Assume it is 1 January 2017. A
Assume it is 1 January 2017. An investor has researched two possible bond investments, but an intermittent printer fault has caused some important information to be missing from the printout. The latest coupon on each bond has just been paid. Each bond has a face, or par, value of £1000. The investor assumes that each bond pays coupons annually. Bond Coupon rate Maturity Current price Yield to maturity ABC 6.50% 31 December 2022 ? 5.50% XYZ 4.45% 31 December 2024 £838.45 ? ·
i. Complete the table by calculating the current price of bond ABC and yield to maturity of bond XYZ . ·
ii. The investor subsequently realises that the printer had not detailed the fact that the ABC bond makes semi-annual coupon payments.
Recalculate the current price of the ABC bond.
iii. Analyze the answers in (i) and (ii) above as an investor. Which coupon option would you choose and why? .
iv. Assume for ABC corporation only, market interest rate increases, which results in increase YTM to 6.50%.
What will be the revised current price of the Bond? What will you deduce about the relationship between market interest rate and bond prices?
In this question you are required to extract financial information on Texas Instruments which can be found in its annual report. You should refer in particular to Texas Instruments’ 2019 consolidated financial statements. The notes to these statements may also be relevant. You are required to:
a. use two appropriate methods to calculate the cost of equity for Texas Instruments
b. use two methods to calculate a cost of debt for Texas Instruments
c. If you have to select one of the methods from above, which one would you choose and why?
d. If you would be prospective investor, would you invest in Texas shares or bonds? Specify the reason.
Make sure you clearly describe and reference the source of the information used in your calculations. If you would like to use an additional approach that requires external information, you should provide details of these additional sources and your reasons for using them.
Note the following:
· the risk-free rate is 1.64% p.a.
· the equity risk premium is 3% p.a.
In addition to your numerical work, you should provide an explanation of your methodology and justify your choice of inputs in the formula. Remember to show all your calculations in detail. Note: this question is not just testing your ability to derive calculations; it is also looking at your understanding of which financial information is relevant for the calculations and how to deploy it.
Answer:
Part i)
| Date | Type | Cash flow | PVF @5.5% | Discountedcashflow |
| 31-Dec-17 | Coupon | 1000*6.5% = 65 | 1/1.055 = 0.9479 | 61.61 |
| 31-Dec-18 | Coupon | 1000*6.5% = 65 | 1/(1.055^2) = 0.8985 | 58.40 |
| 31-Dec-19 | Coupon | 1000*6.5% = 65 | 1/(1.055^3) = 0.8517 | 55.36 |
| 31-Dec-20 | Coupon | 1000*6.5% = 65 | 1/(1.055^4) = 0.8073 | 52.47 |
| 31-Dec-21 | Coupon | 1000*6.5% = 65 | 1/(1.055^5) = 0.7652 | 49.74 |
| 31-Dec-22 | Coupon+Maturity | 1,000+65 = 1,065 | 1/(1.055^6) = 0.7253 | 772.44 |
| Price of ABCbond | 1,050.03 |
Computation of YTM of XYZ bond:
n = 8years (1/Jan/17 to 31/Dec/24); coupon amount = 1000*4.45% =44.5
YTM = {coupon amount+(Maturity value-currentprice)/n}/{(Maturity value+current price)/2} ={44.5+(1000-838.45)/8}/{(1000+838.45)/2} ={44.5+(161.55/8)}/{1838.45/2} = (44.5+20.19375)/919.225 =64.69375/919.225 = 7.04%
Part ii) YTM per 6month = 5.5%/2 = 2.75%
| Date | Type | Cash flow | PVF @2.75% | Discountedcashflow |
| 30-Jun-17 | Coupon | 1000*6.5%/2 = 32.5 | 1/1.0275 = 0.9732 | 31.63 |
| 31-Dec-17 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^2) = 0.9472 | 30.78 |
| 30-Jun-18 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^3) = 0.9218 | 29.96 |
| 31-Dec-18 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^4) = 0.8971 | 29.16 |
| 30-Jun-19 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^5) = 0.8731 | 28.38 |
| 31-Dec-19 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^6) = 0.8497 | 27.62 |
| 30-Jun-20 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^7) = 0.827 | 26.88 |
| 31-Dec-20 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^8) = 0.8049 | 26.16 |
| 30-Jun-21 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^9) = 0.7834 | 25.46 |
| 31-Dec-21 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^10) = 0.7624 | 24.78 |
| 30-Jun-22 | Coupon | 1000*6.5%/2 = 32.5 | 1/(1.0275^11) = 0.742 | 24.12 |
| 31-Dec-22 | Coupon+Maturity | 1000+32.5 = 1032.5 | 1/(1.0275^12) = 0.7221 | 745.57 |
| Price of ABCbond | 1,050.48 |
Part iii)
Always chose option ii, because reinvestment of coupon has notbeen considered above. If we reinvest the coupon we get higherrealised YTM than option i realised YTM.
Part iv)
Increased YTM = 6.5%.
When YTM = Coupon rate, then the bond price will be equal tomaturity value of the bond, hence price of the bond = 1,000.
Relationship between Market interest rate and bond prices:
If the market interest rate increases, then the investorrequired return i.e. YTM will increase so thst bond will be sold atdiscounted price and vice verse.
Market interest rate and bond prices are inversely related.
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