- You are the CFO of Ford Motors Inc. The firm has decided to purchase new fixed assets that will allow them to more efficiently produce electric cars. To raise the funds needed to purchase these assets, you decide to issue bonds. You expect the new fixed assets to last about 20 years so you’d like to issue bonds with a maturity of 20 years and a face value of $2,000. To set the coupon payment, you ask Moody’s what the credit rating is for bonds of this maturity and risk. They tell you they will rate your bonds Aaa which have a 2% return per year, so you set the coupon at $40 per year.
- What is the present value of the bond Ford is offering? Hint: Finding the price of a bond at the time when it is first issued shouldn’t take you long.
Ten years later, market interest rates on bonds of similar risk and maturity and decreased to 1%. Pretend an investor is looking for a Aaa rated bond with a maturity of ten years. They have two choices. They can buy a newly issued bond with a face value of $2,000, say from Toyota. The coupon rate on this newly issued bond would be equal to the current market rate of interest, 1%. This means they would get a coupon of $20 each year. The price of the Toyota bond would be $2,000. The investor’s other option is to buy the Ford bond since it also has a maturity of ten years since ten years have past. The coupon for the Ford bond is still $40 and the coupon rate for the Ford bond is still 4%.
- In order to attract investors, would the price of the Ford bond have to be more or less than the price of the Toyota bond? In other words, does the Ford bond have to be sold at a premium (for more than $2,000) or at a discount (for less than $2,000)? Why?
- Find the price of the Ford bond.
- If you are a risk-averse investor that is buying a bond, which of the following features would you prefer? Explain why you would prefer the feature or why you would not prefer the feature.
- Secured by collateral
- Sinking fund
- Protective covenants
- If we believe there will be less inflation in the future, will the treasury yield curve flatten or steepen? Why?
- Say we are trying to decide between purchasing a ten-year bond issued by Goldman Sachs or JP Morgan Chase. The yield-to-maturity on the Goldman Sachs bond is 10.50% while the yield on the JP Morgan Chase bond is 5.25%. How can yield spreads help us understand why these yields are different?
- Take a look at the last issued bonds by the two companies you choose for your research paper. Go here: https://finra-markets.morningstar.com/MarketData/CompanyInfo/default.jsp
Type in your company’s name. Then click the “Bond Issues” tab. Click the most recent bond issue. What is the coupon rate, maturity, yield, and credit rating for the bond? Repeat for second company.
- Apple currently pays a dividend of $0.80. The company’s goal is to increase dividends by 10% each year. You, the investor, require a rate of return of 15%. What is the current price you would pay now for a share in Apple? What will Apple’s dividend be in ten years?
- One of your first assignments as a financial analyst at Fidelity Investments is to value the stock of Tesla. Unfortunately, Tesla hasn’t paid any dividends yet so we can’t use the dividend discount model. But you do know that the average price-earnings (PE) ratio for the car manufacturing industry is 20 and you also know Tesla’s earnings-per-share (EPS) is $5. Using the PE valuation method, what is the present value (fair price) of Tesla’s stock?