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Haley Grey has learned about a new issue of 6-year bonds announced by Riggers plc. The bonds carry an annual coupon of 4.2% and are
Haley Grey has learned about a new issue of 6-year bonds announced by Riggers plc. The bonds carry an annual coupon of 4.2% and are being issued at a discount of 10% to their face value of 100 each. Haley wants to evaluate whether the bonds being issued by Riggers plc are fairly priced. She has observed that other bonds of that maturity are trading in the market at a yield to maturity of 5.61% per annum. Haley wants to invest in the bond market, and she is attracted by the apparently good yield on the Riggers bond but she is also concerned about the impact of bond duration on the value of her investment. She is therefore considering an alternative plan of investing in 5-year zero coupon bonds of equivalent credit rating, which are currently trading at a price of 75.90 per 100 nominal. Required: (a) Estimate the value of the Riggers bond (in nearest round pounds) on the basis of the yield to maturity of other bonds of similar maturity. State whether your answer indicates that the redemption yield offered on the Riggers bond is more or less than the yield of other similar bonds, and comment on what you think might be the important reasons for the difference. (8 marks) (b) Calculate the yield to maturity of the Riggers bond on the basis of its proposed issue price. (5 marks) (c) Explain the nature of the risk that Haley Grey is apparently concerned about. (3 marks) (d) Explain the meaning and usefulness of the concept of bond duration, and calculate the duration of the six-year bonds being issued by Riggers plc. (5 marks) (e) Calculate the yield to maturity of the zero coupon bonds. (2 marks) (f) What would be the duration of the zero coupon bonds? Explain your answer. (2 marks)
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