Question

Your friend Bill Sing went to Yorkville University and obtained a BBA. Although Bill did graduate, he was a horrible student. He would always cheat on his assignments and exams. Bill would use Course hero and Chegg to complete all his assessments. He rarely attended class and did not take his studies seriously. Bill is the laziest student you have ever met. On the other hand, you were a very good student at Yorkville University who always behaved honestly and ethically and graduated the BBA program with a 78% average.

Bill Sing likes to brag to everyone that his final grade in Managerial Finance was 95%, although everyone knows he cheated throughout the entire course. He really should be ashamed of himself.

Upon graduating 6 months ago, Bill got a job at a major Canadian Investment firm that specializes in Bonds. Trevor Car is Bill Sing’s boss, and has concluded, that Bill is a fraud and should not be working at the company. Trevor is going to give Bill one more chance to prove himself. He has asked Bill to complete an analysis on Bonds from Tata Steel and Rajesh Exports. The bonds from Tata Steel are premium bonds with a 12% coupon. Rajesh Exports bonds sell at a discount with an 8% coupon. The yield to maturity for both bonds is 10% and have eleven years to maturity. Both bonds make annual payments and interest rates are not expected to change over the year.

Trevor Car has asked Bill Sing to calculate the capital gains yield on both bonds and make a recommendation as to which bond will yield the best gains for the firm. Trevor also wants Bill to explain the relationship between coupon rate, yield to maturity and capital gains yield in his report.

Bill Sing is clueless on how to answer this question. Once again, he looks to go onto Course Hero and Chegg to get the answers, but they are not available. After a week of showing no progress, Trevor Car has fired Bill Sing.

You decide to apply for the job and have asked Trevor Car for this opportunity. Trevor agrees to give you the job if you can answer the questions. Trevor wants to see all your work showing the calculations.

Answer 1

Bonds from Tata Steel:

Coupon Rate: 12%

Yield To Maturity: 10%

Years to Maturity: 11

Let the par value be $100,

Then, the PV is $112.99.

If this bond is held till maturity, the capital gains on this bond will be -11.49% ((($100-$112.99)/$112.99)*100)

Bonds from Rajesh Exports:

Coupon Rate: 8%

Yield To Maturity: 10%

Years to Maturity: 11

Let the par value be $100,

Then, the PV is $87.01.

If this bond is held till maturity, the capital gains on this bond will be 14.93% ((($100-$87.01)/$87.01)*100)

Therefore, Rajesh Exports will yield the best capital gain for the firm.

Capital gain is inversely proportional to the coupon rate because the present value (PV) is directly proportional to the coupon rate and capital gain is inversely proportional to the present value.

Capital gain is directly proportional to the yield to maturity because the present value (PV) is inversely proportional to the coupon rate and capital gain is inversely proportional to the present value.