Web Exercise 1: In this exercise, we will examine how the yield on municipal bonds relates to the yield on taxable bonds and also how bond ratings affect the yield that a bond pays. Go to bondsonline website.
Instructions: go to fidelity website "News & Research" "Fixed Income, Bonds & CDs" "Yields". You should be able to find the information for #1; for #2 you will have to manually calculate the spread; for #3 use the corporate AAA and A yields; skip #4 & 5 as those junk bonds are not listed; for #6 use the 2 year and 20 year as opposed to the 1 year and 30 year.)
1. Click on "Today's Market," then on "Composite Bond Yields," and then on "Click for Data." Under the Municipal Bonds table, write down the yield on 20-year, AAA-rated bonds. Divide this value by (1 - 0.35). The value 0.35 is assumed to represent the investor's marginal tax bracket. The answer you get is intended to represent the equivalent before-tax yield on a taxable investment. Now compare this value to the yield on the 20-year, AAA-rated corporate bond (which represents the yield on a before-tax basis of a taxable investment). What is the difference between this value and the value you just computed? Of course, they will never be the same because of the inefficiencies in the market and different tax rates for investors.
2. Bond ratings and yields were discussed in the chapter. Click on "US Corporate Bond Spreads" along the left margin. These spreads represent the difference in yields between a given rated bond and a risk-free Treasury bond. We will work with 10-year issues. As an example, a Aaa/AAA industrial bond usually pays 20 to 50 basis points (percentage points) more than a Treasury bond. The AAA industrial is very low risk, but it is still riskier than a Treasury bond issued by the U.S. government.
3. What is the yield spread for a 10-year, A3/A- industrial bond? How many basis points is it greater than a 10-year, Aaa/AAA industrial bond?
4. What is the yield spread on the highest rated junk bond (10-year column)? Look up Ba1/BB+.
5. What is the yield spread of the lowest rated junk bond (10-year column)?
6. Generally speaking, what happens to the yield spread as the maturity period increases from 1 year to 30 years for all different categories of bond ratings?
Web Exercise2: In this exercise, we will demonstrate how you can get information on the term structure of interest rates and relate yields spreads to the economic outlook. Go to bondsonline website.
Instructions: Review the data provided. (Use the data listed in 1 above)
1. Click on "Today's Market" and then click on "Composite Bond Yields" along the left-hand margin. Select "Click for Data" and write down the yields under "U.S. Treasury Bonds" for three months through 30 years.
2. Based on the expectations hypothesis, would you expect the future movement in interest rates to be up or down?
3. What is the yield on 10-year U.S. Treasuries? What is the yield on 10-year AAArated corporate bonds? Compute the differences between the two to get the so-called spread. The normal spread between the two is 30 to 50 basis points, but it expands to 50 to 100 basis points when people become concerned about the economy (they want an increasingly higher yield to take a risk). Based on the number you just computed, what does it appear bond investors are telling us about their outlook for the economy?
Web Exercise 3: Scholastic Corp. is a major publisher of children's books, including the Harry Potter series. To get more information on Scholastic Corp. go to yahoo finance website.
1. On the home page, enter the ticker symbol for Scholastic Corp. (SCHL) in the left-hand search box and click "Get Quotes."
2. Write down the volume traded for the day and the P/E ratio (trailing).
3. Now record the stock price.
4. Scholastic has convertible securities outstanding. Based on the conversion ratio of 26.022, what is the current conversion value of Scholastic Corp.?
5. Assume the convertible bond is presently trading at 90 dollars above the conversion value. What is the conversion premium? You may refer to Formula below to help you with this calculation.