Assume the interest is paid annually. Your required rates of return are as follows: Emaar-6%, Etisalat-7%, Du-9%. Calculate the value of the bonds. Question B (1.5 marks) Assume that the bonds are selling for the following amounts: Emaar Etisalat AED 1.220 AED 1,400 AED 980 LU Calculate the expected return of each bond Question C (1.5 marks) Calculate the value of each bond, if your required rate of return would decrease by 2 percentage points Question D (2.5 marks) Explain if you should buy the bonds and why

Explanation / Answer

A. Value of the bonds :

r = required rate of return, n = years to maturity.

Present value of bond ( Emaar) = Annual Coupon x PVA 6%, n=13 + Par Value x PV 6%, n=13 = 81 x 8.8527 + 1,000 x 0.4688 = AED 1,185.87

Present value of the bond ( Etisalat) = 39 x 6.5152 + 1,000 x 0.5439 = AED 797.99

Present value of bond ( Du) = 67 x 5.5348 + 1,000 x 0.5019 = AED 872.73

B. Expected return of a bond ( Yield to Maturity ) can be computed as :

YTM = [C + ( M-P) / n] / (0.4M + 0.6 P)

where, C is the annual coupon, M is the par value, P the present value, and n the years to maturity.

Expected return on Emaar = [ 81 + ( 1,000 - 1,220) / 13 ] / ( 400 + 732) = 64.08 / 1,132 = 0.0566 or 5.66 %.

Expected return on Etisalat = [ 39 + ( 1,000 - 1,400) / 9 ] / ( 400 + 840) = 0 %

Expected return on Du = [ 67 + ( 1,000 - 980) / 8] / ( 400 + 588) = 69.5 / 988 = 0.0704 or 7.04 %

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