Assignment:
Amy Kroeger was hired as an investment analyst by Alibaba Wilson Inc. for the Davenport, Iowa office based on her sound academic credentials, which included an MBA from a top ranking mid-west University and a CFA designation. At the time of her recruitment she was told that one of her responsibilities would be to conduct educational seminars for current and prospective clients.
Alibaba Wilson Inc., a prestigious investment services firm, with branches in 30 major metropolitan areas, had achieved most of its success due to its excellent client relations and focus on client support. The firm ranked among the very best in terms of the number of successful equity underwriting deals undertaken. Recently, a large utility company had hired it as the leading investment banker for a major corporate bond issue. Since most of its retail customers were more familiar with stock investment, Jared Wolford, the branch manager at the Davenport office, asked Amy Kroeger to prepare and present a seminar outlining the various implications of fixed income investments. "About 60% of our investors are in the 55+ age group, Amy, so we should not have much trouble convincing them of the benefits of investing in bonds" remarked Jared. "However, they may need clarifications regarding various terms and concepts associated with fixed income investing.
Your job is to convince them of the relative safety and income potential of corporate bonds" said Jared. In preparation for the seminar, Amy called up a few of her best clients and queried them regarding their awareness of the risk and return potential associated with corporate bond investments. She realized that apart from a good knowledge about the current level and stability of interest rates and inflation, most customers were not very familiar about the finer aspects of bond investing. Bond features like callability, convertibility, sinking fund provision, bond ratings, debentures, interest rate risk etc. were not well understood by most of the clients she interviewed.
Most of them seemed awfully interested in knowing more about the opportunities offered by bond investing and Amy knew that she would have a good turnout at the seminar. She decided to refer back to her Finance textbook and dig out some definitions and examples that she could use in her PowerPoint Presentation. She downloaded current data for outstanding bonds of various maturities, ratings, and coupon rates (see table on next page) and started preparing her slides.
Instructions:
- Issuer Face Value Coupon Rate Rating Quoted Price Years until Maturity Sinking fund Call Period
- ABC Energy $1000 5% AAA $703.1 20 Yes 3 years
- ABC Energy $1000 0% AAA $208.3 20 Yes NA
- Trans Power $1000 10% AA $1092.0 20 Yes 5 years
- Telco $1000 11% AA $1206.4 30 No 5 years
Requirement:
Question 1: During the presentation one of the clients is puzzled why some bonds sell for less than their face values while others sell for a premium. She asks whether the discount bonds are a bargain. How should Amy respond?
Question 2: What does the term "Yield to Maturity" (YTM) mean and how is it to be calculated?
Question 3: Amy knows that the call period and its implications will be of particular concern to the audience. How should she go about explaining the effects of the call provision on bond risk and return potential?
Question 4: How should Amy go about explaining the riskiness of each bond? Rank the bonds in terms of their relative riskiness.
Question 5: One of Amy's best clients poses the following question, "If I buy 10 of each of these bonds, reinvest any coupons received at the rate of 5% per year and hold them until they mature, what will my realized return be on each bond investment?" How should Amy respond?
Note: Please explain comprehensively and give step by step solution.