Question 3

As part of his diversification strategy, Mr Gan intends to invest in fixed income investments comprising of Corporate bonds. Advise him on the following:

a) The bond issue by Edra Energy Sdn Bhd has a par value of RM1,000 and a rating of AA3 (RAM). The bond has a coupon rate of 10% per annum and interest is paid semi-annually. Assume the current market interest rate is 8% per annum and the bond has three years until maturity.

Required:

i) Calculate the bonds price today. (3 marks)

ii) Calculate the bond price six months from now after the next coupon is paid. Assume that market interest rates do not change over the next six months. (3 marks)

iii) Determine the rate of return on the bond if Mr Gan were to invest in the bond now and sell the bond in 6 months time after the coupon payment. (3 marks)

b) Mr Gan is comparing corporate bonds with bond funds. If Mr Gan intends to hold the bond until maturity, advise him which has a higher market risk. Explain to Mr Gan if he should choose a bond or bond fund if market interest rates are expected to rise. (7 marks)

c) Give 2 reasons why higher bond yields adversely affect returns from investing in the stock market. (4 marks)