Question

Here are data on ​$1000 par value bonds issued by​ Microsoft, GE​ Capital, and Morgan Stanley. Assume you are thinking about buying these bonds. Answer the following​ questions:

a. Assuming interest is paid​ annually, calculate the values of the bonds if your required rates of return are as​ follows: Microsoft, 6.5 ​percent; GE​ Capital,16.5 ​percent; and Morgan​ Stanley, 10 ​percent; where:

	MICROSOFT	GE CAPITAL	MORGAN STANLEY
Coupon interest rate	5.25%	7.25​%	8.00​%
Years to maturity; Microsoft 31. GE; 26 Morgan Stanley; 17

.

b. The bonds are selling for the following​ amounts:

Microsoft  ​$762

GE Capital ​$538

Morgan Stanley $938

What are the expected rates of return for each​ bond?

c. How would the value of the bonds change if​ (1) your required rate of return increased 2 percentage points or​ (2) decreased 2 percentage​ points?

d. Explain the implications of your answers in part ​(c​) in terms of interest rate​ risk, premium​ bonds, and discount bonds.

e. Should you buy the​ bonds? Explain.

Answer 1

Since, the question has multiple parts and each part has multiple subparts, I have answered the first 3 parts (total 12 subparts) with complete details.

______

Part a)

The value of the bonds can be calculated with the use of PV (Present Value) function/formula of EXCEL/Financial Calculator. The basic function/formula for PV is PV(Rate,Nper,PMT,FV) where Rate = Interest Rate (here, Required Return), Nper = Period, PMT = Payment (here, Coupon Payment) and FV = Future Value (here, Face Value of Bonds).

_____

MICROSOFT

Here, Rate = 6.5%, Nper = 31, PMT = 1,000*5.25% = $52.50 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of Microsoft Bond = PV(6.5%,31,52.50,1000) = $834.99 or $835

_____

GE CAPITAL

Here, Rate = 16.5%, Nper = 26, PMT = 1,000*7.25% = $72.50 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of GE Capital Bond = PV(16.5%,26,72.50,1000) = $449.97 or $450

_____

MORGAN STANLEY

Here, Rate = 10%, Nper = 17, PMT = 1,000*8% = $80 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of Morgan Stanley Bond = PV(10%,17,80,1000) = $839.57 or $840

_____

Tabular Representation

Company	Value of Bonds
Microsoft	$835
GE Capital	$450
Morgan Stanley	$840

_____

Part b)

The expected rates of return for each​ bond can be calculated with the use of Rate function/formula of EXCEL/Financial Calculator. The function/formula for Rate is Rate(Nper,PMT,-PV,FV) where Nper = Period, PMT = Payment (here, Coupon Payment), PV = Present Value (here, Selling Price of Bonds) and FV = Future Value (here, Face Value of Bonds).

_____

MICROSOFT

Here, Nper = 31, PMT = 1,000*5.25% = $52.50, PV = $762 and FV = $1,000

Using these values in the above function/formula for Rate, we get

Expected Rate of Return on Microsoft Bond = Rate(31,52.50,-762,1000) = 7.19%

_____

GE CAPITAL

Here, Nper = 26, PMT = 1,000*7.25% = $72.50, PV = $538 and FV = $1,000

Using these values in the above function/formula for Rate, we get

Expected Rate of Return on GE Capital Bond = Rate(26,72.50,-538,1000) = 13.90%

_____

MORGAN STANLEY

Here, Nper = 17, PMT = 1,000*8% = $80, PV = $938 and FV = $1,000

Using these values in the above function/formula for Rate, we get

Expected Rate of Return on Morgan Stanley Bond = Rate(17,80,-938,1000) = 8.71%

_____

Company	Expected Return on Bonds
Microsoft	7.19%
GE Capital	13.90%
Morgan Stanley	8.71%

_____

Part c)

Required Rate of Return Increased by 2% Points

The value of the bonds can be calculated with the use of PV (Present Value) function/formula of EXCEL/Financial Calculator. The basic function/formula for PV is PV(Rate,Nper,PMT,FV) where Rate = Interest Rate (here, Required Return), Nper = Period, PMT = Payment (here, Coupon Payment) and FV = Future Value (here, Face Value of Bonds).

_____

MICROSOFT

Here, Rate = 6.5% + 2% = 8.5%, Nper = 31, PMT = 1,000*5.25% = $52.50 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of Microsoft Bond = PV(8.5%,31,52.50,1000) = $648.14

_____

GE CAPITAL

Here, Rate = 16.5% + 2% = 18.5%, Nper = 26, PMT = 1,000*7.25% = $72.50 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of GE Capital Bond = PV(18.5%,26,72.50,1000) = $399.26

_____

MORGAN STANLEY

Here, Rate = 10% + 2% = 12%, Nper = 17, PMT = 1,000*8% = $80 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of Morgan Stanley Bond = PV(12%,17,80,1000) = $715.21

_____

Required Rate of Return Decreased by 2% Points

The value of the bonds can be calculated with the use of PV (Present Value) function/formula of EXCEL/Financial Calculator. The basic function/formula for PV is PV(Rate,Nper,PMT,FV) where Rate = Interest Rate (here, Required Return), Nper = Period, PMT = Payment (here, Coupon Payment) and FV = Future Value (here, Face Value of Bonds).

_____

MICROSOFT

Here, Rate = 6.5% - 2% = 4.5%, Nper = 31, PMT = 1,000*5.25% = $52.50 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of Microsoft Bond = PV(4.5%,31,52.50,1000) = $648.14

_____

GE CAPITAL

Here, Rate = 16.5% - 2% = 14.5%, Nper = 26, PMT = 1,000*7.25% = $72.50 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of GE Capital Bond = PV(14.5%,26,72.50,1000) = $399.26

_____

MORGAN STANLEY

Here, Rate = 10% - 2% = 8%, Nper = 17, PMT = 1,000*8% = $80 and FV = $1,000

Using these values in the above function/formula for PV, we get

Value of Morgan Stanley Bond = PV(8%,17,80,1000) = $1,000

_____

Tabular Representation

	Value of Bonds
Company	When Required Rate of Return Increased by 2% Points	When Required Rate of Return Decreased by 2% Points
Microsoft	$648.14	$1,124.08
GE Capital	$399.26	$514.79
Morgan Stanley	$715.21	$1,000.00