Question

Your father is retired and living on his pension benefits and the interest he gets from savings. However, the interest income he receives has dwindled to only 2 percent a year on his RM200,000 in savings as interest rates in the economy have dropped. You have been thinking about recommending that he purchase some corporate bonds with at least part of his savings as a way of increasing his interest income.

Specifically, you have identified three corporate bond issues for your father to consider. The first is an issue from the Lazza Bhd that pays annual interest based on a 7.5% coupon rate and has 10 years before it matures. It is an AA rating bond and currently is selling at RM1,100. The second bond with B rating was issued by Pleton Bhd, and it pays 7.8% semi-annually interest has 7 years until it matures. The market price of the bond is RM980. The final bond issue was sold by Zellig Bhd, and it pays an annual coupon interest payment based on a rate of 7.25%. It was 20 years bond and has been issued for 7 years. The bond is currently selling at RM1,050 and it has BBB rating. All three bond issues have a RM1,000 par value.

Required:

1. What is the yield to maturity for each bond?

A. 6.19%; 8.88%; 6.7%.

2. 6.19%; 4.08%; 6.7%.

3. 6.19%; 4.08%; 6.38%.

4. 6.19%; 8.88%; 6.38%.

2. From (a), determine the value of each bond.

1. RM1487.23; RM945.43; RM1,047.91

2. RM1487.23, RM945.43, RM1046.76.

3. RM1487.23; RM1224.55; RM1046.76.

4. RM1487.23; RM1224.55; RM1047.91.

3. The importance of bond ratings as follows ACCEPT ……..

1. it is an indicator of its default risk

2. most bonds purchased by institutions rather than individuals

3. lower grade bonds have lower required rates of return than high grade bonds

4. If a firm’s bonds fall below BBB, it will have a difficult time selling new bonds.

4. Which of the following statements is CORRECT?

	A bond is likely to be called if its coupon rate is below its YTM.
	A bond is likely to be called if its market price is below its par value.
	A bond is likely to be called if its market price is equal to its par value.
	A bond is likely to be called if it sells at a discount below par.

5. When comparing annuity due to ordinary annuities, annuity due annuities will have higher ______________.

A. present values.

B. annuity payments.

C. future values.

D. both A and C.

Answer 1

for first two questions (calculation of YTM and Price of bond) refer the screenshots. Financial calculator has been used to perform the TVM calculation. Please note that the answer options given in the questions do not exactly match with the correct answers.

1. The importance of bond ratings as follows ACCEPT ……..

1. it is an indicator of its default risk - Correct

2. most bonds purchased by institutions rather than individuals - Cannot be implied by Bond rating

3. lower grade bonds have lower required rates of return than high grade bonds - Incorrect, lower grade bonds need higher required rates of return

4. If a firm’s bonds fall below BBB, it will have a difficult time selling new bonds. - Correct

1. Which of the following statements is CORRECT?

	A bond is likely to be called if its coupon rate is below its YTM. - No.
	A bond is likely to be called if its market price is below its par value. No
	A bond is likely to be called if its market price is equal to its par value. No
	A bond is likely to be called if it sells at a discount below par. No

1. When comparing annuity due to ordinary annuities, annuity due annuities will have higher ______________.

A. present values. - correct, as payments are made pbefore the period in annuity due

B. annuity payments.

C. future values. - correct, Each cash flow is compounded for one additional period compared to an ordinary annuity.

D. both A and C. - Correct answer