1. Purchased par value = $ 50,000 at 106%.
Cash payment should be = 106% x 50,000 = 53,000.
Therefore the interest paid for the bond at time of purchase was $ 3,000 in 1996.
If the market demands 6% for 5 year government bonds and my bond I bought at 106% and has 5 years to expire, it is worth $ 50,000 X 106%= 53,000. This is because the 5 year bond is usually issued at par and the buyer enjoys interest.
If the bond is sold today it will at 106% the same as it was bought therefore there will be no gain or loss.
General Motion bond
Current yield is the interest rate divide by current investment.
Current yield = interest = 9% x 100 = 9.78%
Current value = ∑ interest
Yield to maturity is same as internal rate of return. Using excel
face value 1000 interest rate 9.78 year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 current price 920 interest 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 maturity value 1000 cash flows -920 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 97.8 1097.8 yield to maturity 10.89% The yield to maturity is 10.89%
Using the current yield as a basis of choosing the best bond it will be
Current yield for the government bond is
8% x6/12x1000= 40
40/1060 x12/6 = 7.5%
This will be taxed by federal.
After tax (1-0.28) x7.5%
Current yield for the General motion bond is
9% x6/12x1000= 45
45/920 x12/6 = 9.8%
This will be taxed by both state and the federal
=( 1-0.28)X9.8%(1-0.07) = 6.6%
Current yield for the city of Portland bond is
5% x1000= 50
50/1000 = 5%
This will be taxed by state
=( 1-0.07)X 5% = 4.7%
The best option is the General motion inc. as it offer higher return of 6.6%
Risk structure:-The interest rate risk of a bond is determined by the possibility that the income and the capital arising from a bond will be lost. The statement that bonds with low interest rate risk are safer than those with lower coupon rate is not true because a bond can have a high coupon rate but the issuer of the bond may be having financial problems. Again it can be true because what determinants of the value of the bond is the interest rate payment. However if the interest rate payment are not honored by the issuer, it will mean that it will be risky and in such situations arise when there is liquidity crisis.
Of course a bond at some circumstances can have a low interest rate risk due to high coupon rate. But it is not safer since the payment of the capital and the income arising from any bond will depend on liquidity position of the company. However the statement can be true if the issuer of the bond is liquid and is the same issuer of a low coupon bonds and a high coupon bond. It means that all other factors are held constant except the price volatility of the bond which depends on the time to maturity
2. The options strategy that could be used by megasoff in hedging against price changes between now and then will be the use of stock index options. A stock index option ensures that the buyer receives the shares he purchased at the exercise price. This type of hedging at times is called cold option where the buyer has a right to buy a share at an agreed price without changing.
An investor may have a long-term position in the underlying stock which, for tax reasons, he is reluctant to sell even though he is not optimistic about the near-term price action of the stock. Rather than incur a large tax liability, he writes options to partially insulate him from what he feels is a significant downside risk. If this investor’s appraisal of the stock proves incorrect and it rises over the life of the option, he does not have to deliver his long-term low-cost stock. He can repurchase the option premiums can provide a highly writers’ obligation and realizing an ordinary loss on the option.
If the stock rises above the striking price, these writers are sure to earn the option premiums can provide a highly satisfactory return. The major risk in adopting this strategy is that the premium may limit the return when the stock rises by substantially more than it reduces the loss when the stock declines.
If the investor was worried about fallen down of prices, a different strategy will be used in hedging against prices changes. A strategy that is adopted will depend on position of the shareholder. The investor is intending to buy 500 shares and is worried of shares coming down. He would not enter into any strategy because when the prices are coming down they are becoming cheaper therefore the investor need not to enter into hedging since they are becoming cheaper. However when he owning the shares and he wants to sell them in the future he will need to enter into similar strategy.
3. When asset management ratios are inferior to the industries’ ratios, the company is perceived to be a bad asset management as compared to other industry players. Asset management ratios measure how efficient a company’s ability to utilize its assets. More specifically, the ratios show how the firm used its assets to generate revenue. A company with a low asset turnover signifies that they have a high profit margin, and a company with a high asset turnover tends to have a low profit margin. The inventory turnover ratio measures how much was sold off, or turned over in the course of one year.
Arnold, G. (2008); Corporate financial management; 4th ed. . - Harlow: Financial Times Prentice Hall.
Graham, J. & Harvey, C. (2001): 'The theory and practice of corporate finance: Evidence from the field'. Journal of Financial Economics, vol. 60, pp. 187-243
McLaney E., (2003); Business finance theory and practice; Prentice Hall ISBN 0-273-67356-4
Pandey I M (2008); Financial management; Vikas Publishing House PVT ltd.