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TRINITY UNIVERSITY OF ASIA
COLLEGE OF BUSINESS ADMINISTRATION
FIN 136 ? Capital Markets
PROBLEM SET 2 ? VALUATION OF BONDS
You're an analyst in the finance department of OverPass Corp., a
new firm in a profitable but risky high-tech business. Several growth
opportunities have presented themselves recently, but the company
doesn't have enough capital to undertake them. Stock prices are down,
so it doesn't make sense to try to raise new capital through the sale of
equity. The company's bank won't lend it any more money than it already
has, and investment bankers have said that debentures are out of the
question. The treasurer has asked you to do some research and suggest a
few ways in which bonds might be made attractive enough to allow
Flyover to borrow. Write a brief memo summarizing your ideas.
The Everglo Corp., a manufacturer of cosmetics, is financed with a
50-50 mix of debt and equity. The debt is in the form of debentures,
which have a relatively weak indenture. Susan Moremoney, the firm's
president and principal stockholder, has proposed doubling the firm's debt
by issuing new bonds secured by the company's existing assets and using
the money raised to attack the lucrative but very risky European market.
You're Everglo's treasurer, and have been directed by Ms. Moremoney to
implement the new financing plan. Is there an ethical problem with the
president's proposal? Why? Who is likely to gain at whose expense?
(Hint: How are the ratings of the existing debentures likely to change?)
What would you do if you really found yourself in a position like this?
You're the CFO of Nildorf Inc., a maker of luxury consumer goods
that, because of its product, is especially sensitive to economic ups and
downs. (People cut back on luxury items during recessionary times.) In
an executive staff meeting this morning, Charlie Suave, the president,
proposed a major expansion. You felt the expansion would be possible if
the immediate future looked good, but were concerned that spreading
resources too thin in a recessionary period could wreck the company.
When you expressed your concern, Charlie said he wasn't worried about
the economy, because the spread between AAA and B bonds is relatively
small, and that's a good sign. You observed, however, that rates seem to
have bottomed out recently and are rising along with the differential
between strong and weak companies. After some general discussion, the
proposal was tabled pending further research. Later in the day, Ed
Sliderule, the chief engineer came into your office and asked, "What in the
world were you guys talking about this morning?" Prepare a brief written
explanation for Ed.
4. Paliflex Corp. needs new capital, but is having difficulty raising it. The
firm?s stock price is at a ten year low, so selling new equity means giving
up an interest in the company for a very low price. The debt market is
tight and interest rates are unusually high, making borrowing difficult and
expensive. In fact, it isn?t certain that anyone will lend to Paliflex because
it?s a fairly risky company. On the other hand, the firm?s long-term
prospects are good, and management feels the stock price will recover
within a year or two. Ideally management would like to expand the
company?s equity base, so it can borrow more later on, but at the moment
the stock price is just too low. Suggest a capital strategy that addresses
both the short and long-run explaining why it is likely to work.
5. The Aldana Company issued a 25-year bond 5 years ago with a face
value of P1,000. The bond pays interest semiannually at a 10% annual
a. What is the bond's price today if the interest rate on comparable
new issues is 12%?
b. What is the price today if the interest rate is 8%?
c. Explain the results of parts a and b in terms of opportunities
available to investors.
d. What is the price today if the interest rate is 10%?
e. Comment on the answer to part d.
Calculate the market price of a P1,000 face value bond under the
What is the current yield on each of the bonds in the previous
The Sampson Company issued a P1,000 bond 5 years ago with an
initial term of 25 years and a coupon rate of 6%. Today?s interest rate is
a. What is the bond?s current price if interest is paid semi-annually as it
is on most bonds?
b. What is the price if the bond?s interest is paid annually? Comment on
the difference between a and b.
c. What would the price be if interest was paid semi-annually and the
bond was issued at a face value of $1,500?
Fix-It Inc. recently issued 10-year, P1,000 par value bonds at an 8%
a. Two years later, similar bonds are yielding investors 6%. At what
Fix-Its bonds selling?
b. What would the bonds be selling for if yields had risen to 12%?
c. Assume the conditions in part a. Further assume interest rates
remain at 6% for the next 8 years. What would happen to the price
of the Fix-It bonds over that time?
10. The Mariposa Co. has two bonds outstanding. One was issued 25
years ago at a coupon rate of 9%. The other was issued 5 years ago at a
coupon rate of 9%. Both bonds were originally issued with terms of 30
years and face values of P1,000. The going interest rate is 14% today.
a. What are the prices of the two bonds at this time?
b. Discuss the result of part a. in terms of risk in investing in bonds.
Paper#9210850 | Written in 27-Jul-2016Price : $22