Egis Securities, Inc. provides financial analysis and information about publicly

Question

Egis Securities, Inc. provides financial analysis and information about publicly traded securities. You work as an analyst for Egis. The firm's owner, George Stein, is preparing to make a presentation to the firm's clients and has asked you to provide some input regarding the securities of KLX, a publically traded company. To simplify calculations, assume that it currently is January 1, 2017 Regarding KLX's existing bonds, George wants you to concentrate on the mortgage bonds in th Table below. These bonds were issued at different times but each one of them had 20 years to maturity when first issued. This suggests that, for example, bond III was issued in 2012. bonds pay interest semiannually, and each bond has a par value of $1000. KLX's Table Coupon Rate Years to Maturity BondPrice per bond Maturity Year 3.75% 6.50 9.25 2022 2027 2032 10 15 930.52 fy 1217100 As of January 1, 2017. Given the above information, George asked you to calculate: The nominal annual yield to maturity (YTM) of each bond .The effective annual YTM of each bond .The current yield of each bond . The expected price of each bond on January 1, 2018, assuming interest rates do not change The capital gains (losses) yield of each bond for 2017, assuming interest rates change . The total expected return of each bond for 2017, assuming interest rates do not change .The interest rate risk of each bond (George has asked you tabulate and graph your results) .The 3-year holding period return of each bond for an investor who buys the bond orn January 1, 2019 and reinvests all coupon interest payments at 3% until the end of the 3- year investment horizon, assuming bond yields have dropped to 7.2% at the end of the 3- year holding period The yield to call for bond II, assuming it can be called after 4 years at $1050. From past experience George knows that attendees raise several questions during his presentations. So, once he reviewed your calculations, George asked you to prepare answers to the following questions:

Explanation / Answer

Performing calculations using excel.

Nominal YTM of each Bond:

Bond I : Settlement Date Jan 1, 2017 ; Maturity Date Jan 1, 2022 ; Rate 3.75% ; Pr 82.5 ; Redemption 100 and Frequeny 2 (semi annual)

YTM = Yield (Settlement Date, Maturity Date, Rate, Pr, Redemption, Frequency) = 8.07%

Bond II : YTM = Yield (Jan 1, 2017 , Jan 01, 2027, 6.50%, 93.052, 100, 2) = 7.50%

Bond III : YTM = Yield (Jan 1, 2017 , Jan 01, 2032, 9.25%, 110.808, 100, 2) = 8%

Effective YTM:

Bond I : Semi annual YTM = 4.0365% ; Effective Annual YTM = (1+4.0365%)2 - 1= 8.24%

Bond II : Semi annual YTM = 3.75% ; Effective Annual YTM = (1+3.75%)2 - 1= 7.64%

Bond III : Semi annual YTM = 4% ; Effective Annual YTM = (1+4%)2 - 1= 8.16%

Current Yield Bonds:

Bond I : Annual Coupon / Current Price = 37.5/825 = 4.55%

Bond II : 65/930.52 = 6.99%

Bond III : 92.5/1108.08 = 8.35%

Expected Price on Jan 01, 2018:

Price of Bond = Price (Settlement Date, Maturity Date, Rate, Yield, Redemption, Frequency)

Bond I Price = Price (Jan 01, 2018, Jan 01, 2022, 3.75%, 8.07%, 100, 2) * 10 = 854.69

Note that we have multiplied with 10 since the excel function price, prices bond on base of $100

Bond II Price = Price (Jan 01, 2018, Jan 01, 2027, 6.50%, 7.50%, 100, 2) * 10 = 935.40

Bond III Price = Price (Jan 01, 2018, Jan 01, 2032, 9.25%, 8.%, 100, 2) * 10 = 1104.15

Capital Gain / Loss Yield for 2017:

Capital Gains (CG) = (Jan 1, 2018 Price - Jan 1, 2017 Price)/Jan 1, 2017 Price

Bond I CG = (854.69-825)/825 = 3.60%

Bond II CG = (935.40-930.52)/930.52 = 0.52%

Bond III CG = (1104.15 - 1108.08)/1108.08 = - 0.35%

Total expected return for 2017:

TR = [Coupon + (Jan 01, 2018 Price - Jan 01, 2017 Price)]/Jan 01, 2017 Price

Bond I TR = (37.5 + 854.69 - 825)/825 = 8.14%

Bond II TR = (65 + 935.40 - 930.52)/930.52 = 7.51%

Bond III TR = (92.5+1104.15-1108.08)/1108.08 = 7.99%

Note that since the yields have remain unchanged the total return for 2017 should have been same as YTM calculated for each bond - the minor difference is due to rounding of digits to two decimals .

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