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Peachtree Securities Inc.

Bonds Valuation Case

Diane Carumay Tiffany Ching Melvin Catarroja Jr. Aissa Valerie Sicio Abelardo
Bea Jr.

The Case:
Laura Donahue

Assignment

Strategies

Successful in her risk and


return seminar

Determine the value of


TECO Securities

Jake Taylor gave her


another
assignment/challenge

Prepare a seminar
explaining valuation
process to the customers

Studied long-term debt


obligations: first-mortgage
bonds, installment
contracts and term loans.
Concerned with event
risk and If long term debts
would affect TECOs return

Challenges deep-dive
Statement of the Problem

Is the level of risk of bond


financing for TECO lower?

Objective of the Case


To know the basics of
Bonds Valuation
Determine the level of risk
of Bond Financing for
TECO
Resolve the questions
provided by the case

Question 1
Scenario
To begin, assume that it
is now January 1, 1993,
and that each bond in
Table 1 matures on
December 31 of the year
listed. Further, assume
that each bond has a
$1000 par value, each
had a 30-year maturity
when it was issued, and
the bonds currently have
a 10% required nominal
rate of return.

a.) Why do bonds coupons rates vary so widely?


Changes in market interest rates
Due to the influx of interest rates mainly influenced by
inflation, deflation and market movement
Creditworthiness of the issuer.
Bond issuers with lower credit ratings need to offer even
higher coupons to compensate investors for assuming
additional risk.
Terms to remember:
Bonds - long-term debt instrument. They are long term contracts whereby a
borrower agreed to pay bondholders with Interest and principal.
Maturity (Or maturity date) - the date when the initial value of the bond will be
repaid by the borrower.
Par value - the face value or the amount of the bond bought by the bond holder.
Premium bond - bond value is greater than par value.
Discounted bond - bond value is less than par value.

Question 1
Scenario

b.) What would be the value of each bond if they had annual
coupon payments?
Excel formula to get PV: =PV(rate, nper,pmt,[fv])

To begin, assume that it


is now January 1, 1993,
and that each bond in
Table 1 matures on
December 31 of the year
listed. Further, assume
that each bond has a
$1000 par value, each
had a 30-year maturity
when it was issued, and
the bonds currently have
a 10% required nominal
rate of return.

Mat
urity
Year

Required
Nominal
Rate of
Return

Cou
pon
Rate

Par
Valu
e
(FV)

Year
s to
Mat
urity

199
7

10%

4.50
0%

$1,0
00.0
0

Pay
men
t

$45.
00

Bon
d
Valu
e
(PV)
$79
1.51

c.) TECOs bonds, like virtually all bonds, actually pay interest
$1,0
15
$86
00.0
What
is $82.
the 6.89
each bonds value under these
0
50
conditions? Are the bonds currently selling at a discount or at
201
10%
12.6 $1,0
25
$1,2
a premium?
200
10%
8.25
7
0%
semiannually.

7
Mat
urity
Year

199
7

Required
Nominal
Rate of
Return

5%

25%
Cou
pon
Rate

00.0
0
Par
Valu
e
(FV)

2.25
0%

$1,0
00.0

Year
s to
Mat
urity

10

$12
6.25
Pay
men
t

38.2
7
Bon
d
Valu
e
(PV)

22.5

$78
7.65

Question 1
Scenario
To begin, assume that it
is now January 1, 1993,
and that each bond in
Table 1 matures on
December 31 of the year
listed. Further, assume
that each bond has a
$1000 par value, each
had a 30-year maturity
when it was issued, and
the bonds currently have
a 10% required nominal
rate of return.

d.) What is the effective annual rate of return implied by the


values obtained in part c?
Excel formula to get effective annual rate of return:
=EFFECT(nominal_rate,npery)
Nominal
Annual
Rate of
Return

Effective Annual Rate of


Return (Semiannual
periods)

Excel

Terms to remember:
10%

10.25%

Coupon - specified amount of interest paid by the borrower to the bondholders.


Nominal rate of return - this is the offered rate of return of bond during its initial
offering.
Effective annual rate of return - this is the effective interest rate of the security
when compounded more than once.

Question 1
Scenario
To begin, assume that it
is now January 1, 1993,
and that each bond in
Table 1 matures on
December 31 of the year
listed. Further, assume
that each bond has a
$1000 par value, each
had a 30-year maturity
when it was issued, and
the bonds currently have
a 10% required nominal
rate of return.

e.) Would you expect a semiannual payment bond to sell at a


higher or lower price than an otherwise equivalent annual
payment bond? Now look at the 5-year bond in parts b and c.
Are the prices shown consistent with your expectations?
Explain.
Mat
urity
Year

Required Cou
Nominal pon
Rate of Rate
Return

Par
Valu
e
(FV)

Year
s to
Mat
urity

Pay
men
t

Bon
d
Valu
e
(PV)

Mat
urity
Year

Required Cou
Nominal pon
Rate of Rate
Return

Par
Valu
e
(FV)

Year
s to
Mat
urity

Pay
men
t

Bon
d
Valu
e
(PV)

$1,0
00.0
0

199
7

10%

4.50
0%

$45.
00

$79
1.51

2.25 is$1,0
10
$22. $78RELATED the maturity and
Bond5%value
INVERSELY
0% 00.0
50
7.65
0 compounding period

199
7

Question 2
Scenario
Now, regardless of your
answers to Question 1,
assume that the 5-year
bond is selling for
$800.00, the 15-year
bond is selling for
$865.49 and the 25-year
bond is selling for
$1,220.00. (Note: Use
these prices, and
assume semiannual
coupons for the
remainder of the
questions).

a.) Explain the meaning of the term yield to maturity.


This is the rate of the return when the bond is held until
maturity.
This is the same with the total rate of return, the totality of the
interest earned when the bond is being paid for and adhered to
until maturity. x
b.) What is the nominal (as opposed to effective annual) yield
to maturity (YTM) on each bond?
Excel formula to get nominal YTM: =RATE(nper,pmt,pv,fv)
Co Par
up Valu
on
e
Rat (FV
e
)

2.2
5%
4.1

Year
s to
Matu
rity
(Peri
ods)

Pay
men
t

Valu
e of
Bon
d
(PV)

10
$1,
000

$22. $800
50
.00
30

Nomi
nal
Semi
Annu
al
YTM

No
min
al
Ann
ual
YT
M

4.82
%

9.6
3%

5.00

10.

Question 2
Scenario
Now, regardless of your
answers to Question 1,
assume that the 5-year
bond is selling for
$800.00, the 15-year
bond is selling for
$865.49 and the 25-year
bond is selling for
$1,220.00. (Note: Use
these prices, and
assume semiannual
coupons for the
remainder of the
questions).

c.) What is the effective annual YTM on each issue?


Excel formula to get effective annual rate of return:
=EFFECT(nominal_rate,npery)
Co Par
upo Val
n
ue
Rat (F
e
V)

Yea
rs
to
Mat
urit
y
(Pe
riod
s)

2.2
10
5%Yield
$1, to
00
0

Pa
ym
ent

Valu No No Eff
e of min min ecti
Bon
al
al
ve
d
Se Ann YT
(PV miA ual
M
)
nnu YT
al
M
YT
M

$22 $80
Maturity
.50 0.00

4.8
2%
to

9.6 9.8
3% used
7%
be

in comparing securities

Terms to remember:
4.1
30
5.0 10. 10.
3% $1,
$41 $86 0% 00
25
Yield 00
- amount of.25
return
will
5.49on investment
%
% realize on a security, in this case, a
bond. 0
6.3
50
$1,2 5.0 10. 10.
Yield
to
Maturity
(YTM)
(interest
1% $1,
$63 20.0- the
9%rate18
44 rate) effective (inclusive of gains and
loss) of
until maturity
00the bond.13
0
%
%
0

Question 3
Scenario

a.) What is (1) the nominal yield and (2) the effective annual
YTM on this bond?
Nominal YTM - coupon rate of the bond = 7 percent

Supposed TECO has a


second bond with 25
years left to maturity (in
addition to the one listed
in Table 1), which has a
coupon rate of 7
percent and a market
price of $747.48.

Terms to remember:
Current Yield - annual interest
paymet divided by bonds current
price

Excel formula to get effective YTM: =RATE(nper,pmt,pv,fv)


N

Coup
on
Rate

Paym
ent

Market
Value
(PV)

Par
Value
(FV)

YTM

b.) What is the current yield on each of the 25-year bonds?


Current Yield = annual interest payment / bonds current price
25 7.375 73.75 747.48 1,000
N %Coup Paym Mark
Par
on
ent
et
Value
Rate
Value (FV)
(PV)

25

7.38
%

10.2
Curr
0%
ent
Yield

73.75
747.4 price
1,000 9.87
Bonds
=
8
%

Bonds value

Question 3
Scenario

c.) What is each bond's expected price on January 1, 1994 and


its capital gains yield for 1993, assuming no change in
interest rates? (Hint: Remember that the nominal required
rate of return on each bond is 10.18%)

Supposed TECO has a


second bond with 25
years left to maturity (in
addition to the one listed
in Table 1), which has a
coupon rate of 7
percent and a market
price of $747.48.

Req
uire
d
Co Par
No
up Val
min
on ue
al
Rat (FV
Rat
e
)
e of
Ret
urn

Terms to remember:

10.
18
%

Capital Gains Yield - rise (or fall) in


the price of the security, in this case
bond.

4.5 100
0%
0

Y
for
19
93

Y1
for
19
94

Bon Bon
d
d
Valu Valu
Pay
e
e
me
(PV (PV
nt
at
at
199 1994
3)
)

45

Capital Gains Yield is


10.
8.2 100are as
82.
computed
18
15 14
5%
0
5
%
follows:
10.
18
%
10.

12.
63
%

100
0

7.3

100

25

24

$78 $820
5.67 .65
Change '93 - '94
$85 $859
4.70 .21

Capital Gains Yield

$1,2
126
18.9
.25
0

$34.98
$1,2
16.7
3

4.45%

73.

$4.51
$751

0.53%

$74

Question 3
Scenario

d.) What would happen to the price of each bond overtime?


(Again, assume constant future interest rates.)

Supposed TECO has a


second bond with 25
years left to maturity (in
addition to the one listed
in Table 1), which has a
coupon rate of 7
percent and a market
price of $747.48.

Premium bond = declining towards par value


Discounted bond = increasing towards par value

Question 3
Scenario
Supposed TECO has a
second bond with 25
years left to maturity (in
addition to the one listed
in Table 1), which has a
coupon rate of 7
percent and a market
price of $747.48.

e.) What is the expected total (percentage) return of each


bond during 1993?

f.) If you were a taxpaying investor, which bond would you


prefer? Why? What impact would this preference have on the
prices hence YTMs of the two bonds?
Acquired income based on the interest paid by the borrower is an
income for the bondholder. Income holds tax and other duties,
this as a taxing investor, you would prefer one that has the
current yield, and this is the 4th bond option.

Question 4
Scenario

a. Explain the difference between interest rate (price) risk and


reinvestment rate risk.

Consider the riskiness of


the bonds

Price risk is the uncertainty associated with potential changes in


the price of an asset caused by changes in interest rate levels in
the economy.
Reinvestment risk is the risk that a particular investment might be
canceled or stopped somehow, and that one may have to find a
new place to invest their money with the risk that there might not
be a similarly attractive investment available
b.) Which of the bonds listed in Table 1 has the most price
risk? Why?
The longer the maturity of the bond, the more it is susceptible to
fluctuating interest rates and the riskier the bond is.

Question 4
Scenario
Consider the riskiness of
the bonds

c.) Assume that you bought 5-year, 15-year and 25-year bonds
all with a 10% coupon rate and semiannual coupons, at their
$1,000 par values. Which bonds value would be most affected
if interest rates rose to 13%? Which would be least affected?
If you are using the Lotus modem, calculate the new value of
each bond.
Re
quir
ed
No
min
al
Rat
e
of
Ret
urn

Co
up
on
Ra
te
@
10
%

Co
up
on
Ra
te
@
10
%

P
a
r
V
al
u
e
(
F
V
)

M
at
uri
ty

P
M
T
@
10
%

P
M
T
@
13
%

BV
@
10
%

BV
@
13
%

%
DI
FF

10. 5.0 6.5 1 10 50 65 6 7 12


00 Remember
0% 0% 0 that the shorter
92. 84. the
.4
shorter the bond, the lesser
%
0
77 94
7
0
susceptible
the bond from %
the influx of recurring interest
10.
00
%

5.0
0%

6.5
0%

1
0
0
0

30

50

65

5
28.
65

6
23
changes.
70. .5
06
9
%

Question 4
Scenario
Consider the riskiness of
the bonds

d.) Assume that your investment horizon (or expected holding


period) is 25 years. Which if the bonds listed in Table 1 has
the greatest reinvestment rate risk? Why? What is a type of
bond you could buy to eliminate reinvestment rate risk?
Shorter period bonds = greater reinvestment risk

YEAR 5

YEAR
10

YEAR
15

YEAR
20

DECLINING INTEREST REINVESTMENT

YEAR 25
ONE INTEREST REINVESTMENT

YEAR
25

Question 4
Scenario
Consider the riskiness of
the bonds

Question 5
Scenario

a.) What is its yield to call (YTC)?

Now assume that the 15year bond is callable after


5 years at $1,050.

Yield to call is yield of the bond if the bond is to be bought and


hold until the call date. The call date is the date less than that of
the maturity date
a.) What is its yield to call (YTC)?

Req
uire
d
Co Par
No
up Val
min
on ue
al
Rat (FV
Rat
e
)
e of
Ret
urn

10

8.2

100

Bon Bon
Yd
d
Ma
Pay
5
Valu Valu
tur
me
for
e@ e@
e Proposed
nt
> calculated
bond value
5th
Mat
5th
ure Loss
year of $157.53
Borrower

$82

$86

$892

Solution
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Implementation

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11.01.XX

The team
CEO

Jude Parker

Dir. of Sales

Dir. of
Engineering

Ashton Smith

Casey Baumer

North America
Lead

Asia Lead

Europe Lead

Front End Lead

Back End Lead

Ashley Smith

Torrence Reyes

Sam Lincoln

Jessie Baker

Alison Brown

max growth

Impact
XX% sales increase