Assessment Task Description

Yousif, the owner of Bicycles Galore (BG), has decided to expand his business operations. He worked with Rashmi, his financial analyst, and they agreed that the business needs approx. $2 million for the expansion project. One of his business associates mentioned to him that the best way to finance such a project would be through 10-year Bonds. Yousif has asked Rashmi to look at using Bonds to finance the expansion. Yousif told Rashmi that he is comfortable with receiving the full amount ($ 2M.) or 95% of the par value. Yousif asked Rashmi to decide on which types of bonds BG should consider and what coupon rate the bond issue is likely to have to meet Yousifs financial requirements. Rashmi analysed similar risk bonds issued and determined that the Yield to maturity (YTM) should be 5%.

Although Rashmi is aware of the features of different types of bonds, she is uncertain about the costs and benefits of some different types of bonds, so she is not clear how each type of the bond would affect the coupon rate of the bond issue.

Required

You are Rashmis assistant, and she has asked you to calculate the coupon rates if bonds currently sell for par value or for 95% of par value respectively. You are asked to prepare a detailed report to Yousif describing the effect of each of the bond features (different types of bonds) on the coupon rate of the bond. He would also like you to describe any advantages or disadvantages of different types of bonds.

In your report

1. Explain how a bond issuer decides on the appropriate coupon rate to set on its bonds. Explain the difference between the coupon rate and the required return (YTM) on a bond.

2. Calculate Coupon rates to set on its bonds (par value and 95% of par value respectively) and evaluate.