- 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.
Question
(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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