Question Tag: Yield to Maturity

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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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  • 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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  • 20 Marks

FM – May 2018 – L3 – SB – Q2 – Investment Appraisal Techniques

Evaluate two corporate bonds for investment based on price, yield to maturity, and duration.

Kazaure Limited has a cash surplus of N20m, which the financial manager is keen to invest in corporate bonds. He has identified two potential investment opportunities in two different companies which are both rated A by the major credit rating agencies.

Bond A: The issuer plans to raise an N500m 2-year bond with a coupon rate of 10%. The bond is redeemable at a premium of 8% to nominal value.

Bond B: The issuer plans to raise an N800m 3-year bond with a coupon rate of 12% and redeemable at par.

The annual spot yield curve for government bonds is:

Term Spot Yield
1-Year 9.50%
2-Year 10.40%
3-Year 10.50%

Extract from a major credit rating agency’s website:

Rating 1-Year Spread 2-Year Spread 3-Year Spread
AAA 6 16 28
AA 15 25 40
A 20 30 50

Required:

a. For a nominal value of N1,000, calculate the theoretical issue prices of the two bonds and indicate how many of each of the bonds Kazaure Limited can buy, assuming it invests in only one of them. (5 Marks)
Note: Calculate issue prices to the nearest Naira.

b. Irrespective of your answer in (a), assume Bond A is issued at ₦1,054 and Bond B is issued at N1,026. Calculate the yield to maturity of each bond at the time of issue. (5 Marks)

c. Calculate the duration of each bond. What does duration measure? (6 Marks)

d. If you expect interest rates to increase in the market, which of the two bonds, A or B, would you like to buy and why? (4 Marks)
Note: No calculation is required.

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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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  • 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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  • 20 Marks

FM – May 2018 – L3 – SB – Q2 – Investment Appraisal Techniques

Evaluate two corporate bonds for investment based on price, yield to maturity, and duration.

Kazaure Limited has a cash surplus of N20m, which the financial manager is keen to invest in corporate bonds. He has identified two potential investment opportunities in two different companies which are both rated A by the major credit rating agencies.

Bond A: The issuer plans to raise an N500m 2-year bond with a coupon rate of 10%. The bond is redeemable at a premium of 8% to nominal value.

Bond B: The issuer plans to raise an N800m 3-year bond with a coupon rate of 12% and redeemable at par.

The annual spot yield curve for government bonds is:

Term Spot Yield
1-Year 9.50%
2-Year 10.40%
3-Year 10.50%

Extract from a major credit rating agency’s website:

Rating 1-Year Spread 2-Year Spread 3-Year Spread
AAA 6 16 28
AA 15 25 40
A 20 30 50

Required:

a. For a nominal value of N1,000, calculate the theoretical issue prices of the two bonds and indicate how many of each of the bonds Kazaure Limited can buy, assuming it invests in only one of them. (5 Marks)
Note: Calculate issue prices to the nearest Naira.

b. Irrespective of your answer in (a), assume Bond A is issued at ₦1,054 and Bond B is issued at N1,026. Calculate the yield to maturity of each bond at the time of issue. (5 Marks)

c. Calculate the duration of each bond. What does duration measure? (6 Marks)

d. If you expect interest rates to increase in the market, which of the two bonds, A or B, would you like to buy and why? (4 Marks)
Note: No calculation is required.

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