Question

Q.1. A9% Government Bond having a face value of Rs.1000/- matures after one year. The bond has a yield of 10%. Determine its current market price? Also we have a similar Corporate Bond, but with a default probability of 20%. Will the Corporate Bond have the same market price as that of Government Bond? What is the risk premium in absolute and percentage terms? Q.2. A firm is thinking of raising Rs.5.00 crore. It has 5 lakh shares outstanding and the current market price of share is Rs.170/-. The subscription price of new share will be Rs. 125/- per share. Please answer: i. How many shares will be sold? How many rights are needed to purchase one new share? What is the value of one right? iv. Show the impact on the shareholder's wealth who holds required rights to buy one new share if (a) he exercises rights, (b) sells his rights, (e) does not sell or exercise his rights. ii. Q.3. How much money is required to be invested by an investor for an auction of 10.71% Goverment Paper having Face Value of Rs.100/- if the quantity to be purchased is 100? Given the cut-off price at auction of 10.71% paper is Rs121.92, while the weighted average price is Rs.121.99. Interest on securities are to be paid on April 29 and Oct. 29 each year. The investor pays for the securities on Dec. 29.

Answer 1

Calculation of value of 9%Goverment Bond :

Given , Face Value = Rs1000

Time = 1 year

Yield = 10%

Current value of Goverment bond = P.V of the interest payments + P.V of the bond price

= ( 1000 *9% / 1.10) + (1000 /1.10)

= 81.81 + 909.09

= Rs 990.90

Corporate bonds has high risk than goverment bonds . This implies that interest rate for corporate bonds are always high. the reason is that the corporate bonds come with more default risk. For goverment bonds yield comprises of federal funds rate , interest risk rate premium and inflation risk premium . However , Corporate bonds demand compensation for risk of corporate default also.

Thus , the market price of both the bonds will not be same .

Calculation of risk premium = (Rm - Rf)

= ( 10 -9 )

= 1%

In absolute terms = 990.90 *1%

= Rs 9.90