Question

1. Jaime Bond is a fixed income portfolio manager. He has the following investment alternatives:

a. AA Corporate-Alegre Vengo bond with a coupon rate of 5%. This bond is trading at $ 925.

      Jaime expects an increase of 40% in the price of this bond.

b. AA Corporate-de La Montana bond, selling for $ 850 with a 6% coupon rate. Target price is par.

  More important info:     

Jaime investment horizon is 5 years.

Alegre Vengo and De La Montana bonds have the same duration.

                Required:

                               What bond would you recommend, why?

                               Back your arguments with numbers relevant to the situation.

Answer 1

Answer: I would recommend buying AA Corporate-Alegre Vengo bond as it would fetch higher net cash inflow to the Jaime Bound.

Reason

	AA Corporate - Alegre bond Vengo Bond	AA Corporate -de la montana Bond
Cash Outflow	$ 925	$ 850
Year	5	5
Rate p.a	5%	6%
Interest income	231.25   (925x5%x5year)	255 (850x6%x5year)
Sale Proceeds at the 5th year	1295 (925*140%)	850
Net Cash InFlow	$ 601.25   (1295+231.25-925)	$ 255   (850+255-850)
Recommend	Yes	No

2 -Answer: Bond  AA Corporate - Alegre bond Vengo Bond although having higher price and lower rate of interst but the apprecialion at the end of the year is nearly 40% which make thses bonds attractive, By purchasing these bond Jaime Bond earn not only interest of 231.25 but capital will also be appreciated by $370 (925*40%). Whereas AA Corporate -de la montana Bond having low price and higher interest rate but there is no capital appreciation. Interest income of $ 255 only earned by Jaime Bond. when compare both AA Corporate - Alegre bond Vengo Bond will fetch extra income at the end of 5 year i.e $ 346.25. so its better to buy AA Corporate - Alegre bond Vengo Bond.