Bond Case Analysis
Case 18
Gilda Sears
Finance 650: Investments
Date: July 22, 2010
Table of Contents
Summary of Facts 3 Problems 3 Analysis and Solution 4 I. Boston Edison and American Brand 4 II. AT&T and Baltimore Gas and Electric 4 III. Largest potential capital gain 4 Annexures 5
Summary of Facts
Gilda Sears who is enrolled in an Investments class has picked a project on bond price theorems.
The two main theorems that she decided to illustrate dealt with coupon rate and term-to-maturity and how these factors influence the price. Thus she included 2 bonds with the same rating and term with a different coupon rate, as well as two bonds with the same rating and coupon rate with different terms.
She thought that if the bond markets were efficient, bonds with similar characteristics would be priced so that there would be little difference in the YTM.
Besides S&P, she also looked at Moody’s for additional information.
There was an increase in the interest rates over 1984-1986 and hence observed the actual YTM at different point in time. Three periods were selected: November 1, 1984, 1985, and 1986.
The theorem states that YTM and price, as well as coupon rate and price, should have an inverse relationship, while bond duration and price should have a direct relationship.
** Please refer to Annexure 1 for a summary on the Factual Numbers in the case.
Problems
The following are the problems of the case:
Q1: Using the prices given, calculate the percentage price changes for the three periods for the Boston Edison and American Brand bonds and explain the difference between the changes.
Q2: Using the prices given, calculate the percentage price changes for the three periods for the AT&T and Batimore Gas bonds and explain the difference between the changes.
Q3: Also, assuming there is a significant decline in interest rates, which of the four bonds would provide the largest potential capital gain?
Analysis and Solution **
Gilda Sears
Finance 650: Investments
Date: July 22, 2010
Table of Contents
Summary of Facts 3 Problems 3 Analysis and Solution 4 I. Boston Edison and American Brand 4 II. AT&T and Baltimore Gas and Electric 4 III. Largest potential capital gain 4 Annexures 5
Summary of Facts
Gilda Sears who is enrolled in an Investments class has picked a project on bond price theorems.
The two main theorems that she decided to illustrate dealt with coupon rate and term-to-maturity and how these factors influence the price. Thus she included 2 bonds with the same rating and term with a different coupon rate, as well as two bonds with the same rating and coupon rate with different terms.
She thought that if the bond markets were efficient, bonds with similar characteristics would be priced so that there would be little difference in the YTM.
Besides S&P, she also looked at Moody’s for additional information.
There was an increase in the interest rates over 1984-1986 and hence observed the actual YTM at different point in time. Three periods were selected: November 1, 1984, 1985, and 1986.
The theorem states that YTM and price, as well as coupon rate and price, should have an inverse relationship, while bond duration and price should have a direct relationship.
** Please refer to Annexure 1 for a summary on the Factual Numbers in the case.
Problems
The following are the problems of the case:
Q1: Using the prices given, calculate the percentage price changes for the three periods for the Boston Edison and American Brand bonds and explain the difference between the changes.
Q2: Using the prices given, calculate the percentage price changes for the three periods for the AT&T and Batimore Gas bonds and explain the difference between the changes.
Q3: Also, assuming there is a significant decline in interest rates, which of the four bonds would provide the largest potential capital gain?
Analysis and Solution **