Question

The government has five bonds in issue .Each has a par value of $100,pays coupon interest annually and is redeemable at its par value at the end of the stated maturity term. The table below summaries the relevant information about each of the five government The following additional information is available in respect of each bond:

Bond	Maturity term	Annual coupon Rate	price
Bond P	Year 1	3.40%	$101.55
Bond Q	Year 2	3.80%	$100.85
Bond R	Year 3	4.25%	$99.25
Bond S	Year 4	4.55%	$96.25
Bond T	Year 5	5.15%	$95.50

GHI Plc is a stock exchange listed company. The company has in issue Bond X that has a coupon rate of 7% and is redeemable at its par value of $100 in four years’ time. Coupon interest on Bond X is paid annually.

GHI Plc has now announced the issue of bond A which is a five year Bond. Bond A has a par value of $100 and will be redeemed at this par value in five years’ time from the issue date. The bond will pay annual coupon interest at the rate of 6.5%.As a result of this this bond issue, the credit rating of the company will drop from the current credit rating of A to the credit rating of BBB

The following tables showing the credit spreads, in basis point are available from the credit rating agency. They are applicable to the industry sector in which GHP Plc operates

Credit spreads in basis points

Credit Rating	Year 1	Year 2	Year 3	Year 4	Year 5
A	10	23	35	48	52
BBB	26	39	53	62	70
B	42	60	72	85	98

Required

1. Calculate the government bond annual spot rate for years from 1 to 5 by bootstrapping the above coupon paying government bonds and state the shape of the resulting government bond yield curve.
2. Identify and explain four(4) possible reasons why the credit rating agency has decreased GHI plc credit rating from A to BBB
3. Calculate the percentage change in the price of GHI plc bonds arising from the decrease in the company credit rating from A to BBB and briefly explain why the bonds prices are likely to change in that way.
4. Calculate the issue price of GHI plc’s proposed Bond A
5. Calculate the yield to maturity of GHI Plc’s proposed Bond A and comment on your result.

Answer 1