Question

Your investment department has researched possible investments in corporate debt securities. Among the available investments are the following $100 million bond issues, each dated January 1, 2016. Prices were determined by underwriters at different times during the last few weeks. (FV of $1, PV of $1. FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) 1. 2. 3. Company ВВ Corp. DD Corp. GG Corp. Bond Price $110 million $100 million $ 90 million Stated Rate 10% 9% 8% Each of the bond issues matures on December 31, 2035, and pays Interest semiannually on June 30 and December 31. For bonds of similar risk and maturity, the market yield at January 1, 2016, IS 9%. Required: Other things being equal, which of the bond issues offers the most attractive Investment opportunity If It can be purchased at the prices stated? the least attractive? Most attractive investment Least attractive investment

Answer 1

Solution:

To check, which of the investments are most attractive we would compare the present value of inflows discounted at market rate of interest from the investment and their respective prices at which they are issued.

1) BB Corp Bonds

Interest	$ 5,000,000 x 18.401584*	$ 92,007,920
Principal	$ 100,000,000 x 0.17193	$ 17,193,000
Present value of bonds	Total	$109,200,920

Interest calculation = $ 100,000,000 x 10% x (6/12) = $ 5,000,000

Present value of an ordinary annuity of $1: n = 40, i = 4.5% (PVA of $1) = 18.401584

Present value of $1: n = 40, i = 4.5% (PV of $1) = 0.17193

Since the price of bonds is 110 million and the present value of cash flows is $109,200,920 we can say that the bonds are overpriced.

2) DD Corp Bonds

Interest	$ 4,500,000 x 18.401584*	$ 82,807,128
Principal	$ 100,000,000 x 0.17193	$ 17,193,000
Present value of bonds	Total	$100,000,128

Interest calculation = $ 100,000,000 x 9% x (6/12) = $ 4,500,000

Present value of an ordinary annuity of $1: n = 40, i = 4.5% (PVA of $1) = 18.401584

Present value of $1: n = 40, i = 4.5% (PV of $1) = 0.17193

Since the price of bonds is 100 million and the present value of cash flows is also $100,000,128 ( Differs slightly due to rounding of present value factors) we can say that these bonds are appropriately priced.

3) GG Corp Bonds

Interest	$ 4,000,000 x 18.401584*	$ 73,606,336
Principal	$ 100,000,000 x 0.17193	$ 17,193,000
Present value of bonds	Total	$90,799,336

Interest calculation = $ 100,000,000 x 8% x (6/12) = $ 4,000,000

Present value of an ordinary annuity of $1: n = 40, i = 4.5% (PVA of $1) = 18.401584

Present value of $1: n = 40, i = 4.5% (PV of $1) = 0.17193

Since the price of bonds is 90 million and the present value of cash flows is $90,799,336 we can say that the bonds are under priced and hence the most attractive.While, BB corp bonds are least attractive because they are overpriced.

Most attractive Investment	GG Corp Bonds
Least attractive Investment	BB Corp Bonds