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Essay Instructions: Bonds and stocks are very similar securities in many respects. For example, market value of both are determined by their expected future cash flows; and both show price sensitivity- some more, some less- to a set of common market factors. At the same time, some may even go further and state that when it comes to portfolio investing details, there is really no difference between the two either. What do you think? Do you think that investing in financial assets is just investing and it does not matter whether we are talking about bond portfolios or stock portfolios? What advice would you give to your clients? Explain your position in 3 to 4 paragraphs.

Essay Instructions: This paper should explore the processes in which we determine bond prices as well as how this relates to the inflation rates set by the government. The topic given is extremely broad so I am less concerned about the actual direction of the paper as I am with meeting its requirements.

Essay Instructions: Part I: Bonds

To review the configuration of today's "yield curve" click on the following: http://www.bondsonline.com/Todays_Market/Treasury_Yield_Curve.php

A simple calculator of the yield to maturity of a bond can be found at the following site.

As an alternative you may use Excel spreadsheet in order to perform the computations. Here's an example showing how to do this.

1. Consider the following information on a series of government bonds as of this week. All bonds have a "face value' or maturity value of $1,000:

Bond No. Maturity Coupon Price Yield to Maturity

1 2 years $51 $993 ?

2 3 years $46 ? 5.54%

3 4 years $61 $1,017 ?

4 6 years $54 ? 5.84%

5 6 years $9 ? 5.80%

(a) Compute the yield to maturity on bonds no. 1 and 3, and the market price of bonds no. 2, 4 and 5 (the market price is actually the present value of the cash flow that a buyer of the bond receives, where the present value is computed using the yield to maturity that is given).

(b) Plot on a diagram the yield to maturity of the bonds as a function of the time to maturity. You may find how such a Yield Curve looks like today by referring to the web site cited on the top of this page. What you should do is to prepare a diagram where you plot five 'dots' - one for each of the bonds. On the horizontal axis you depict the number of years until maturity of each bond and on the vertical axis the yield to maturity of the same bond. Then connect the dots 'free hand' - that is, pass a curve through these bonds. The graph is known as 'The Yield Curve' for a particular date. You may use the Excel graphics. Choose THE XY (scatter) PLOT in Excel, not the line plot because otherwise bonds 4 and 5 will be plotted as if they mature in 5 and in 6 years while both mature in 6 years. You may again refer to the example by clicking here.

(c) What might explain this 'shape' of the yield curve? Refer to the literature (Pool's article in the Background readings) or by browsing on the Internet to find the term 'Yield curve'. You are required to provide references to your sources.

(d) Now assume that the Federal Reserve System lowered interest rates and that as a results the yield to maturity on all of these bonds fell by one half of a percentage point. (This means from 5.54% to 5.04%, and from 5.84% to 5.34% etc.). Compute the new market prices of all of the bonds. Once you did this, compute and examine the percentage change of the price of each of these bonds from its original price. Which bond price moved by the largest percentage? Which bond price moved by the smallest percentage?

(e) Go back to the original set of bond prices and yields and now assume that the yield to maturity on all of the bonds rose by 0.5 percent. Compute the new prices of all five bonds and then the percentage change in the price of the bond from its original price. Which bond price fell by the largest percentage? The smallest?

(f) What conclusions can you draw from the results in (d) and in (e) with regard to the risk of investing in bonds if investors with to hold their investment only for a short time? Be sure to explain.

(g) The bonds that you analyzed above were default-free government bonds. You must have realized that even these bonds are risky in the sense that investors in these bonds for a short time are not certain about the rate of return that they'll earn on their investment. Now explain the implications of the results to companies that wish to raise funds by issuing bonds. Note that corporate bonds are not default-free...

Part II: Stocks

The dividend growth model referred to in the background readings provides some 'clues' to what might determine and affect stock prices. Briefly describe the three components that affect stock prices according to the model and discuss the practical difficulties you see in applying the model in order to determine the 'proper' price of a stock.

Essay Instructions: 1. Bond Selection

In at least 200 words, fully answer questions 6 and 7 from that case. Be sure to fully and carefully explain your answer.

FINANCING EAST COAST YACHTS? EXPANSION PLANS WITH A BOND ISSUE

After Dan?s EFN analysis for East Coast Yachts (see the Closing Case in Chapter 3), Larissa has decided to expand the company?s operations. She has asked Dan to enlist an underwriter to help sell $40 million in new 20-year bonds to finance new construction. Dan has entered into discussions with Renata Harper, an underwriter from the firm of Crowe & Mallard, about which bond features East Coast Yachts should consider and also what coupon rate the issue will likely have. Although Dan is aware of bond features, he is uncertain as to the costs and benefits of some of them, so he isn?t clear on how each feature would affect the coupon rate of the bond issue.

6. Are investors really made whole with a make-whole call provision?

7. After considering all the relevant factors, would you recommend a zero coupon issue or a regu- lar coupon issue? Why? Would you recommend an ordinary call feature or a make-whole call feature? Why?


2. International

In at least 200 words, fully answer question 5 based upon the presented material and the answers from the four previous questions from that case. Be sure to fully and carefully explain you answer.

EAST COAST YACHTS GOES INTERNATIONAL

Larissa Warren, the owner of East Coast Yachts, has been in discussions with a yacht dealer in Monaco about selling the company?s yachts in Europe. Jarek Jachowicz, the dealer, wants to add East Coast Yachts to his current retail line. Jarek has told Larissa that he feels the retail sales will be ap- proximately ?5 million per month. All sales will be made in euros, and Jarek will retain 5 percent of the retail sales as commission, which will be paid in euros. Since the yachts will be customized to order, the first sales will take place in one month. Jarek will pay East Coast Yachts for the order 90 days after it is filled. This payment schedule will continue for the length of the contract between the two companies.

Larissa is confident the company can handle the extra volume with its existing facilities, but she is unsure about any potential financial risks of selling its yachts in Europe. In her discussion with Jarek, she found that the current exchange rate is $0.73/?. At this exchange rate, the company would spend 70 percent of the sales income on production costs. This number does not reflect the sales commission to be paid to Jarek.

Larissa has decided to ask Dan Ervin, the company?s financial analyst, to prepare an analysis of the proposed international sales. Specifically, she asks Dan to answer the following questions:

5. Taking all factors into account, should the company pursue international sales further? Why or why not?

Reference:
Ross, S., Westerfield, R., Jaffe, J., & Jordan, B. (2011). Corporate Finance: Core Principles & Application (3rd ed.). New York, NY: McGraw-Hill/Irwin