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Good Evening
this in relation to #27, airline business, in the latest bpp kit
we have to advise on a coupon rate for a bond issue (of 400m for 4 years) and estimate current and revised market values of the debt and the increase in the cost of debt after the issue.
i was able to do 40% of the calculations but then did not know how to use them.
however, my first question is:
the question states “the yield curve suggests that at three years, govt treasuries yiled 3.5% and at four years they yield 5.1%”
when i read this line i thought that it was saying that yields are 3.5% for years 1-3 and for year 4 the yield is 5.1%.
to be honest, i cant blame this on my lack of english but its more a lack of understanding.
can u write a line or two how to get around this
There are different government bonds with different terms to maturities – in this question there are 3 year ones and 4 year ones.
Depending on how long the different bonds last, the yield they give will be different.
So ones lasting 3 years give 3.5% p.a.., whereas ones lasting 4 years give 5.1% p.a..
Since they will be issuing 4 year debt, they should compare with 4 year government bonds.
thanks… i have 2 more questions on the same question. i will ask only one right now.
please ignore if this is too muchthe MV of the existing debit is 400m and the coupon rate is 4% and maturity of 3 years. and it also says that it is at par since the coupon rate and the (given) market yield is also 4% (3.5 + 50 basis points)
the co wants to issue a new bond of 400m at a coupon of 6% for 4 years. it has been suggested to the co that to ensure a full take up, the credit spread has to go up by 90 basis points.
we have to estimate the current and revised market valuation of the debt and the increase in the effective cost of debt.
the answer says:
effect of new debt on market value of old debt
the net increase of coupon is 4 + (90-50) = 4.4 (i under stand this part)
it then computes the pv = 400/1.044 + 400/1.044^2 + 400/1.044^3
and this pv is termed as “110 basis points reduction”what i dont understand is,
1. how is this a DIFFERENCE? this is just the pv at 4.4%. the DIFFERNCE SHD be pv@4% – pv@4.4%. no? (am pretty sure am missing the concept here!)
2. and if the existing bond is for 3 years, shdnt we also include the redemption in the last year’s calculation? (we r not given the redemption)
please explain
They layout of the answer is confusing.
Firstly, since the current MV is 400, the coupon rate is 4%, and the yield is 4%, it must mean that the redemption is at par (if the redemption were at higher than par then the yield would be higher than the coupon rate).
If you take a nominal/par value of 100, then there is interest of 4 p.a. for 3 years, and a repayment of 100 in 3 years time.
If you discount at the current yield of 4% you get a current MV of 100.If you then take the same flows (interest of 4 p.a. for 3 years and a repayment of 100 in 3 years time) but then discount at the new yield of 4.4%, you will get a new MV of 98.9.
(Which is obviously 98.9% of the current MV).yes!!!!!!!…..its great to be able to “blabber”…because when i am writing or reading ur replies.. it makes me think and put my thoughts in order..thank u!!
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