Bond valuations and yields: What do they mean, and how do you derive their value
ID: 2618104 • Letter: B
Question
Bond valuations and yields: What do they mean, and how do you derive their values? Consider the following case of investment-grade bonds issued by Procter & Gamble Co. (P&G;) in August 2011. Proctor & Gamble (NYSE: PG) I Issue Details Issue Size ($Mil) $1,000 Coupon 0.700% Maturity Date 08/15/2014 Coupon Type Fixed Callable Yes Coupon Frequency Semiannually Proctor and Gamble's total amount of debt increased from 31.9% in March 2011 to 34.2% in December 2011, mainly due to its net debt issuances to fund general corporate purposes. What was the annual cost of the funds to P&G; raised from the $1.0 billion bonds that mature in 2014? basis points.Explanation / Answer
Since, the question has multiple parts, I have answered the first seven parts. The blanks have been filled in the same order as provided in the question.
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Part 1)
The annual cost of funds is 70 (.7*100) basis point. It is the value of coupon payment the company is expected to pay on $1 billion payments on annual basis expressed in basis points.
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Part 2)
If the bonds sold at 100.10 at the time of issue, investors observed that required annual yield would be .67%.
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Explanation:
The annual yield can be calculated with the Rate function/formula of EXCEL/Financial Calculator. The function/formula for Rate is Rate(Nper,PMT,-PV,FV) where Nper = Period, PMT = Payment (here, Coupon Payment), PV = Present Value (here, Current Price of Bonds) and FV = Future Value (Face Value of Bonds).
Here, Nper = 3*2 = 6, PMT = 100*.700%*1/2 = $.35, PV = 100*100.10% = $100.10 and FV = 100
Using these values in the above function/formula for Rate, we get,
Rate (Annual Yield) = Rate(6,.35,-100.10,100)*2 = .67%
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Part 3)
Looking at the comparable U.S. Treasury Yield, these bonds were issued at a spread of 51 [(.7 - .19)*100] basis points.
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Part 4)
Because the coupon rate is greater than the yield required by the market, the bond sold at premium at the time of issue. [the answers are self explanatory in nature].
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Part 5)
If the new observed yield of the bond is 1.8%, the bond is likely to be trading at a price of $96.80.
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Explanation:
The bond price can be calculated with the use of PV (Present Value) function/formula of EXCEL/Financial Calculator. The function/formula for PV is PV(Rate,Nper,PMT,FV) where Rate = Interest Rate (here, Yield), Nper = Period, PMT = Payment (here, Coupon Payment) and FV = Future Value (here, Face Value of Bonds).
Here, Rate = 1.8%/2, Nper = 3*2 = 6, PMT = 100*.700%*1/2 = .35 and FV = $100
Using these values in the above function/formula for PV, we get,
Bond Price = PV(1.8%/2,6,.35,100) = $96.80
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Part 6)
If the current yield is higher than the coupon rate, investors would want a higher return on their investment. If the coupon rate is less than the yield required by the market, the price of the bond is most likely to be less than the par value of the bond and the bond will sell at a discount.
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Part 7)
As interest rates increase, the yield required by the market will increase, and the price of the bond is likely to decrease. Thus, when the yield increases to 1.8%, the bond's price declines by 3.30% [(100.10 - 96.80)/100.10*100].