Question

Part a. In Feb’2018, Amazon raised US$3.5bn by issuing 10-year bonds carrying annual coupon of 3.15%. Amazon could also have raised the same amount of funds from the equity market. What benefits does Amazon get by raising funds via bonds that they would not have received by issuing equity? Why do you think the company did not take a bank loan for the total amount raised?

Part b ) In Feb’2018, Amazon raised US$3.5bn by issuing 10-year bonds carrying annual coupon of 3.15%. The face value of the bond is $1000 and the coupon is paid every six months.

i. If the bond yield at the time of issue was 3.5%, what would be the price of the bond at the time of issue?

ii. If the bond yield at the time of issue was 3.0%, what would be the price of the bond at the time of issue?

iii. It is said that the price of a bond is inversely proportional to the prevailing interest rates. Prove this statement by taking the case of the above bond and computing the price of the bond at the above two yields (3.0%, and 3.5%) for different times from maturity. You may compute the bond prices at 5 years, 2 years, 1 year, and at maturity.

iv. What would be the price of the bond immediately before the payment of the final coupon (compute for both bond yields)?

v. What would be the price of the bond immediately after the payment of the final coupon (compute for both bond yields)?

Part c: Note down price of FaceBook Inc. dated 1st November, and then note down price of FaceBook dated 28th Feb. Calculate holding period return for FaceBook for given time period. Now research internet to get risk-free rate of return, market return and beta for FaceBook. Appropriately refer all information and give reasons for selecting this data. Then calculate value of value of FaceBook using CAPM Model.

can someone please solve b and c part?

Answer 1

Step-by-step explanation:

Question a)

Benefits of issuing bonds over stocks include the following:

1)     Issuing bonds allows the company to deduct interest paid from its income taxable returns reducing the company's tax burden unlike stocks whose dividend is paid from net income.

2)     Issuing bonds doesn't involve transferring a portion of the company unlike in shares where the shareholders would own a portion of the company equal to the value of shares held.

3)     Issuing bonds allows the company to raise a higher debt which could be higher than the company's enterprise value unlike stocks whose value should be equivalent or less the company's enterprise value.

4)     Bonds allows the company to access long-term funding which enables the company to fund its long-term projects or investments unlike stocks which are more appropriate for funding operational activities project to generate annual revenues that would be used to pay dividends.

Advantages of issuing bonds to taking bank loans include the following:

1)     The company has the ability to raise large sums of money from issuing bonds at lower cost unlike if it were to borrow from banks

2)     Issuing bonds has minimum regulatory restrictions compared to bank loans which allows the company to invest the capital raised as it sees fit

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Question b)

i.  Bond Price at 3.5% yield

Bond Price = PMT*[1-(1+r)^-n/r]+FV/(1+r)^n

= (3.15%*1000*0.5)*[1-(1+3.5%/2)^-20/3.5%/2]+1000/(1+3.5%/2)^20

= $970.68

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ii. Bond Price at 3.0% Yield

= (3.15%*1000*0.5)*[1-(1+3.0%/2)^-20/3.0%/2]+1000/(1+3.0%/2)^20

= $1,012.88

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iii. Relationship between price and interest rate at different maturity

At 3.0%

5 Year Maturity

Bond Price = (3.15%*1000*0.5)*[1-(1+3.0%/2)^-10/3.0%/2]+1000/(1+3.0%/2)^10

= $1,006.92

2 Year Maturity

Bond Price = (3.15%*1000*0.5)*[1-(1+3.0%/2)^-4/3.0%/2]+1000/(1+3.0%/2)^4

= $1,002.89

1 Year Maturity

Bond Price = (3.15%*1000*0.5)*[1-(1+3.0%/2)^-2/3.0%/2]+1000/(1+3.0%/2)^2

= $1,001.47

At 3.5%

5 Year Maturity

= (3.15%*1000*0.5)*[1-(1+3.5%/2)^-10/3.5%/2]+1000/(1+3.5%/2)^10

= $984.07

2 Year Maturity

= (3.15%*1000*0.5)*[1-(1+3.5%/2)^-4/3.5%/2]+1000/(1+3.5%/2)^4

= $993.30

1 Year Maturity

= (3.15%*1000*0.5)*[1-(1+3.5%/2)^-2/3.5%/2]+1000/(1+3.5%/2)^2

= $996.59

From the calculations above, it is clear that interest has an inverse relationship with bond price since the bond price was higher at 3% interest throughout the 5,2, and 1-year maturity periods as compared to a yield of 3.5% at the same maturity periods.

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iv. Bond Price before payment of final coupon (i.e. 0.5 years to maturity)

For 3.0% Yield

Bond Price = (3.15%*1000*0.5)*[1-(1+3.0%/2)^-1/3.0%/2]+1000/(1+3.0%/2)^1

= $1,000.74

For 3.5% Yield

= (3.15%*1000*0.5)*[1-(1+3.5%/2)^-1/3.5%/2]+1000/(1+3.5%/2)^1

= $998.28

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v. Price after payment of final coupon

For 3.0% Yield

Bond Price = (3.15%*1000*0.5)*[1-(1+3.0%/2)^-0/3.0%/2]+1000/(1+3.0%/2)^0

= $1,000.00

For 3.5% Yield

= (3.15%*1000*0.5)*[1-(1+3.5%/2)^-0/3.5%/2]+1000/(1+3.5%/2)^0

= $1,000.00