1. Briefly explain the following, debt features:
a. Indenture
b. Restrictive covenant
c. Trustee
d. call provision
2. a. What are the three primary bond rating agencies?
(2) What do bond ratings measure?
(3) HOW do investors interpret bond ratings?
(4) What is the difference between an A-rated bond and a B-rated bond?
b. (1) Why are bond ratings important to investors?
(2) Why are ratings important to businesses that issue bonds?
3. a. What is interest rate risk?
b. What is price risk?
c. What is reinvestment rate risk?
4. Is this statement true or false? "The values of outstanding bonds change whenever the going rate of interest changes. In general, short-term interest rates are more volatile than long-term rates, so short-term bond prices are more sensitive to interest rate changes than are long-term bond prices." Explain your answer.
Problems
1. Assume Venture Healthcare sold bonds that have a ten-year maturity, a 12 percent coupon rate with annual payments, and a $1,000 par value.
a. Suppose that two years after the bonds were issued, the required interest rate fell to7 percent. What would be the bonds' value?
b. Suppose that two years after the bonds were issued, the required interest rate rose to 13 percent. What would be the bonds' value?
c. What would he the value of the bonds three years after issue in each scenario above, assuming that interest rates stayed steady at either 7 percent or 13 percent?
2. Twin Oaks Health Center has a bond issue outstanding with a coupon rate of 7 percent and four years remaining until maturity. The par value of the bond is $1,000, and the bond pays interest annually.
a. Determine the current value of the bond if present market conditions justify a 14 percent required rate of return.
b. Now, suppose Twin Oaks's four-year bond had semiannual coupon payments. What would be its current value? (Assume a 7 percent semiannual required rate of return. However, the actual rate would be slightly less than 7 percent because a semiannual coupon bond is slightly less risky than an annual coupon bond.)
c. Assume that Twin Oaks's bond had a semiannual coupon but 20 years remaining to maturity. What is the current value under these conditions? (Again, assume a 7 percent semiannual required rate of return, although the actual rate would probably be greater than 7 percent because of increased price risk.)
3. Tidewater Home Health Care, Inc., has a bond issue outstanding with eight years remaining to maturity, a coupon rate of 10 percent with interest paid annually, and a par value of $1,000. The current market price of the bond is $1,251.22.
a. What is the bond's yield to maturity?
b. Now, assume that the bond has semiannual coupon payments. What is its yield to maturity in this situation?
4. Pacific Homecare has three bond issues outstanding. All three bonds pay $100 in annual interest plus $1,000 at maturity. Bond S has a maturity of five years, Bond M has a 15-year maturity, and Bond L matures in 30 years.
a. What is the value of each of these bonds when the required interest rate is 5 percent, 10 percent, and 15 percent?
b. Why is the price of Bond L more sensitive to interest rate changes than the price of Bond S?
5. Minneapolis Health System has bonds outstanding that have four years remaining to maturity, a coupon interest rate of 9 percent paid annually, and a $1,000 par value.
If the current market price is $1,104?
Would you be willing to buy one of these bonds for $829 if you required a 12 percent rate of return on the issue? Explain your answer.
6. Six years ago, Bradford Community Hospital issued 20-year municipal bonds with a 7 percent annual coupon rate. The bonds were called today for a $70 call premium-that is, bondholders received $1,070 for each bond. What is the realized rate of return for those investors who bought the bonds for $1,000 when they were issued?
7. Regal Health Plans issued a 12 percent annual coupon bond with a $1,000 par value a few years ago. The bond now has ten years remaining to maturity and sells for $1,100. The bond has a call provision that allows Regal to call the bond in four years at a call price of $1,060.
a. What is the bond's yield to maturity?
b. What is the bond's yield to call?
8. Jane Smith, MD, has had a great year in her pediatrics practice and has cash that she wants to invest. Her financial adviser suggests she buy a seven-year, $1,500 par value bond with an annual coupon rate of 10 percent and three years remaining to maturity. Dr. Smith decides to explore her options. She discovers that new, similarly risky bonds have an average annual rate of return of 12 percent. Bank certificates of deposit are returning 5 percent annually on average while a mutual fund investing in high-risk-growth stocks has an average annual rate of return of 20 percent. If Dr. Smith follows her financial adviser's advice, what is the maximum amount she should pay for the bond? Explain your answer.
9. Orange District Hospital issued a 30-year, 10 percent annual coupon bond (par value $1,000) two years ago. The bond now has 28years remaining to maturity and sells for $1,400. The bond has a call provision that allows the hospital to call the bond in ten years at a call price of $1,100. If an investor expects a call and requires a 6.5 percent rate of return, will the investor be likely to purchase the bond? Explain your answer.
Case 6.2: Big Valley Hospital
Key Concept - Bond issuance valuation and bond interest expense
Questions
1. How much cash will big Valley Hospital get from issuing the bonds?
2. What will be the amount of Year 1 interest expense in the financial statements for the bonds?
3. What journal entry would be required to record interest expense for Year 1?