Mini-Case 2. The bond issues are currently selling for the following amounts: Young Corp. Thomas Resorts Entertainment, Inc. $1,030 $ 973 $1,035 Your grandfather is retired and living on his Social Security ben- efits and the interest he gets from savings. However, the interest income he receives has dwindled to only 2 percent a year on his $200,000 in savings as interest rates in the economy have dropped. You have been thinking about recommending that he purchase some corporate bonds with at least part of his savings as a way of increasing his interest income. Specifically, you have identified three corporate bond is- sues for your grandfather to consider. The first is an issue from the Young Corporation that pays annual interest based on a 7.8 percent coupon rate and has 10 years before it matures. The sec- ond bond was issued by Thomas Resorts, and it pays 7.5 percent annual interest and has 17 years until it matures. The final bond issue was sold by Entertainment, Inc., and it pays an annual coupon interest payment based on a rate of 7.975 percent and has only 4 years until it matures. All three bond issues have a $1,000 par value. After looking at the bonds' default risks and credit ratings, you have very different yields to maturity in mind for the three bond issues, as noted below. Before recommending any of these bond issues to your grandfather, you perform a number of analyses. Specifically, you want to address each of the following issues: 1. Estimate an appropriate market's required yield to maturity for each of the bond issues using the credit spreads reported in Table 9.4. What is the yield to maturity for each bond? 3. Given your estimate of the proper discount rate, what is your estimate of the value of each of the bonds? In light of the prices recorded above, which issue do you think is most attractively priced? 4. How would the values of the bonds change if the market's required yield to maturity on a comparable-risk bond (i) in- creases 3 percentage points or (ii) decreases 3 percentage points? Which of the bond issues is the most sensitive to changes in the rate of interest? 5. What are some of the things you can conclude from these computations? 6. Which of the bonds (if any) would you recommend to your grandfather? Explain. Inc. Coupon interest rate Years to maturity Current market price Par value Bond rating Thomas Entertainment, Young Corp. Resorts 7.8% 7.5% 7.975% 1017 $1,030 $973 $1,035 $1,000 $1,000 $1,000 AA B BBB Table 9-4 Corporate Bond Spread Tables YIMO . AIMA Spread + YTM of m y -1.28% + 2.76% -4,04% Maturity Rating 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 30 yr Aaa/AAA 5 7 12 19 31 49 78 Aal/AA+ 10 22 31 43 55 7 0 103 Aa2/AA 506779 91128 Aa3/AA- 16 40 54 72 84 96 134 A1/A+ 17 42 58 76 88 101 140 A2/A 44 66 79 96 107 118 152 A3/A2- 53 84 103 127 143160210 Baal/BBB+ 78 113 132 157 174 1 91 245 Baa2/BBB 137 160 188 208 227 289 Baa3/BBB- 157 194 215 242 259 278 336 Bal/BB+ 287 337 358 379 433 Ba2/BB 379 403 433 455 479 532 Ba3/BB- 472 498 528 553 580 629 B1/B + 530 564 623 650 680 727 B2/B 624 656 686 719 781 824 B3/B- 716 749 780 814 847 881 923 Caa/CCC+ 810 841 875 908 944 982 1020 U.S. Treasury Yield 0.18% 0.25% 0.32% 0.60% 100% 1.59% 2.76% http://www.bondsonline.com/Todays Market Corporate Bond Spreads.php YTM30 y Barbe: - Spread + YTM -4.33% + 2.76% = 7.09% 592 749