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FIN 115 Chapter 15 FINANCIAL PLANNING PROBLEMS - DOC

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FIN 115 Chapter 15 FINANCIAL PLANNING PROBLEMS - DOC Powered By Docstoc
					FIN 115: Chapter 15 FINANCIAL PLANNING PROBLEMS

1. Calculating Interest. Calculate the annual interest and the semiannual interest payment for the following corporate
   bond issues with a face value of $1,000. (p. 482)
         Annual Interest       Annual Interest       Semiannual Interest
             Rate                 Amount                  Payment
             5.125%                 $51.25             $25.625 = $25.63
             6.25%                  $62.50                   $31.25
              7.0%                  $70.00                   $35.00
             7.125%                 $71.25             $35.625 = $35.63


2. Analyzing Why Investors Purchase Bonds. In your own words, explain how each of the following factors is a reason
   to invest in bonds.
    a.     Interest income
    b.     Possible increase in value
    c.     Repayment at maturity
    a.  Interest income is a primary reason why investors choose to invest in either corporate or government bonds.
        Interest is calculated on the face value of the bond and is usually paid every six months. (p. 487)
   b. Generally, bonds are issued with a stated face value. Once issued, the price may be higher or lower than its face
        value. Financial returns for comparable investments and interest rates in the economy are two factors that may
        cause the market value of a bond to increase or decrease. (p. 488)
   c. Whenever you purchase a bond, you have two options: you may keep the bond until maturity and then redeem it,
        or you may sell the bond at any time to another investor. In either case, the value of your bond is closely tied to
        the corporation’s ability to repay its bond indebtedness. (p. 488)
3. Evaluating Zero-Coupon Bonds. List the reasons investors might want to buy zero-coupon bonds. Then list the
   reasons investors might want to avoid zero-coupon bonds. Based on these lists, do you consider zero-coupon bonds a
   good alternative for your investment program? Why or why not?
    A zero-coupon bond is sold at a price far below its face value, makes no annual or semiannual interest payments, and
    is redeemed for its face value at maturity. An investor who wants dollar appreciation over a long period of time should
    purchase a zero-coupon bond. Before investing in zero-coupon bonds, an investor should consider at least two factors.
    First, even though all of the interest on these bonds is paid at maturity, the IRS requires zero-coupon bondholders to
    report interest each year—as it is earned and not when it is actually received. Second, zero-coupon bonds are more
    volatile than other types of bonds. Student answers for the last part of this question will vary depending on each
    individual investor’s financial goals. (p. 488)
4. Determining the approximate market value for a bond. Approximate the market value for the following $1,000 bonds.
   (p. 488)
                            Dollar Amount of       Interest Rate for
         Interest Rate                                                        Approximate
                             Interest for the     Comparable Bonds
         When Issued                                                          Market Value
                             Existing Bond           Issued Today
              5%                  $50.00                   6%                   $ 833.33
              6%                  $60.00                  5.5%                  $1,090.91
              8%                  $80.00                   7%                   $1,142.86


5. Calculating total return. Jean Miller purchased a $1,000 corporate bond three years ago for $910. The bond pays 6
   percent annual interest. Three years later, she sold the bond for $1,020. Calculate the total return for Ms. Miller’s
   bond investment. (pp. 490-491)
    The total return is $290, calculated as follows:
    Annual interest = $1,000 x 0.06 = $60
    Three years interest = $60 x 3 = $180
    Dollar appreciation = $1,020 – $910 = $110
    Total return = $180 + $110 = $290
6. Complete the following table:
                             Minimum Amount            Maturity Range         How Interest is Paid
     Treasury bills          _______________           _______________        _______________
     Treasury notes          _______________           _______________        _______________
     Treasury bonds          _______________           _______________        _______________

    Treasury bills, sometimes called T-bills, are issued in minimum units of $1,000 with additional increments of $1,000
    and maturities that may be as long as one year. T-bills are discounted securities which means that these securities are
    sold at less than face value. At maturity, the owner of the bond receives the face value.
    Treasury notes are issued in $1,000 units. The maturity for treasury notes is more than one year but not more than ten
    years. Interest for Treasury notes is paid every six months.
    Treasury bonds are issued in minimum units of $1,000 with maturities ranging from ten to thirty years. Interest on
    Treasury bonds is paid every six months. The Treasury Department no longer issues bonds, but they are still available
    in the secondary market. (pp. 493-495)
7. Calculating the purchase price for a T-Bill. Calculate the purchase price for a 26-week $1,000 treasury bill with a
   stated interest rate of 2.5 percent. (p. 493)
    Step 1: Discount amount for one year = Maturity value x interest rate
                                            = $1,000 x 0.25
                                            = $25
    Step 2: Discount amount for 26 weeks = $25 ÷ 2
                                             = $12.50
    (Note: In the above calculation, the 2 is used to adjust for the fact that this T-bill has a 26-week maturity.)
    Step 3: Purchase price = $1,000 – $12.50
                            = $987.50
8. Calculating Tax-equivalent Yields. Assume that you are in the 35 percent tax bracket and that you purchase a 5.12
   percent tax-exempt municipal bond. Calculate the tax equivalent yield for this investment.
    Tax equivalent yield = tax-exempt yield divided by (1.0 minus current tax rate) (p. 496)
    Tax equivalent yield = 5.12 percent divided by (1.0 minus 0.35) = 0.0788=7.88 percent
9. Using the Internet. Use the information at http://bondsyahoo.com to answer the following questions about a corporate
   bond. To complete this activity, follow these steps:
    a. Go to http://bonds.yahoo.com and click on bond screener.
    b. Click on corporate and enter the information requested and click find bonds.
    c. Choose one of the issues listed.
    d. Using the information on the Yahoo bond website, determine the current yield for this bond issue. What does the
       current yield calculation measure?
    e. Using the information on the Yahoo bond website, what is the yield-to-maturity for this bond issue. What does the
       yield-to-maturity calculation measure?
    f. What is the rating for this bond? What does this rating mean?
    g. Based on your answer to the above questions, which bond would you choose for your investment portfolio?
       Explain your answer.
Although answers to the above questions will vary, you may want to review the process used to evaluate a bond issue.
Factors like current yield, yield to maturity, and bond ratings are included on this Web site. (p. 498)
10. Evaluating a Corporate Bond Issue. Choose a corporate bond and use Mergent’s Industrial Manuals and Standard &
    Poor’s Stock and Bond Guide (available at your college or public library) to answer the following questions on this
    bond issue.
    a.   What is Standard & Poor’s rating for the issue?
    b.   What is the purpose of the issue?
    c.   Does the issue have a call provision?
    d.   Who is the trustee for the issue?
    e.   What collateral, if any, has been pledged as security for the issue?
    f.   Based on the information you have obtained, would the bond be a good investment for you? Why or why not?
    The answers for each of the above questions will depend on the bond that each student chooses. An alternative
    approach may be to require all students to research the same bond. (pp. 498-501)
11. Calculating current yields. Calculate the interest amount and current yield for the following $1,000 bonds. (Obj. 5)
                        Interest        Current           Current
     Interest Rate
                        Amount         Market Value        Yield
           5%              $50             $870            5.75%
          6.9%             $69            $1,115           6.19%
          4.875          $48.75            $815            5.98%

12. Calculating yields. Assume you purchased a corporate bond at its current market price of $850 on January 1, 1999. It
    pays 9 percent interest and it will mature on December 31, 2008, at which time the corporation will pay you the face
    value of $1,000.
    a. Determine the current yield on your bond investment at the time of purchase.
    b. Determine the yield to maturity on your bond investment.
    a. The current yield = interest income ÷ market value
       The current yield = $90 divided by $850 = 10.6 percent (p. 501)
                                                  Face Value - Market Value
                                  Interest amount +
    b. The yield to maturity =                       Number of Periods
                                          Market Value + Face Value
                                                     2
                                 $1,000  850
                           $90 
       Yield to maturity =             10
                               $850  1,000
                                    2
       Yield to maturity = 11.4 percent (p. 502)


FINANCIAL PLANNING ACTIVITIES

1. Explaining the Purpose of a Bond Indenture. Prepare a one-minute oral presentation that describes the type of
   information contained in a bond indenture.
    The bond indenture is the legal document that details all of the conditions relating to a bond issue. Often comprising
    over 100 pages of complicated wording, the bond indenture remains in effect until the bonds reach maturity or are
    redeemed by the corporation. (p. 483)
2. Investigating a New Bond Issue. Locate an advertisement for a new bond issue in The Wall Street Journal, Barron’s,
   The New York Times, or a local newspaper. Then go to the library or use the Internet to research the corporation or
   government entity that is issuing the bonds. Based on your research, prepare a two-page report on the issuer. Be sure
   to describe its financial condition and how it will use the money raised by selling bonds.
   Student answers will vary, but you may want to review the material on why corporations sell bonds on page 483.
3. Interviewing an Account Executive. Talk to an account executive or a banker about the differences among debentures,
   mortgage bonds, and subordinated debentures. Describe your findings.
   A debenture is a bond that is backed only by the reputation of the issuing corporation. A mortgage bond, sometimes
   referred to as a secured bond, is a corporate bond that is secured by various assets of the issuing firm. A subordinated
   debenture is an unsecured bond that gives bondholders a claim secondary to that of other designated bondholders
   with respect to income, repayment, and assets. (p. 484)
4. Making Investment Decisions. Assume that you just inherited ten Kerr-McGee Corporation bonds that are
   convertible, and each bond is convertible to 16.373 shares of the corporation’s common stock.
   a.   What type of information would you want to help you decide whether to convert your bonds to common stock?
   b.   Where would you obtain this information?
   c.   Under what conditions would you convert your bonds to common stock?
   d.   Under what conditions would you keep the bonds?
   a. Most investors would begin their search for information about this Kerr-McGee bond with information contained
      in the newspaper. Then a trip to the library could provide more detailed information about the bond and the
      company. While at the library, investors could examine Mergent’s Industrial Manuals for detailed information
      about the information contained in the bond indenture. They could also find information about the company. The
      same type of information may be available on the Internet.
   b. Most investors could obtain this information by making a trip to the library or by using the Internet. Investors
      could also write or call Kerr-McGee and request an annual report which would provide detailed financial
      information about the company and its ability to pay interest until maturity and its ability to repay the bond at
      maturity.
   c. The most obvious answer is when the stock is worth more than the bond. But this question is difficult to answer
      because if the market value of the common stock increases, the market value of the bond also increases.
   d. Often the market value of the common stock will ―push‖ the value of the bond higher. As a result, many investors
      would prefer to keep their bonds because of more secure interest payments and eventual repayment at maturity.
      (p. 484)
5. Analyzing Why Investors Purchase Bonds. Survey at least two investors who own either corporate or government
   bonds. Then answer the following questions.
   a.   Why did these investors purchase the bonds?
   b.   How long have they invested in bonds?
   c.   Do they consider their bond issues conservative or speculative investments?
   d.   Why did they decide to purchase bonds instead of other investments like certificates of deposit, stocks, mutual
        funds, or real estate.
   a. Although answers will vary, most investors purchase corporate or government bonds because they feel these
      investments are more secure and because interest must be paid until maturity and eventual repayment at maturity.
   b. Answers will vary.
   c. Most investors consider corporate and government bonds a conservative investment. (Note: You may want to
      remind students that some bonds may be considered speculative investments because of the corporation or
      government entity that issued them.)
   d. Most investors would indicate an increased total return on their bond investment when compared to other
      conservative investments. (pp. 487-497)
6. Using the Internet to Obtain Investment Information. Use the Internet to locate the website for Treasury Direct
   (www.treasurydirect.gov). Then prepare a report that summarizes the information provided on Treasury bills,
   Treasury notes, and Treasury bonds.
   This website provides a wealth of information about Treasury bills, Treasury notes, and Treasury bonds. Specifically,
   information is included describing the nature of these investments, how investors can buy government securities, and
   a detailed history of interest rates. (p. 498)
     7. Finding Financial Information. Using information from the local newspaper, The Wall Street Journal, or on the
        Internet, answer the following questions for one of the bond issues listed below.
              Source _________________                     Date ______________


              Bond Issue         Interest Rate    Maturity Date      Current Yield       Last Price

           Ford Motor Credit         7.0%          Oct. 1, 2013

                 Hertz              6.350%        June 15, 2010

                 Alcan              5.25%          Jan. 15, 2014

         The answers for this question will depend on the source of the information, the date of the publication, and the bond
         chosen. An alternative approach would be to require all students to use the same publication on the same date for one
         of the above bonds. (pp. 498-499).
     8. Analyzing Yields. In your own words, describe what affects the current yield and the yield to maturity for a bond.
         In both cases, the biggest factor that influences the current yield and the yield to maturity is the current market value
         of the bond. In addition, the yield to maturity is affected by the number of investment periods until maturity. Most all
         other factors stay the same regardless of when the calculations are calculated. (pp. 500-502)
9.       Evaluating a Bond Transaction. Choose a corporate bond that you would consider purchasing. Then, using
         information obtained in the library or on the Internet, answer the questions on the evaluation form that was presented
         in the Financial Planning sheet ―Evaluating Corporate Bonds‖ at the end of the text. Based on your research, would
         you still purchase this bond? Explain your answer.
         Answers will vary depending on the bond that students choose and the source of the information used for evaluation
         purposes. (pp. 497-503)

				
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