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Wednesday, November 28, 2012

MGT201 GDB Solution IDEA 2012

Total Marks
2
Starting Date
Tuesday, November 27, 2012
Closing Date
Wednesday, November 28, 2012
Status
Open
Question/Description
Bond Valuation and Yield on Bond


Learning Objective:
To understand the application of bond valuation for investment decisions.

Learning Outcome:
After attempting this GDB, the students would be able to understand the application of bond valuation for investment decisions.

The Case:

Suppose, you are working as an investment consultant in a consultancy firm and most of your clients are habitual investors, who are maintaining their own portfolios comprising of various combinations of stocks and bonds. 

Mr. Zahid, a habitual investor comes to you for consulting about adding one more potential investing option to his existing portfolio. Currently, as per your analysis, there are two bonds available in the market with the following data:


Bond A
Bond B
Maturity
3 years
8 years
Coupon payment
10% Annual
10% Semiannual
Yield
6.23%
9.8%

*Note: Interest rate fluctuations are high in the market

Required:
·        Suggest Mr. Zahid, who is interested to add only one bond to his portfolio about the suitable bond for his portfolio.
·        Support your choice by elaborating the reason on which the suggested bond is considered as a preferred option.

Important Instructions:
1.       Your discussion must be based on logical facts.
2.       The GDB will remain open for 2 working days/48 hours.
3.       Your answer should be relevant to the topic i.e. clear and concise.
4.       Your discussion should not exceed 60 words.
5.       Do not copy or exchange your answer with other students. Two identical / copied comments will be marked Zero (0) and may damage your grade in the course.
6.       Obnoxious or ignoble answer should be strictly avoided.
7.       Questions / queries related to the content of the GDB, which may be posted by the students on MDB or via e-mail, will not be replied till the due date of GDB is over.
Ø        For detailed instructions, please see the GDB announcement.



SOLUTION IDEAS




Dear friends, if we consider the face value of both the bonds Rs. 1000. Then apparently it seems that investment in bond B will be better. Rest i can better comment after detailed calculations. Anybody who has different opinion can share immediately, so that we can arrive at correct solution by fruitful discussion


------------------------------------------------------

I think, Bond A is better. Keeping in mind the following points:
Maturity: Shorter maturities have less risk, so their interest rates don't have to be as high as long-term maturities to attract buyers.
The longer the time to maturity for a bond, the greater the risk that the issuing company will experience financial trouble.
Coupon Payment: A bond with semiannual payments would have a higher price than a bond with annual payments when they both are selling at a premium. 
In general, bonds with semiannual payments are more sensitive to changes in market interest rates. For the same amount of decline in market interest rates, bonds with semiannual payments tend to see more price increases.
Hence the one with annual payments is better.
Read more: Bond Prices: Annual Vs. Semiannual Payments | eHow.com http://www.ehow.com/info_8552770_bond-annual-vs-semiannual-payments...
Yield: If you purchase a higher grade, lower yield bond, you are exposed to less default risk, and you have a higher chance of getting all of the promised coupon payments and the par value if you hold the bond to maturity.
Read more: http://www.investopedia.com/ask/answers/06/highyieldlowyieldbonds.a...

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if we go with the handout and lectures then Bond B is Better because long bond risk theory ,yield to maturity and biannual payment all says Bond B is better


--------------------------------------------------------


(i)
Face value= FV=Rs. 100
Annual Coupon = 10%
Yield = 6.23%
Maturity = 3 yrs
CF = Coupon Interest Rate * Par value
CF = 10% * 100
CF = Rs. 10 p.a
PV (6.23%) = CF /(1+6.23%)+ CF /(1+6.23%)2+ CF /(1+6.23%)3+ FV /(1+6.23%)3
PV = 10/1.0623 +10/(1.063) 2 + 10/(1.063) 3+ 100/(1.063) 3
PV = 9.41 + 8.85 + 8.33 + 83.26
Bond Price = 109.85
Rs. 100 today at 10% mark-up for 3 years is worth positive Rs. 109.85 to the client today.


(ii)
Face value= FV=Rs. 100
Semi Annual Coupon = 10%
Yield = 9.8%, semi-annual = 4.9%
Maturity = 8 yrs
Total Coupon payments = 2*8 = 16 coupon payments
Each coupon payment = 10%*100
                                                = Rs. 10 p.6m
Bond Price = 10 * [1 – [ 1/(1+0.049)16]]/0.049 + 100/(1+0.049)16
Bond Price = 10 *[1-0.465]/0.049 + 100/2.15
Bind Price = 109 + 46.5
Bond Price = 155.5 = 156
Rs. 100 today at 10% mark-up semi-annual for 8 years is worth positive Rs. 156 to the client today.

When Market Interest Rate (ie. Investors’ Required Rate of Return) Increases, the Value (or
Price) of Bond Decreases. So, when interest rate in denominator goes up the present value (price) will decrease. When investor buy a long term bond he is locked in investment for long term period there are more chances of fluctuation in interest rate and the inflation rate.
So, the impact of interest rate changes on Long Term bonds is greater. Long Term Bond Prices fluctuate more because their Coupon Rates are fixed (or locked) for a long time even though Market Interest Rates are fluctuating daily; therefore the price of Long Bonds has to constantly keep adjusting. Price of the long term bond fluctuates more as compared to the short term bond.  So we will suggest Bond A to Mr. Zahid to add in his portfolio.


=----------------------------------------------------------                        






                   

32 comments:

  1. When
    investor buy a long term bond he is locked in investment for long term period there are more chances of
    fluctuation in interest rate and the inflation rate.
    So, the impact of interest rate changes on Long Term bonds is greater. Long Term Bond Prices
    fluctuate more because their Coupon Rates are fixed (or locked) for a long time even though Market
    Interest Rates are fluctuating daily; therefore the price of Long Bonds has to constantly keep adjusting.
    Price of the long term bond fluctuates more as compared to the short term bond. Because, you
    have a long term bond with fix coupon rate but the market interest rate is fluctuating in between the
    years

    ReplyDelete
  2. GDB IDEA MGT 201
    1 shorter maturities have low risk so there interest rate rate hav dnt there long term maturities to attract buyers
    bcz long term maturities have more risk

    --------------------------------------------------------------------------------
    yeild if u purchase ahigher grade, lower yeild bond you exposed to less default risk and u hav achance to getting higher all of the prominced coupon payments

    --------------------------------------------------------------------------------
    so in both these case A is better
    COUPAN PAYMENT: A bond with semi annual payments would have higher price then bond A WITH ANNUAL PRICE WHEN THEY BOTH ARE SELLING in general bonds semi annual payments is more sensitive to changes in market interest rate.

    ReplyDelete
  3. the higher yield bond will give you a higher return, in the form of coupon payments, but the default risk is higher..........
    as mn yeh baat gor karny wali hay k................
    Coupon payment
    10% Annual
    10% Semiannual
    bond A ki annual hay aur bond B ki semi annual hy to jo semiannual hy aski value asko chance zada mil rahy hn aski values zada na ho gi kia????
    bond B better hua na...............koi to share kary views

    ReplyDelete
  4. Definitely bond b will give you higher return but most of today's investors invest their money where risk is lower. But risk lover will go for bond B.
    But it is depend on investor. It is totally confusing. If the investor is risk averse then Bond A should be suggest otherwise B.
    It is also point to note that interest rate fluctuations are high in market.

    ReplyDelete
  5. proper bond A becuse
    higher the maturity higher the rate of risk and the more chances of the fluctuation
    on the other hand
    bond A k pass less maturity hai yield of coupen ko b dhkein tab b A he suitable hai

    ReplyDelete
  6. short life bonds have less interest rate risk than long bonds
    if u have long term bond its means u fix with coupon rate

    vumba2009.blogspot.com

    ReplyDelete
  7. Interest Rate Insensitive - As you might guess, short maturity implies short duration, which means your principal won’t fluctuate much with interest rates. Add to that the fact that interest rates tend to be a bit more stable over periods of less than a year or so and you’ve got a relatively stable asset class.

    ReplyDelete
  8. Long term bond are Very Sensitive To Interest Rates – Long term bonds have high durations, which means their prices tend to fluctuate wildly in response to relatively mild changes in interest rates. Most long term bond funds seem to hover around an effective duration of 10 years or so, which means the fund’s NAV will rise or fall about 10% for every 1% change in interest rates.

    ReplyDelete
  9. 1 shorter maturities have low risk so there interest rate rate hav dnt there long term maturities to attract buyers
    bcz long term maturities have more risk

    --------------------------------------------------------------------------------
    yeild if u purchase ahigher grade, lower yeild bond you exposed to less default risk and u hav achance to getting higher all of the prominced coupon payments

    --------------------------------------------------------------------------------
    so in both these case A is better
    COUPAN PAYMENT: A bond with semi annual payments would have higher price then bond A WITH ANNUAL PRICE WHEN THEY BOTH ARE SELLING in general bonds semi annual payments is more sensitive to changes in market interest rate.

    ReplyDelete
  10. Bond A is Better
    The longer the maturity of your bond investments, the greater the price volatility.

    Why?

    The reason is that the maturity value of the long-term bond, as well as many of the interest payments that are being paid, are future cash flows that are very distant points in the future. If interest rates rise, those very distant cash flows of the long-term bond are discounted in value significantly, and the price of the long-term bond falls in the market abruptly.

    Coupon rates—the periodic interest payment that is paid by the issuer of the bond—also affect bond price volatility. A higher coupon means that more cash in the form of interest payments flows to the investor before maturity than is the case with a lower coupon bond. What this means is that when interest rates rise and future cash flows are discounted at a higher rate, the lower coupon bond has relatively more cash flow in the distant future, the maturity value of the bond represents a greater portion of the total cash flow, and the bond's value today will fall relatively more.

    Combining these characteristics produces the riskiest bonds in terms of price volatility: The most price volatile bonds are those with longer maturities and lower coupons. A long-term zero-coupon bond defines the outer boundary for riskiness.

    Investors who are risk averse should look for bonds and bond mutual funds that have shorter average maturities—less than five years—and should avoid zero-coupon bonds, particularly long-term zero-coupon bonds.

    ReplyDelete
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