Description / paper instructions
managerial finance
Forum 4
Sam Strother and Shawna Tibbs are vicepresidents of Mutual of Seattle Insurance Company and codirectors of the company’s pension fund management division. A major new client, the Northwestern Municipal Alliance, has requested that Mutual of Seattle present an investment seminar to the mayors of the represented cities, and Strother and Tibbs, who will make the actual presentation, have asked you to help them by answering the following questions. Because the Boeing Company operates in one of the league’s cities, you are to work Boeing into the presentation.
 What are the key features of a bond?What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
 How is the value of a bond determined? What is the value of a 10year, $1,000 par value bond with a 10 percent annual coupon if its required rate of return is 10 percent?What would be the value of the bond if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13 percent return? Would we now have a discount or a premium bond?What would happen to the bonds’ value if inflation fell, and required rate of return declined to 7 percent? Would we now have a premium or a discount bond?
 What is the yield to maturity on a 10year, 9 percent annual coupon, $1,000 par value bond that sells for $887.00? That sells for $1,134.20? What does the fact that a bond sells at a discount or at a premium tell you about the relationship between rd and the bond’s coupon rate?What are the total return, the current yield, and the capital gains yield for the discount bond? (Assume the bond is held to maturity and the company does not default on the bond.)
 How does the equation for valuing a bond change if semiannual payments are made? Find the value of a 10year, semiannual payment, 10 percent coupon bond if nominal rd = 13%.
 Suppose a 10year, 10 percent, semiannual coupon bond with a par value of $1,000 is currently selling for $1,135.90, producing a nominal yield to maturity of 8 percent. However, the bond can be called after 5 years for a price of $1,050.What is the bond’s nominal yield to call (YTC)?If you bought this bond, do you think you would be more likely to earn the YTM or the YTC? Why?
 Write a general expression for the yield on any debt security (rd) and define these terms: real riskfree rate of interest (r*), inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturity risk premium (MRP).
 What is a bond spread and how is it related to the default risk premium? How are bond ratings related to default risk? What factors affect a company’s bond rating?What is interest rate (or price) risk? Which bond has more interest rate risk, an annual payment 1year bond or a 10year bond? Why?What is reinvestment rate risk? Which has more reinvestment rate risk, a 1year bond or a 10year bond?
 Briefly describe bankruptcy law. If this firm were to default on the bonds, would the company be immediately liquidated? Would the bondholders be assured of receiving all of their promised payments?
