The head portfolio has asked you to identify any bonds that offer a return YTM that would exceed the average inflation?

Case study 4: Bond Valuation (10 marks) On January 15, 2017. Huskies Inc., a company founded by a USM graduate, donated $10 million to USM to fund scholarships for students in the business school. USM has hired your investment firm to manage an endowment funded by the gift. You work in the bond research department. The head portfolio manager has asked you to evaluate several bonds for potential purchase. All bonds were issued yesterday. Bond A is a 10 year $1,000 par value 12% annual coupon U.S. Treasury bond. Bond B is a 10 year $1,000 par value 12% annual coupon BBB rated corporate bond. Bond C is a 7 year $1,000 par value 12% annual coupon BBB rated corporate bond. All three bonds are trading at $950 per bond. The firm uses an annual average of expected U.S. inflation to determine the inflation premium over the remaining years to maturity and 1.5% as the real risk free rate, U.S. treasury bonds are assumed to have no default risk. The firm uses the required return formula taught in the USM Financial Management 320 class and will purchase a bond when it reaches a price at or below the price calculated using the required return from the formula below as the discount rate. Required return - real risk free rate + IP (inflation premium) + DRP (default risk premium) + LP (liquidity premium) Economic data: US inflation 3.0% Treasury bond default risk primuim 0.0% Real risk rate 1.5% BBB rate bond default risk primuim 3.0% liquidity premium 2.0%