Question

SECTION B: ANSWER ANY THREE (3) QUESTIONS QUESTION TWO John and Joseph are vice presidents of Congorbalt Money Management (CMM) and co-directors of the company's pension fund management division. A major new dent. the Nkana League of Cities has requested that CMM present an investment seminar to the mayors of the represented cties John and Joseph, who will make the presentation, have asked you to help them by answering the following questions a) What are a bond's key features? (4 Marks) b) How is the values of any asset whose value is based on expected future cash flows determined? (1 mark) c) What is the value of a 10-year $1.000 par value bond with a 10% annual coupon, paid semi-annually, if its required return is 10%? (2 Marks) d) I. What is the value of a 13%, coupon bond that is otherwise identical to the bond described in part 'c' above? Would we now have a discount or a premium bond? (2 Marks) H. What is the value of a 7% coupon bond with these characteristics? Would we now have a discount or premium bond? (2 Marks) III. What would happen to the values of the 7%, 10% and 13% coupon bonds over time if the required return increased to 13%? (3 Marks) e) I. what is the yield to matunity on a 10-year, 4% semi-annual coupon, $ 1.000 par value bond that sells for $ 887.00 and another that sells for $ 1.134 20? What does the fact that it sells at a discount or at a premium tell you about the relationship between and the coupon rate? (3 Marks) II. what are the total return, the current yield and the capital gains yield for the premium bond in parts 'e (1)? Assume that it is held to maturity and the company does not default on it. (3 Marks) [TOTAL: 20 MARKS]

Answer 1

Solution to (a)

Most individual bonds have five features when they are issued: issue size, issue date, maturity date, maturity value, and coupon. Once bonds are issued, yield to maturity becomes the most important figure for determining the actual yield an investor will receive.

Issue size: The issue size of a bond offering is the number of bonds issued multiplied by the face value

Issue date: The issue date is simply the date on which a bond is issued and begins to accrue interest

Maturity date: The maturity date is the date on which an investor can expect to have his or her principal repaid. It is possible to buy and sell a bond in the open market prior to its maturity date.

Maturity value: the amount of money the issuer will pay the holder of a bond at the maturity date. This can also be referred to as “par value” or “face value.”

Coupon: The coupon rate is the periodic interest payment that the issuer makes during the life of the bond

Solution to (b)

The value of an asset whose value is based on expected future cash flows is determined by the present value of all future cash flows the assets will generate.

Solution to (c)

PV = [ Summation of  CF_t/(1 + i)^t] + [FV / (1 + i)^t]

PV = 1000, t = 20, i = 10%, CF per year = 10

FV = 1000 (Answer)