Question

Q: 4. Suppose, you are hired by Microsoft Corporations as their Finance director. In order to expand its production, the company needed more capital funds. Microsoft Corporations is issuing shares and selling both short-term and long-term bonds. In order to assist, you the finance director are considering the prospect of helping finance their expansion. (10 points, 5 each).

a. If you were to buy both short- and long-term bonds from Microsoft Corporation, from which bond would you demand a higher rate of return: short or long term? Why?

b. If Apple Inc. (another multinational technology company) lowered the credit worthiness of, Microsoft Corporation would this affect the rate of return you would demand when buying their bonds? Why?

Answer 1

ANSWER (a)

Shorter-term bonds will provide better total returns than longer-term bonds when yields are rising; while longer-term bonds will provide better total returns than their shorter-term counterparts when yields are falling (bond prices go up when yields fall. The farther they fall, the higher the prices go).

This tells us that while bond yields and maturities usually have a static relationship (the longer the maturity, the higher the yield), the relationship between maturity and total return is dependent on the direction of interest rates.

ANSWER (b) If Apple Inc lowered the credit worthiness, Microsoft will not be affected by the increase or decrease of credit worthiness of rival company, which will result into no change in return. Bonds returns depends upon yield of company itself not of its rival. Thus return from bond remain unchanged.

answered by: anonymous