Question 2 (20 Marks) (A) On June 1, 2019, a bond portfolio manager is evaluating the following data concerning the following 3 bonds held in his portfolio. Bond Rating Coupon Maturity Call Price (Date) Market Price X 0% 8/14/2024 Noncalt 59.44 Y A 14% 3/30/2028 Noncall 116.60 Z 10.25% 7/15/2027 100 (6/1/2020) 98.63 YTM Modified Change in Duration Market Price 10.25% 5.2 years +5.1% 11.00% 5.2 years +5.5% 10.50% 5.2 years +2.4% He observed that all 3 bonds have the same modified duration and thus are expected to rise in price by 5.2% for a 1% decline in interest rates. However, the data shows that a different change in price occurs for each bond (1) Discuss 2 reasons for the discrepancy between the expectations and the actual change in market price for the bonds. (8 marks) (B) China Air Lid has issued a Convertible Bond of US$100,000,000 with the following conditions: Price at Issue Annual Coupon 4% 100 Maturity Conversion 5 year (final payment at par) At any time, a bond with a US$6000 nominal (or face) value can be exchanged against one China Air share. On issue date, a China Air 5 year straight bond with a 4.25% coupon was quoted at 83.00 (which gives a yield to maturity of 6.75%). An investor who is considering buying the China Air Convertible Bond, has a very bullish view on China Air share price over the next 5 years seeing an upside of at least 30% from share price on issue date. Analyse using conversion premium and minimum target share price to determine if the investor should buy the China Air Convertible Bond? (12 Marks) Question 2 (20 Marks) (A) On June 1, 2019, a bond portfolio manager is evaluating the following data concerning the following 3 bonds held in his portfolio. Bond Rating Coupon Maturity Call Price (Date) Market Price X 0% 8/14/2024 Noncalt 59.44 Y A 14% 3/30/2028 Noncall 116.60 Z 10.25% 7/15/2027 100 (6/1/2020) 98.63 YTM Modified Change in Duration Market Price 10.25% 5.2 years +5.1% 11.00% 5.2 years +5.5% 10.50% 5.2 years +2.4% He observed that all 3 bonds have the same modified duration and thus are expected to rise in price by 5.2% for a 1% decline in interest rates. However, the data shows that a different change in price occurs for each bond (1) Discuss 2 reasons for the discrepancy between the expectations and the actual change in market price for the bonds. (8 marks) (B) China Air Lid has issued a Convertible Bond of US$100,000,000 with the following conditions: Price at Issue Annual Coupon 4% 100 Maturity Conversion 5 year (final payment at par) At any time, a bond with a US$6000 nominal (or face) value can be exchanged against one China Air share. On issue date, a China Air 5 year straight bond with a 4.25% coupon was quoted at 83.00 (which gives a yield to maturity of 6.75%). An investor who is considering buying the China Air Convertible Bond, has a very bullish view on China Air share price over the next 5 years seeing an upside of at least 30% from share price on issue date. Analyse using conversion premium and minimum target share price to determine if the investor should buy the China Air Convertible Bond? (12 Marks)
