Question

Go online and research the current bond issue for a large company (Fortune 500) and provide its yield, compare the bond to those of the US Government and discuss your company's bond sensitivity to changes in interest rates and other economic factors. - I chose Ford Motor company at ROE = 10.40%

Assume that the bond market participants expect inflation to increase drastically to 9%, how would this affect the price of your bond? Provide both an explanation and best estimate for Price. Assume that the economy experiences high economic growth. What market would you choose to invest equity or debt? Explain.

Answer 1

The Ford motor company has bonds with yield 5.79% and the duration is 6.55. The current inflation is ~ 2%. With inflation rising to 9%, the current interest rate is also expected to rise to 12.79% ( 5.79% + (9%-2%))

As per duration rule, the price would decrease by 6.55*7% = 45.85%

Currently the price of bond is $91 and post an increase in inflation the price is likely to be 91*(1-45.85%) = 49.27

If the economy experiences high growth, then chances of defaulting on loan would be low and interest servicing would be better. So it would be wiser to issue bond to raise capital and increase return on equity.

From investor's perspective, a growing economy means that return on equity is expected to be high and so it would make sense to invest in equity rather than bond markets.