Question

Part a)In Feb’2018, Amazon raised US$3.5bn by issuing 10-year bonds carrying annual coupon of 3.15%. Amazon could also have raised the same amount of funds from the equity market. What benefits does Amazon get by raising funds via bonds that they would not have received by issuing equity? Why do you think the company did not take a bank loan for the total amount raised? .

Part b) In Feb’2018, Amazon raised US$3.5bn by issuing 10-year bonds carrying annual coupon of 3.15%. The face value of the bond is $1000 and the coupon is paid every six months. i. It is said that the price of a bond is inversely proportional to the prevailing interest rates. Prove this statement by taking the case of the above bond and computing the price of the bond at the above two yields (3.0%, and 3.5%) for different times from maturity. You may compute the bond prices at 5 years, 2 years, 1 year, and at maturity. ii. What would be the price of the bond immediately before the payment of the final coupon (compute for both bond yields)? iii. What would be the price of the bond immediately after the payment of the final coupon (compute for both bond yields)?

Part c) Note down price of FaceBook Inc. dated 1st November, and then note down price of FaceBook dated 28th Feb. Calculate holding period return for FaceBook for given time period. Now research internet to get risk-free rate of return, market return and beta for FaceBook. Appropriately refer all information and give reasons for selecting this data. Then calculate value of value of FaceBook using CAPM Model.

Answer 1

Part a. Issuing equity means allowing participation in ownership of the company, giving voting rigts & share in after-tax profits & dividend payments out of the after-tax net income--- even though repayment of the capital borrowed , is neither time-bound nor compulsory.

Whereas,

Moneys borrowed by bonds , even though , have a time-frame for repayment--their interests are tax deductible(reduces taxable income) & do not have any ownership rights.Large sums can be borrowed at quite lower costs.

In contrast, bank loans come with covenants, like not to incur any more debts, till theirs are repaid & the financials are continuously monitored by the lending banks---so there is a pressure to constantly maintain ratios , to comply with their requirements. Such things are not required , while borrowing through issue of bonds , where the company has teh freedom of both quantum as well as terms of the moneys borrowed.Often,interest on bonds are lower than that charged by banks.

The above might have been the reasons for Amazon to raise finance needed through issue of bonds.

Part b.

Price of the bond at the   3.0% Yield------Maturity-- 5 yrs.

Price=PV of coupons +PV of Face value to be recd. At maturity (both discounted at the Yield)

ie.Price=($ Coupon.*(1-(1+Yield)^-n)/Yield)+(Face Value/(1+Yield)^n)

so, semi-annual coupon amt.=($ 1000*3.15%= $ 31.5) ; Semi-annual Yield= 3%/2=1.5% , n= 5*2=10 , FV=$ 1000

Then, Price=(31.5*(1-(1+3%)^-10)/3%)+(1000/(1+3%)^10)

1012.80

Price of the bond at the   3.5% Yield------Maturity-- 5 yrs.

Price=(31.5*(1-(1+3.5%)^-10)/3.5%)+(1000/(1+3.5%)^10)

970.89

Similarly for othr years to maturity

Price of the bond at the   3.0% Yield------Maturity-- 2 yrs.--4 semi-annual coupon periods

Price=(31.5*(1-(1+3%)^-4)/3%)+(1000/(1+3%)^4)

1005.58

Maturity-- 1 yrs.--2 semi-annual coupon periods

Price=(31.5*(1-(1+3%)^-2)/3%)+(1000/(1+3%)^2)

1002.87

At maturity

Price=(31.5*(1-(1+3%)^-0)/3%)+(1000/(1+3%)^0)

1000

Price of the bond at the   3.5% Yield------Maturity-- 2 yrs.--4 semi-annual coupon periods

Price=(31.5*(1-(1+3.5%)^-4)/3.5%)+(1000/(1+3.5%)^4)

987.14

Maturity-- 1 yrs.--2 semi-annual coupon periods

Price=(31.5*(1-(1+3.5%)^-2)/3.5%)+(1000/(1+3.5%)^2)

993.35

At maturity

Price=(31.5*(1-(1+3.5%)^-0)/3.5%)+(1000/(1+3.5%)^0)

1000

Tabulating the Prices
Yrs. To maturity/YTM	3%	3.50%
5	1012.8	970.89
2	1005.58	987.14
1	1002.87	993.35
0	1000	1000

ii. Price of the bond immediately before the payment of the final coupon

3.0% yield--- 1 coupon left

Price=(31.5*(1-(1+3%)^1)/3%)+(1000/(1+3%)^1)=

939.37

3.5% yield--- 1 coupon left

Price=(31.5*(1-(1+3.5%)^1)/3.5%)+(1000/(1+3.5%)^1)=

934.68

iii.Price of the bond immediately after the payment of the final coupon

3.0% yield--- 0 coupon left

Price=(31.5*(1-(1+3%)^0)/3%)+(1000/(1+3%)^0)=

1000.00

3.5% yield--- 0 coupon left

Price=(31.5*(1-(1+3.5%)^0)/3.5%)+(1000/(1+3.5%)^0)=

1000