Question

Question 8

BOND VALUATION - Ch 6 and pages OM 11-14: In 2014 Carnival Cruise Lines decided to sell some new bonds (something about fixing a big ship). They sold the bonds for $1,000 (face value) with a 20 year maturity and an 7% coupon. Two years have passed. Interest rates on similar bonds have declined to 4%. If an owner attempts to sell her/his Carnival bond bought for $1,000 in 2014, what should they expect to receive for it in the

secondary market?

Question 9

Continuing with question 8 above. Let's say that interest rates stayed at 7% (didn't fall to 4%) and they will stay there for at least the next 5 years. What would be the value of Carnival's bonds in 2018?

Question 10

The Going to the Sun Highway in Glacier National Park - located in northwestern Montana - is one of the most spectacular drives in North America. Unfortunately the road needs to be resurfaced due to many harsh winters. The State of Montana has decided to sell state bonds to cover the needed repairs, A Montana state savings bond can be converted to $2000 at maturity six years from purchase. If the state bonds are to be competitive with U.S. savings bonds, which pay 9% annual interest (compounded annually), at what price must Montana sell its bonds? (Assume no cash payments on savings bonds prior to redemption.)

Question 11

Risk & return is a classic item in finance. You would like to estimate what the return on General Electric stock could be given it's beta of 2. Other data you have collected: the rate of return on 90 day T-Bills is 1.5%, on 5 year T-Notes it 4% and on the "long bond", the 30-year T- Bond = 6.5%. The Prime is 8%, LIBOR is 5.5% and the average return on the overall stock market is estimated to be 8%.

OK again, what do you expect the rate of return on G.E.'s stock to be?

Hint: note that term "beta" - there's a classic formula that uses "beta"!

Answer 1

Solution:

8.Calculation of selling price of bond

No. of years to maturity(n)=20-2=18 years

Annual coupon=$1000*7%=$70

YTM(discounting rate)=4% or 0.04

Selling price of bonds is the sum of present value of coupon on bonds and its maturity value.accordingly ,selling price of bond is calculated as follows

=Annual Coupon*Present value Annuity factor @4% for 18 years+Face Value/(1+YTM)^n

=$70*12.6593+$1000/(1+0.04)^18

=$1380.00

Thus, Carnival will receive $1380(approx) for the bond in the secondary market.

9.Calculation of value of bonds in 2018

YTM will be 7% for 2018,2019,2020 and 2021 and after that it will reduced to 4%

Terminal value of maturity amount at year end of 2021=$1000/(1+0.4)^12

=$625

Bond's value=Annual coupon*PVAF@7% for 4 years+Annual coupon*PVAF@4% for 12years+Terminal value/(1+YTM)^4

=$70*3.3872+$70*9.385+$625/(1+0.07)^4

=$894.05+476.81

=$1370.86