Question

a) Pearson Publishing Ltd needs to borrow money for two purposes: purchase of inventory and purchase of a building to expand its business. Please advise this company on how to raise funds for these two purposes. In your discussion you need to define and distinguish between the debt markets advised. (6 marks)

b) Pearson decides to issue a 90-day commercial paper at a yield of 2.5% p.a. If the face value of the paper is $150,000, how much fund will Pearson be able to raise? (3 marks)

c) The company has decided to issue a bond at a Face Value of $1,000. The coupon rate of the bond is 8% per annum and the coupons are paid semi-annually. The bond has a term to maturity of 5 years and the yield-to-maturity is 8% per annum as well. Without calculation, briefly explain what the implied price of this bond would be? (2 marks)

d) If an investor bought the bond at issuance at the implied price in part c) and then sold it at $1030 after holding it for 1.5 years, what was his holding period yield per annum? (4 marks)

Answer 1

1. Borrowing of money depends on their purposes. Accordingly short term loan and long term loan are classified. In the given question Purchase of inventory is short term requirement therefore should be finance through short term loan. These are liquid loans with a short term. The period for which these loans are given is usually a year or less. Similarly Purchase of building is long term requirement therefore should be finance through long term loan. Term loans, as the name suggests, are loans that take more time, from one to ten years.

2. Issue price of bond = Face Value / (1 + r)

                                = 150000/ (1 + 0.025*90/365)                

                                = 150000/1.00616

                                = 149081.65

Pearson company can raise 149081.65 from commercial paper.

3. Since interest rate and yield rate are same therefore implied price of these bond will be equals to par value i.e.1000

4. Return form bond is simply interest earned and difference of value invested and maturity/sale value, if any. it can be calculated in following manner:

Return = (I + SV - PV )/ PV*100*1/n

          = (120+ 1030- 1000)/1000 * 100 * 1/1.5

          = 10%