Question Tag: Bond pricing

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  • 20 Marks

FM – May 2016 – L3 – Q3 – Financing Decisions and Capital Markets

Calculation of bond issue price, yield to maturity, and duration, and discussion of conflicts between shareholders and bondholders.

(a)

Skylet Limited is a major player in the aviation industry with a credit rating of AA. The company plans to raise ₦5 billion from the bond market. The features of the bond are:

  • Maturity: 4 years
  • Coupon payment: Annual
  • Coupon rate: 5%
  • Redemption value: Par

The current annual spot yield curve for government bonds is as follows:

Term Spot Rate
One-year 3.3%
Two-year 3.8%
Three-year 4.5%
Four-year 5.3%

The following table of spreads (in basis points) is given for the aviation industry:

Rating 1 Year 2 Year 3 Year 4 Year
AAA 12 23 36 50
AA 27 40 51 60
A 43 55 67 80

You are required to calculate:
i. The issue price of the bond. (6 Marks)
ii. The yield to maturity. (3 Marks)
iii. The duration. (6 Marks)

(b)

Discuss why conflicts of interest might exist between shareholders and bondholders. (5 Marks)

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  • 40 Marks

FM – May 2021 – L3 – Q1 – Business Valuation Techniques

Evaluate the value of Zinco Limited using various valuation techniques and estimate the coupon rate for bond financing.

Palemo Temidayo (PT) is a large engineering company listed on the stock market. The company is considering the purchase of Zinco, an unlisted company that produces a number of engineering components.
The board of directors is concerned about the appropriate price to pay for Zinco. As a starting point, it has been decided to provide a range of valuations based on different industry-recognized techniques.

Summarized financial statements of Zinco Limited for the last two years are shown below:

Statements of Profit or Loss for the years ended 30 June

2020 (N’000) 2019 (N’000)
Sales Revenue 112,400 101,090
Opening Profit before exceptional items 6,510 4,100
Exceptional Items (10,025) –
Interest Paid (Net) (1,400) (890)
Profit/(Loss) before Tax (4,915) 3,210
Taxation (1,050) (890)
Profit/(Loss) after Tax (5,965) 2,320
Note: Dividend 1,000 500

Statement of Financial Position as at 31 March (N’000)

Additional Information Relating to Zinco:

  1. If the acquisition succeeds, there will be revenue synergy leading to an increase in annual sales revenue of Zinco of 25% for three years, and 10% per year thereafter.
  2. Non-cash expenses, including depreciation, were N4,100,000 in 2020.
  3. Income tax rate is 30% p.a.
  4. Capital expenditure was N5 million in 2020 and is expected to grow at approximately the same rate as revenue.
  5. Working capital, interest payments, and non-cash expenses are expected to increase at the same rate as revenue.
  6. Zinco has a patent with a current market value of N50 million. This has not been included in the non-current assets.
  7. Operating profit is expected to be approximately 8% of revenue in 2021 and to remain at the same percentage in future years.
  8. Dividends are expected to grow at the same rate as revenue.
  9. The realizable value of inventory is expected to be 70% of its book value.
  10. The estimated cost of equity is 12%.
  11. The average P/E ratio of listed companies of similar size to Zinco is 30:1.
  12. Average earnings growth in the industry is 6% per year.

Required:

a. Prepare a report that gives an estimate of Zinco using:
(i) Asset-based valuation (8 Marks)
(ii) P/E ratios (6 Marks)
(iii) Dividend-based valuation (6 Marks)
(iv) The present value of expected future cash flows (5 Marks)
(v) Discuss the potential accuracy of each of the methods used and recommend, with reasons, a value or range of values that PT might bid for Zinco. State clearly any assumptions that you make.

b. The directors of PT are considering issuing some ₦100 nominal value ten-year bonds to finance the purchase of Zinco. To make the bonds look attractive to potential investors, the bonds are to be issued at a discount of 10%. Based on PT’s credit rating, investors are expected to require a return of 7% per year from such bonds.

You are required:
To estimate the coupon rate that PT will have to pay on these bonds in order to satisfy the investors. (5 Marks)

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  • 20 Marks

FM – May 2024 – L3 – SB – Q4 – Investment Appraisal Techniques

Analyze forward rates and bond valuation, calculate bond prices and YTM, evaluate price changes over time, and interpret modified duration.

The following information is on 3 default-free bonds.

Bonds Price (₦) Coupon (%) Redemption Value (₦) Maturity (Years)
A 105 10 100 1
B 96 4 100 2
C 98 6 100 3

Required:

a. Estimate the two-year forward rate at the end of year 1 and the one-year forward rate at the end of year 2.
(5 Marks)

b. You are considering buying a three-year 9% annual-coupon paying bond with a face value of ₦1,000. The bond is default-free.

i. Calculate the price of the bond and its yield to maturity. Clearly explain why you may not realize the calculated yield.
(6 Marks)

ii. One year after purchasing the bond at the price you have calculated, if there are no changes in market interest rates, do you expect the price of the bond to increase, fall, or remain constant? Explain.
(2 Marks)

iii. Estimate and interpret the modified duration of the bond. Identify the key limitations of modified duration in bond analysis.
(7 Marks)

(Total 20 Marks)

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  • 9 Marks

FM – MAY 2019 – L2 – Q5a – Cost of capital

Calculate the price investors would be willing to pay for a bond and explain how changes in interest rates affect bond values.

Anape Ltd is considering issuing a new 10-year bond in the domestic market. The interest rate on the bond is 20%. Interest will be paid semi-annually. The directors are considering the appropriate price at which the new bonds should be sold. The market required return is 25%.

Required:

  1. Compute the price investors would be willing to pay for each GH¢100 face value bond. (5 marks)
  2. Explain how changes in average interest rate affect the value of bonds. (4 marks)

(Total: 9 marks)

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  • 20 Marks

FM – May 2016 – L3 – Q3 – Financing Decisions and Capital Markets

Calculation of bond issue price, yield to maturity, and duration, and discussion of conflicts between shareholders and bondholders.

(a)

Skylet Limited is a major player in the aviation industry with a credit rating of AA. The company plans to raise ₦5 billion from the bond market. The features of the bond are:

  • Maturity: 4 years
  • Coupon payment: Annual
  • Coupon rate: 5%
  • Redemption value: Par

The current annual spot yield curve for government bonds is as follows:

Term Spot Rate
One-year 3.3%
Two-year 3.8%
Three-year 4.5%
Four-year 5.3%

The following table of spreads (in basis points) is given for the aviation industry:

Rating 1 Year 2 Year 3 Year 4 Year
AAA 12 23 36 50
AA 27 40 51 60
A 43 55 67 80

You are required to calculate:
i. The issue price of the bond. (6 Marks)
ii. The yield to maturity. (3 Marks)
iii. The duration. (6 Marks)

(b)

Discuss why conflicts of interest might exist between shareholders and bondholders. (5 Marks)

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  • 40 Marks

FM – May 2021 – L3 – Q1 – Business Valuation Techniques

Evaluate the value of Zinco Limited using various valuation techniques and estimate the coupon rate for bond financing.

Palemo Temidayo (PT) is a large engineering company listed on the stock market. The company is considering the purchase of Zinco, an unlisted company that produces a number of engineering components.
The board of directors is concerned about the appropriate price to pay for Zinco. As a starting point, it has been decided to provide a range of valuations based on different industry-recognized techniques.

Summarized financial statements of Zinco Limited for the last two years are shown below:

Statements of Profit or Loss for the years ended 30 June

2020 (N’000) 2019 (N’000)
Sales Revenue 112,400 101,090
Opening Profit before exceptional items 6,510 4,100
Exceptional Items (10,025) –
Interest Paid (Net) (1,400) (890)
Profit/(Loss) before Tax (4,915) 3,210
Taxation (1,050) (890)
Profit/(Loss) after Tax (5,965) 2,320
Note: Dividend 1,000 500

Statement of Financial Position as at 31 March (N’000)

Additional Information Relating to Zinco:

  1. If the acquisition succeeds, there will be revenue synergy leading to an increase in annual sales revenue of Zinco of 25% for three years, and 10% per year thereafter.
  2. Non-cash expenses, including depreciation, were N4,100,000 in 2020.
  3. Income tax rate is 30% p.a.
  4. Capital expenditure was N5 million in 2020 and is expected to grow at approximately the same rate as revenue.
  5. Working capital, interest payments, and non-cash expenses are expected to increase at the same rate as revenue.
  6. Zinco has a patent with a current market value of N50 million. This has not been included in the non-current assets.
  7. Operating profit is expected to be approximately 8% of revenue in 2021 and to remain at the same percentage in future years.
  8. Dividends are expected to grow at the same rate as revenue.
  9. The realizable value of inventory is expected to be 70% of its book value.
  10. The estimated cost of equity is 12%.
  11. The average P/E ratio of listed companies of similar size to Zinco is 30:1.
  12. Average earnings growth in the industry is 6% per year.

Required:

a. Prepare a report that gives an estimate of Zinco using:
(i) Asset-based valuation (8 Marks)
(ii) P/E ratios (6 Marks)
(iii) Dividend-based valuation (6 Marks)
(iv) The present value of expected future cash flows (5 Marks)
(v) Discuss the potential accuracy of each of the methods used and recommend, with reasons, a value or range of values that PT might bid for Zinco. State clearly any assumptions that you make.

b. The directors of PT are considering issuing some ₦100 nominal value ten-year bonds to finance the purchase of Zinco. To make the bonds look attractive to potential investors, the bonds are to be issued at a discount of 10%. Based on PT’s credit rating, investors are expected to require a return of 7% per year from such bonds.

You are required:
To estimate the coupon rate that PT will have to pay on these bonds in order to satisfy the investors. (5 Marks)

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  • 20 Marks

FM – May 2024 – L3 – SB – Q4 – Investment Appraisal Techniques

Analyze forward rates and bond valuation, calculate bond prices and YTM, evaluate price changes over time, and interpret modified duration.

The following information is on 3 default-free bonds.

Bonds Price (₦) Coupon (%) Redemption Value (₦) Maturity (Years)
A 105 10 100 1
B 96 4 100 2
C 98 6 100 3

Required:

a. Estimate the two-year forward rate at the end of year 1 and the one-year forward rate at the end of year 2.
(5 Marks)

b. You are considering buying a three-year 9% annual-coupon paying bond with a face value of ₦1,000. The bond is default-free.

i. Calculate the price of the bond and its yield to maturity. Clearly explain why you may not realize the calculated yield.
(6 Marks)

ii. One year after purchasing the bond at the price you have calculated, if there are no changes in market interest rates, do you expect the price of the bond to increase, fall, or remain constant? Explain.
(2 Marks)

iii. Estimate and interpret the modified duration of the bond. Identify the key limitations of modified duration in bond analysis.
(7 Marks)

(Total 20 Marks)

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  • 9 Marks

FM – MAY 2019 – L2 – Q5a – Cost of capital

Calculate the price investors would be willing to pay for a bond and explain how changes in interest rates affect bond values.

Anape Ltd is considering issuing a new 10-year bond in the domestic market. The interest rate on the bond is 20%. Interest will be paid semi-annually. The directors are considering the appropriate price at which the new bonds should be sold. The market required return is 25%.

Required:

  1. Compute the price investors would be willing to pay for each GH¢100 face value bond. (5 marks)
  2. Explain how changes in average interest rate affect the value of bonds. (4 marks)

(Total: 9 marks)

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