Business Economics 271
John W. Sell
BOND VALUE PROBLEM SET
Although most bonds promise to pay a fixed interest rate and have a standardized par value, there are many factors that interact to determine the economic value of a bond. How these factors interact is the main problem of bond analysis.
Consider two bonds: Xerox 9.5s07
Xerox 9.5s10
Assume both bonds were issued four years ago and carry a Moody’s rating of “A.”
Problem: Find the risk-adjusted economic value of each bond if the risk-free interest rate is 8%. Let the settlement date be today and the maturity date be today's date of the year indicated. Use annual interest payments. Use Altman’s historical data to help you make the risk adjustment. Give two reasons why the value of these bonds is different despite the fact that they are issued by the same company and carry the same coupon rate of interest.
Problem: Xerox also has another A-rated bond: Xerox zr07. How does the value of this bond compare with the other bond of similar maturity? Why? How does the Yield to Maturity (YTM) of this bond compare with the YTM of the other? Can you explain this result?
Problem: On which bond would the value change the most if the risk-free rate increased to 9%? Do you think that this result is unique to these bonds? Why or why not?
Problem: Would all Xerox bonds be affected the same way if the company lost a patent fight in court and its bonds were all downgraded to "BBB?" Would the size of this change be the same?
Modified April 2002 by Jws.