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CASE 1: (Bond Valuation and Selection)
You are working as a Fund Manager in an investment bank. You have been allocated A$1million to invest in corporate bonds. You have researched the bond market and shortlisted the following three bonds:
Your investment bank requires a minimum rate of return of 6% from any bond investment.
- What maximum price would you be willing to pay for each bond?
- Considering the pandemic driven recession and lack of investment opportunities your company is willing to reduce the required rate of return from 6% to 5%. What prices would you be willing to pay now for each bond?
What is the percentage change in prices for each bond in (b) compared to the prices obtained under (a) above?
- As more and more investment opportunities opened up in 6 months’ time, there are alternative investment opportunities offering 7% return on investment of similar risk. You company now requires a minimum return of 7%.
What are the new values for each bond? What is the percentage change in values for each bond compared to prices calculated under (a) above?
- Which of the three bonds is least sensitive to market interest rate change? Which one is most sensitive? Explain your reasoning.
- Which bond(s) will you buy if your required rate of return is 6% and the market price for each bond is as follows? Why?
Alpha – $670.55
Beta – $940.88
Theta – $1,203.80