A. MINI CASE_BONDS
The management of a construction company is considering issuing a 5-year bond to finance its future investment projects in Dubai. However, all members of the BoD are civil engineers and have very vague and sporadic knowledge of finance. You are hired by the firm to act as a financial advisor.
Q1. Explain to the manager of the firm the obligations of a bond issuer.
Currently, the economy is experiencing a positive business cycle and the management believes that the time is perfect for the issue of the bond.
Q2. (i). Explain the management the risks and opportunities given contemporary business conditions. What is your advice to the firm?
(ii). How demand and supply bond curves react under these conditions?
Q3. (i). How is the value of a bond determined?
(ii). Which factors affect price sensitivity?
Q4. What is the value of a 5-year, AED 1,000 par value bond with an 8% annual coupon if the YTM (required rate of return) of return is 8%? Explain to the manager of the firm without calculation.
Q5. (i). What would be the value of the bond if, just after it had been issued, the expected inflation rate rose by 2%, causing investors to require a 10% return? Would we now have a discount or a premium bond?
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(ii). What would happen to the value of this bond over time if the required rate of return remained at 10% until maturity? Show with a graph and explain to the manager.
Q6. (i). What is an approximation of the yield to maturity for this bond if the bond is selling at AED 900?
(ii). Explain to the management what your fears are, and you believe that the selling price would reach AED 900?
Q7. Calculate the current yield, the capital gains yield, and the duration of the bond (price is found in Q5).
Q8. How would the composition of capital gain yield and current yield fortis bond change over time, as the bond approaches maturity.?
B. Exercises
1). A bond pays a coupon of AED 115 every April 1st for 5 years. Today is October 1, 2019; On September 30rd, 2029 it pays an additional $1,000. YTM is 7.5%. What is the value of the bond?
2). In April 2020 you purchase 100 euros of bonds in Greece which pays a 5% coupon every year. If the bond matures in 2025 (five years) and the YTM is 3.0%, what is the value of the bond?
3). Sheikha just graduated from ZU major in Finance and immediately found a good job in a bank. She plans her retirement. Hence, she contacted an insurance company and she has (a) to choose to invest 1,500 and per quarter at 7.3% compounding for 32 years or invest the corresponding amount of money annually, and (b) to choose when to make payments; at the beginning of the end of the period.
