Bond Analysis and Valuation Corporate Bonds-They Are More Complex Than you Think Jill Dougherty was hired as an investment analyst by A. Smith Inc.

Bond Analysis and ValuationCorporate Bonds-They Are More Complex Than you ThinkJill Dougherty was hired as an investment analyst by A.M. Smith Inc. for the Cincinnati, Ohio office based on her sound academic credentials, which included an MBA from a top ranking university and a CFA designation. at the time of her recruitment she was told that one of her responsibilities would be to conduct educational seminars for current and prospective clients.A.M. Smith Inc, a prestigious investment firm, with branches in 30 major metropolitan areas, had achieved most of its success due to its excellent client relations and focus on client support. The firm ranked among the very best in terms of the number of successful equity underwriting deals undertaken. Recently, a large utility company had hired it as the leading investment bankers, for a major corporate bond issue. Since most of its retail customers were more familiar with stock investments, John Sullivan, the branch Manager at the Cincinnati office, asked to prepare and present a seminar outlining the various implications of fixed income investments. About 60% of our investors are in the 55+ age group. Jill, so we should not have much trouble convincing them of the benefits of investing in bonds remarked John. ” However, they may need clarifications regarding various terms and concept associated with fixed income investing. Your job is to convince them of the relative safety and income potential of corporate bonds” said John.In preparation for the seminar, Jill called up a few of her best clients and queried them regarding their awareness of the risk and return potential associated with corporate bond investments. She realized that apart from a good knowledge about the current level and stability of interest rates and inflation, most customers were not very familiar about the finer aspects of bond investing Bond features like callability, convertibility, sinking fund provision, bond ratings, debentures, interest rate risk, were not well understood by most of the clients she interviewed. most of them seemed awfully interested in Knowing more about the opportunities offered by bond investing and Jill Knew that she would have a good turnover at the seminar. She decided to refer back to her finance textbook and dig out some definitions and examples that she could use in her Power Point presentation. She downloaded current data for outstanding bonds of various maturities, rating, and coupon rates( see table1) and started preparing her slides.                     Table 1                  Corporate Bond informationIssuer Face   coupon  Rating Quoted years Sinking Call       Value  Rate           price until  Fund  period                                  MaturityABC    Energy $1,000  5%     AAA   $703.1  20    yes  3 yearsABCEnergy  1,000  0%    AAA     208.3  20    yes    NATransPower   1,000  10%   AA    1092.0  20    yes  5 yearsTelcoUtilities1,000 11%   AA     1,206.4 30    no  5 years`Questions:1) How should Jill go about explaining the relationship between coupon rates and prices? Why do the coupon rates for the various bonds vary so much?2) How are the ratings of these bonds determined? What happens when the bond rating get adjusted downwards?3) During the presentation one of the clients is puzzled why some bonds sell for less than their face value while others sell for a premium. She asks whether the discount bonds are a bargain? How should Jill respond?4) What does the term “yield to maturity” mean and how is it to be calculated?5) What is the difference between the “nominal” and effective yields to maturity for each bond listed in table 1? Which one should the investor use when deciding between corporate bonds and other securities of similar risk? Please explain.6) Jill Knows that the call period and its implications will be of particular concern to the audience. How should she go about explaining the effects of the call provision on bond risk and return potential.7)what does the term ‘yield of maturity” mean and how is it to be caculated?

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