Bond valuation
Atlantic Airlines issued $100 million in bonds in 2015. Due to th
Bond valuation
Atlantic Airlines issued $100 million in bonds in 2015. Due to the company’s low credit rating (3B),
The bonds were considered junk bonds. At the time of issuance, the 20-year bond was paying a yield of 12 percent.
Investor Tom Phillips thought the bond yield was particularly attractive and called his broker, Roger Brown, to ask for more…
Information about the debt issue. Tom currently owns Treasury bonds that pay four percent interest and corporate bonds yielding interest
By six percent. He wondered why Atlantic Airlines’ debt issue paid twice the value of the company’s other bonds and 8%
cent more than treasury bonds.
His broker, Roger Brown, had been a financial advisor to Merrill Lynch for 10 years, and was often asked such questions about…
The return. He explained to Tom that the bonds were not considered investment grade because of the industry they were in. Airline bonds are considered
It is inherently risky due to exposure to volatile energy prices and the high level of debt carried by many companies
Aviation. He further explained that they are often called “junk bonds” because their rating does not fall within the top four categories.
From ratings by bond rating agencies Moody’s and Standard & Poor’s.
This explanation did not prevent Tom from showing continued interest. In fact, he couldn’t wait to get 12 percent of the money
First, “What is the real risk and is it worth the risk?” Yield securities. But he asked Roger,
Roger explained that there is a higher risk of default with junk bonds. It sometimes reached 2-3% during…
periods of severe economic downturns (compared to 0.5% for more traditional versions). Roger also noted that although
The yield at the time of issuance appeared high, but it could rise significantly if conditions in the aviation industry worsen.
This will happen if the price of oil moves up sharply or if people start flying less due to the economic downturn. Explain
Roger believed that if the yield (required return) on bonds of this type increased, the price of the bonds would fall and could eliminate…
High interest payment feature.
Liabilities:
1. If the yield in the bond market of this type rises to 15% due to bad economic conditions, what will be the new rate?
A year for bonds? They have an initial face value of $1,000. Suppose two years have passed and there are 18 years left to live
Bonds. Use annual analysis.
2. Compare the decline in value to the eight percent initial interest advantage on Treasury bills (12 percent versus four
percent) for this biennium. Base your analysis on a $1,000 bond. Regardless of tax considerations, does
Will Tom go ahead or behind in buying high-yield bonds?
3. Recalculate the bond price if interest rates rise by only 1% to 13% with 18 years remaining. Is the interest rate advantage
8 percent over a two-year holding period covers the loss in value?
4. If Tom holds the bonds to maturity (and there is no default), will the change in the required market return
Over the life of the bond has any direct impact on the investment?