Corporate Finance: Bond Value, Yield to Maturity, Bond Laddering, Diversification, Riding the Yield Curve, Treynor's Measure

This article covers topics related to corporate finance such as bond value, yield to maturity, bond laddering, diversification, riding the yield curve, and Treynor's measure.

Running Head: Corporate Finance
Bond Value

Corporate Finance
Question 1
Part a
Yield to maturity is the rate that is used to discount the future cash flows associated with the
bond. Typically it is the return earned by the bondholder for purchasing and holding the
bonds till their maturity. This rate equates the present value of the cash flows related to bond
with their current market price. YTM is also referred as internal rate of return or the market
interest rate (Stack Exchange, 2018).
Part b
Formula
$1,276.76 = $80 ×Annuity factor(r, 30) + $1,000 ×PV
factor(r, 30)
FV 1000
Price 1276.76
Maturity 30
Coupon 8%
PMT $80.00
Bond Equivalent
Yield 6% (rounded off)
Part c
The critical assumptions embedded in the 30-Year Bond yield to maturity figure are as
follows:
 The holder of the bond will keep the bond till the maturity of such bonds.

Corporate Finance
 The coupon (interest on bonds) must be invested at the same rate as that of YTM
(Stack Exchange, 2018).
Question 2
Part a
Year
s Cash Flows ($) DCF PV ($)
1 60 0.917 55.046
2 60 0.982 58.934
2 1000 0.982 982.240
Price of bond 1096.220
Part b
Bond Price=
( (Coupon/YTM)* ( 1-(1/(1+YTM/2)2M) ) +
(FV/(1+YTM/2)^2M)
Part c
Yield at year 2 is lesser than yield to maturity at year 2 because the yield to maturity includes
the year 1 interest payment made on the bond. However, year 2 yield only covers only
interest and principle payment.
Question 3
Part a

Corporate Finance
Bond Laddering is a strategy which involves maturity weighting under which funds of the
investors are divided among different bonds that have longer maturities. This strategy is used
to reduce or minimise the risk of interest rate fluctuation and re-investment risk
(Investinginbonds.com., 2018).
For example:
John has invested funds in equal amounts to different bonds which will mature at the regular
intervals.
Bond A Bond B Bond C Bond D Bond E
Maturity: 2
Years
Maturity: 4 Year Maturity: 6 Year Maturity: 8 Year Maturity: 10
Year
Amount=
$20000
Amount=
$20000
Amount=
$20000
Amount=
$20000
Amount=
$20000
Interest Rate=
1.55%
Interest Rate=
2.05%
Interest Rate=
2.80%
Interest Rate=
3.22%
Interest Rate=
3.30%
The average maturity of the portfolio consisting of above bonds is 15 years. Now, when the
bond A will mature after 2 years, John will have two options:
Either to reinvest his principle in a fresh 10 year bond or to take the money out and invest
somewhere else. The other bonds will be 2 years closer to their respective maturity now.
Bond laddering strategy is a buy-hold strategy that can be used as support for the potential
impact of rising interest rates (Carlson, 2018).
Part b:

Corporate Finance
Dollar cost averaging involves purchasing of more shares when the market is down and less
shares when the market is up. While bond ladder involves investment in multiple securities at
a single time, in almost equal amount (Leach, 2018). Bond ladder is for high interest yielding
securities.
Question 4
Part a
Open-Ended Mutual Fund v/s Exchange Traded Fund (ETF)
Similarities:
 The prime similarity among Open ended Mutual Funds and Exchange Traded Fund is
that they both portray professionally managed baskets or the collections of various
bonds or securities.
 Further, both of these funds provide a wide variety for the investment options.
Differences:
Basis Exchange traded funds Open Ended Mutual Funds
Expense Ratio The expense ratio of ETFs
lies in between the range of
0.1% to 1.25%
The expense ratio of Open
ended mutual funds lies in
between the range of 0.1% to
10%

Corporate Finance
Pricing These funds are priced
throughout the day at the
market price on the trading
day which may not be similar
to the Net asset value.
These are priced once per
day and that too at the end of
the trading day. These are
priced at NAV
Tax efficiency Low Cost, Tax efficient and
involves transparency.
These are less tax efficient
(Anspach, 2018).
Part b
Open-Ended Mutual Fund vs. Hedge Fund
Similarities:
 Both the funds work as an investment pool and involve investment in various
securities such as stocks bonds and commodities.
 Further, both the funds are managed by the professional experts.
Differences:
Basis Hedge funds Open Ended Mutual Funds
Investors In hedge funds, funds of limited
investors are permitted to be
pooled for the purchase of
assets.
In Mutual funds, the funds of
number of investors are
managed by the fund
manager to purchase bunch of
securities from the market.
Aim These funds aim at offering
maximum possible returns to
These funds aim at provision
of return in excess of risk free

Corporate Finance
the investors. return rate that is offered in
market.
Investors Established individuals with
high risk bearing capacity.
Retail investors who invests
their limited income to
multiply their money.
Question 5
An investment plan must be diversified so as to manage the risk of overall investment.
Diversification involves making investment in different types of investment vehicles in the
amounts that must be decided according to the risk and reward generating capacity of each
investment vehicle. Stocks give the investors income in two forms: dividend and capital gain.
When the investors are not looking for a source of steady income they can opt for equity
investment which will not only provide them return in the form of dividend but also it will
provide them the stake in the company’s holding in the form of voting rights (Finra, 2018).
However, when the investors expect steady returns they must invest in bonds as they
generally provide fixed income. Mutual funds are again a better option for the potential
investors as these funds allow them to put their savings in the pool of investments on the
basis of benefits and limitations of each security. Since in the current case, Anna will require
a loan to be repaid and for this purpose it will require funds it must invest prudently.
For example Anna has 100 lacks dollars to be invested. Then it must invest 40% in equity,
30% in debt or bond and in mutual funds. This will allow her to diversify the investment.
Question 6

Corporate Finance
Current Free Cash Flow to the Firm
(FCFF) 745
Outstanding shares 309.39
Equity beta 0.9
risk-free rate 5.04%
Equity risk premium 5.50%
Cost of debt = 7.10%
Marginal tax rate 34%
Capital structure:
Debt 20%
Equity 80%
Long-term debt=
Growth rate of FCFF
1-4th Years 8.80%
Year 5 7.40%
Year 6 6.00%
Year 7 4.60%
Year 8 3.20%

Corporate Finance
Ke
RF + Beta (Risk
Premium)
9.99%
Kd
Before tax Kd (1-tax
rate)
4.69%
WACC Proportions Rates
Weighted
Rates
Debt 20% 4.69% 0.94%
Equity 80% 9.99% 7.99%
WACC 8.93%
Value of firm
1 810.56 0.918 744.12
2 881.88928 0.843 743.23
3 959.4955366 0.774 742.35
4 1043.931144 0.710 741.47
5 1121.182049 0.652 731.06
6 1188.452971 0.599 711.40
7 1243.121808 0.550 683.13
8 1282.901706 0.504 647.20
PV of Cash Flows 5743.97
Continuing Value 1282.90
5.73%

Corporate Finance
CV 22392.33586
PV of CV 11296.52549
Part c Value of firm 17040.50
Part d Value of Equity
Value of firm 17040.50
Less: Value of Debt 1518
Value of Equity 15522.50
Value per share
Value of Equity/ Number of shares 15522.50/309.39
Value per share $ 50.17
Question 7
Part a
An investor pays attention to interest rates and yield spreads because:
The yield of any bond is mainly comprised of two things: Interest rate and the Credit spread.
Interest rate serves as the base rate for each type of bond which is denominated in a particular
currency and it compensates for the baseline economic risks of the investors (Finra, 2018).
The credit spread or yield spread reflects the difference between rates quoted for two
investments with different qualities and maturities. This spread represents idiosyncratic risks
which is associated with the specific issuer of the bond or security (Fidelity, 2018).
Part b

Corporate Finance
The key factors that cause interest rates to move:
 Supply or demand: The demand and supply of money in an economy leads to change
in movement in interest rates. Increase in demand or decrease in supply of money
leads to the interest rates of an economy go up and vice versa.
 Inflation: When the rates of goods and services in an economy rise, the interest rates
also increases and vice versa.
 International borrowings: With the increased scope of globalisation it has become
quite common that the companies can borrow required funds from the foreign markets
and when foreign investors competes the local finance providing institutions, the
interest rates moves.
 Federal fund rates: These are the rates that are being charged by one bank from
another for their short term borrowing and lending transactions. When federal banks
charges higher rates, the interest rates for the normal citizens of the country increase.
Question 8
Part a
Riding the yield curve means purchasing the long term bonds or securities and selling them
before their maturity. The basic purpose behind their execution is to reap certain interest rate
benefits from the market. Suppose we are riding a yield curve and the yields rises
considerably we will have to bear a capital loss on such a riding position. If such instrument
was purchased which matched our investment horizon, it would certainly result in positive
return (Bieri & Chincarini, 2005).
Part b
Year CFS PVF PV of

Corporate Finance
CFS
1 60
0.93457
9
56.0747
7
2 60
0.88999
6
53.3997
9
3 60
0.81629
8
48.9778
7
3 1000
0.81629
8
816.297
9
974.750
3
Question 9:
Part a
Portfolio A offers most of the income to the investors in the form of dividend and it seems to
be held by the retired couple as they would be looking for an investment that is less risky in
terms of return fluctuations and they could have a steady source of income. The portfolio that
provides dividend as the income generally involves less risk because of constant income. On
the other hand, portfolio B provides returns to the investors in the form of capital gains. This
is likely to be held by someone who is not in the need of current income and is willing to bear
high risk as the prices of the shares keeps on fluctuating and there is a risk of fluctuation of
such price on a negative side and also there are possibilities of price increment where one can
make higher returns.
Part b

Corporate Finance
Face Value 100000
Bond Interest Rate 12%
Income 12000
Tax Rate 25%
Tax 3000
Net Tax Income 9000
Annual HPR 9.00%
Part c
Beta 1.3
Market Return 10%
Risk Free Rate 2%
Portfolio Return 12%
Treynor's Measure Portfolio Return - Risk Free Rate
for portfolio Portfolio beta
7.69%
Treynor's Measure Market Return - Risk Free Rate
for portfolio Portfolio beta
6.15%

Corporate Finance
References:
Stack Exchange. 2018. Yield-to-Maturity and its assumption. Retrieved from:
https://quant.stackexchange.com/questions/33028/yield-to-maturity-and-its-assumption
Investinginbonds.com. 2018. Bond Investment Strategies. Retrieved from:
http://investinginbonds.com/learnmore.asp?catid=6&id=386
Finra, 2018. Smart Bond Investing. Retrieved from:
https://www.azinvestor.gov/Documents/Smart_Bond_Investing-FINRA.pdf
Leach, 2018. Are There Better Strategies Than Dollar Cost Averaging? Retrieved from:
https://www.suredividend.com/better-than-dollar-cost-averaging/
Carlson, B., 2018. The Lump Sum vs. Dollar Cost Averaging Decision. Retrieved from:
https://awealthofcommonsense.com/2018/05/the-lump-sum-vs-dollar-cost-averaging-
decision/
Anspach, D. 2018. The Difference Between ETFs and Open-Ended Mutual Funds. Retrieved
from: https://www.thebalance.com/differences-between-etf-s-and-open-ended-mutual-funds-
2388639
Fidelity. 2018. How interest rates affect bonds. Retrieved from:
https://www.fidelity.com.sg/beginners/bond-investing-made-simple/how-interest-rates-affect-
bonds
Bieri, D. S., & Chincarini, L. B. (2005). Riding the yield curve: a variety of
strategies. Journal of Fixed Income, 15(2), 6.