You are interested in investing in some corporate bonds from companies that have been severely hurt by the Covid virus. You do some research and find there are five companies whose bonds are currently yielding around 20%. Each of the bonds is described in the table below. Answer the questions that follow. You may use Excel if you wish, although with some time on a calculator you can answer each of the questions. If you do use Excel I still want to see your work: formulas used, sub-amounts calculated, etc.
Coupon | YTM | Maturity Date | Face Amount | |
Bond 1 | 8% | 20% | 2025 | $10,000 |
Bond 2 | 10% | 18% | 2025 | $20,000 |
Bond 3 | 12% | 28% | 2025 | $5,000 |
Bond 4 | 12% | 20% | 2025 | $10,000 |
Bond 5 | 10% | 22% | 2025 | $10,000 |
a. What is the price of each bond? What is your total investment amount?
b. What is the par value of each bond?
c.Assume you purchase one of each bond. i. What is the YTM of your portfolio? ii. Assume that one week after you purchase the bonds, the company that issued Bond 5 defaults and never pays you one cent of principal or interest. Assume further that all the other bonds pay interest (annually) and principal according to the terms. What would your YTM turn out to be?
d. What would your YTM have been if you invested in Bond 3 ONLY?
e. What would your YTM have been if you invested in Bond 1 ONLY?
f. Using your answers to d. and e. and any other concepts we’ve covered in class, describe the difference and expected outcomes of following each of these strategies: i. Buying one of the bonds in enough quantity to approximate your total investment from a. above, or ii. Buying one of each bond. When answering this question, you can and should use some of the numbers you obtained in answering the earlier questions, but this question is primarily descriptive and conceptual, bolstered by numbers to illustrate your point. This is an “explain it to your little brother” answer. A paragraph should do it.
g. Consider bonds 3 and 4. They have the same coupon and the same maturity date. Why then do they have different YTMs? Or must that be a mistake? I urge you to try to do this problem using Excel, but if you don’t have Excel or are a complete novice and have no interest in learning, it can be done by hand, although your answer to the pre- and post-default YTM question will be a bit rougher – you should be able to get to within a percent or two.
Solution :
Bond | Coupon | YTM | Maturity Dt. | Face Value/ Par Value | Price |
Bond 1 | 8% | 20% | 2025 | $10,000 | $6412 |
Bond 2 | 10% | 18% | 2025 | $20,000 | $14,994 |
Bond 3 | 12% | 28% | 2025 | $5,000 |
$2,974 |
Bond 4 | 12% | 20% | 2025 | $10,000 | $7,608 |
Bond 5 | 10% | 22% | 2025 | $ 10,000 | $6,564 |
Total | $38,552 |
Detailed Solution below:
PG1:
PG2 :
PG 3:
PG4 :
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