Your grandfather is retired and living on his Social Security benefits 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 issues 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 second 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 markets required yield to maturity for each of the bond issues using the credit spreads reported in Table 9.4.

   	Young Corp.	Thomas Resorts	Entertainment, Inc.
   Coupon interest rate	7.8%	7.5%	7.975%
   Years to maturity	10	17	4
   Current market price	$1,030	$973	$1,035
   Par value	$1,000	$1,000	$1,000
   Bond rating	AA	B	BBB

2. The bond issues are currently selling for the following amounts:

   Young Corp.	$1,030
   Thomas Resorts	$ 973
   Entertainment, Inc.	$1,035

   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 markets required yield to maturity on a comparable-risk bond (i) increases 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.

Table 9.4

Corporate Bond Yields: Bond Yields by Bond Rating and Term to Maturity

Rating	1 year	2 years	3 years	5 years	7 years	10 years	30 years
Aaa/AAA	0.22	0.31	0.42	0.76	1.26	2.00	3.41
Aa1/AA+	0.26	0.43	0.58	0.96	1.46	2.17	3.62
Aa2/AA	0.29	0.55	0.74	1.16	1.66	2.35	3.83
Aa3/AA	0.31	0.58	0.77	1.20	1.70	2.39	3.88
A1/A+	0.32	0.60	0.80	1.23	1.73	2.43	3.93
A2/A	0.55	0.80	0.98	1.40	1.89	2.57	4.03
A3/A	0.62	0.95	1.18	1.66	2.19	2.92	4.51
Baa1/BBB+	0.83	1.19	1.42	1.91	2.45	3.18	4.80
Baa2/BBB	1.00	1.39	1.65	2.17	2.73	3.48	5.17
Baa3/BBB	1.49	1.87	2.11	2.62	3.16	3.91	5.56
Ba1/BB+	2.27	2.64	2.90	3.41	3.98	4.75	6.37
Ba2/BB	3.04	3.41	3.68	4.21	4.79	5.58	7.19
Ba3/BB	3.82	4.18	4.47	5.00	5.61	6.42	8.00
B1/B+	4.60	4.95	5.25	5.79	6.42	7.26	8.82
B2/B	5.38	5.72	6.04	6.59	7.24	8.10	9.63
B3/B	6.15	6.49	6.82	7.38	8.06	8.93	10.45
Caa/CCC+	6.93	7.26	7.61	8.17	8.87	9.77	11.26
U.S. Treasury Yield	0.18	0.25	0.32	0.60	1.00	1.59	2.76