Question

 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 1

Part i)

Date	Type	Cash flow	PVF @ 5.5%	Discounted cashflow
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 ABC bond			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-current price)/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%	Discounted cashflow
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 ABC bond			1,050.48

Part iii)

Always chose option ii, because reinvestment of coupon has not been considered above. If we reinvest the coupon we get higher realised YTM than option i realised YTM.

Part iv)

Increased YTM = 6.5%.

When YTM = Coupon rate, then the bond price will be equal to maturity 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 investor required return i.e. YTM will increase so thst bond will be sold at discounted price and vice verse.

Market interest rate and bond prices are inversely related.