Other
Bman 23000 Workshop 2 Solutions
- Institution
- The University Of Manchester (UOM)
This is a unique document that contains workshop 2 Solutions for Bman 23000. Essential !! To your success in Manchester!!
[Show more]
Content preview
The University of ManchesterManchester Business School
Manchester Accounting & Finance Group
BMAN23000 Foundations of Finance – Kostakis/Marchica
SOLUTIONS
WORKSHOP 2:
STOCK AND BOND VALUATION
Question 1.
HMK Enterprises would like to raise $10 million to invest in capital expenditures.
The company plans to issue five-year bonds with a face value of $1,000 and a coupon
rate of 6.5% (annual payments). The following table summarizes the yield to maturity
for five-year (annual-pay) coupon corporate bonds of various ratings:
Rating AAA AA A BBB BB
YTM 6.20 % 6.30 % 6.50 % 6.90 % 7.50 %
a) If a similar U.S. Treasury security has a YTM of 6.10%, what is the credit
spread of corporate bonds of various ratings given in a table above?
b) Assuming the bonds will be rated AA, what will the price of the bonds be?
c) What must the bond rating be for them to sell at par?
d) Suppose that when the bonds are issued, the price of each bond is $959.54.
What is the likely rating of the bonds? Are they junk bonds?
, Solution:
a)
Credit spread (or default spread) is the difference between yields on Treasury
securities and yields on corporate bonds.
It can be expressed in % or in basis points (basis point is one hundredth of a
percentage point).
Rating AAA AA A BBB BB
Credit spread in % 0.10% 0.20% 0.40% 0.80% 1.40%
Credit spread in basis points 10 20 40 80 140
b)
The price of a coupon bond is calculated using the following formula:
1 1 FV
P CPN 1
y (1 y ) N (1 y ) N
So the price for AA-rated bond will be:
1 1 1000
P 65 1 $1008.36
0.063 (1 0.063) 5 (1 0.063) 5
c)
For the bonds to sell at par, the coupon must be equal to the yield-to-maturity. Since
the coupon is 6.5%, the yield-to-maturity must also be equal to 6.5%, as it is for the
A-rated bond.
d)
First we can find the yield-to-maturity for the bond priced at $959.54 (using a trial-
and-error method, or a function in Excel):
65 65 1000
959.54 ... YTM 7.5%
(1 YTM) (1 YTM)5
Given a yield of 7.5%, these bonds are BB rated. Yes, BB-rated bonds are junk bonds.
Alternative solution:
You can calculate the price for a bond of each rating:
Rating AAA AA A BBB BB
Price, $ 1012.57 1008.36 1000.00 983.56 959.54
Since when the bonds are issued, the price of each bond is $959.54, it is likely these
bonds are BB rated. Yes, BB-rated bonds are junk bonds.
Question 2.
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller anyiamgeorge19. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for £9.69. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
81113 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy revision notes and other study material for 14 years now