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I need answer for attach case ( FINANCING EAST COAST YACHTS'S EXPANSION PLANS WITH A BOND ISSUE) related to finance subject

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Chapter 8 271 Interest Rates and Bond Valuation Another advantage of using duration to immunize a portfolio is that the duration of a portfolio is simply the weighted average of the duration of the assets in the portfolio. In other words, to find the duration of a portfolio, you simply take the weight of each asset multiplied by its duration and then sum the results. www.mhhe.com/rwj range will have the same coupon rate as the current YTM and these bonds make semiannual coupon payments. b. Assume that the interest rates remain constant for the next five years. Thus, when the company reinvests the coupon payments, it will reinvest at the current YTM. What will be the value of the portfolio in five years? c. Assume that immediately after the company purchases the bonds, interest rates either rise or fall by 1 percent. What will be the value of the portfolio in five years under these circumstances? One way to eliminate reinvestment risk is called immunization. Rather than buying bonds with the same maturity as the liability, the company instead buys bonds with the same duration as the liability. If you think about the dedicated portfolio, if the interest rate falls, the future value of the reinvested coupon payments decreases. However, as interest rates fall, the price of the bond increases. These effects offset each other in an immunized portfolio. d. What is the duration of the liability for Ice Cubes, Inc.? e. Suppose the two bonds shown below are the only bonds available to immunize the liability. What face amount of each bond will the company need to purchase to immunize the portfolio? Mini Case Settlement Maturity Coupon rate YTM Coupons per year Bond A Bond B 1/1/2000 1/1/2003 7.00% 7.50% 2 1/1/2000 1/1/2008 8.00% 9.00% 2 FINANCING EAST COAST YACHTS'S EXPANSION PLANS WITH A BOND ISSUE After Dan's EFN analysis for East Coast Yachts (see the Mini Case in Chapter 3), Larissa has decided to expand the company's operations. She has asked Dan to enlist an underwriter to help sell $50 million in new 20-year bonds to finance new construction. Dan has entered into discussions with Kim McKenzie, 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. 1. You are Kim's assistant, and she has asked you to prepare a memo to Dan describing the effect of each of the following bond features on the coupon rate of the bond. She would also like you to list any advantages or disadvantages of each feature. a. b. c. d. ros34779_ch08_238-272.indd 271 The security of the bond, that is, whether or not the bond has collateral. The seniority of the bond. The presence of a sinking fund. A call provision with specified call dates and call prices. 24/08/12 1:54 PM 272 Part II Valuation and Capital Budgeting e. A deferred call accompanying the above call provision. f. A make-whole call provision. g. Any positive covenants. Also, discuss several possible positive covenants East Coast Yachts might consider. h. Any negative covenants. Also, discuss several possible negative covenants East Coast Yachts might consider. i. A conversion feature (note that East Coast Yachts is not a publicly traded company). j. A floating rate coupon. www.mhhe.com/rwj Dan is also considering whether to issue coupon bearing bonds or zero coupon bonds. The YTM on either bond issue will be 7.5 percent. The coupon bond would have a 6.5 percent coupon rate. The company's tax rate is 35 percent. ros34779_ch08_238-272.indd 272 2. How many of the coupon bonds must East Coast Yachts issue to raise the $50 million? How many of the zeroes must it issue? 3. In 20 years, what will be the principal repayment due if East Coast Yachts issues the coupon bonds? What if it issues the zeroes? 4. What are the company's considerations in issuing a coupon bond compared to a zero coupon bond? 5. Suppose East Coast Yachts issues the coupon bonds with a make-whole call provision. The make-whole call rate is the Treasury rate plus .40 percent. If East Coast calls the bonds in seven years when the Treasury rate is 4.8 percent, what is the call price of the bond? What if it is 8.2 percent? 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 regular coupon issue? Why? Would you recommend an ordinary call feature or a make-whole call feature? Why? 24/08/12 1:54 PM