Bond valuations and yields: What do they mean, and how do you derive their value
ID: 2618548 • 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 pointsExplanation / Answer
Annual cost of funds = 0.7% = 70 basis points
Annual yield if they were sold at 100.10 is given by =rate(nper,pmt,pv,fv)*2 in excel =rate(3*2,0.7/2,-100.10,100) *2 = 0.6663% (We multiply the result by 2 becauase the bond has semi-annual payments)
The spread is (by looking at the graph) = 0.79-0.19 = 0.6 = 60 basis points
Becuase the coupon rate is higher than the yield required by the market, the bond is sold at a premium at the time of issue.
If the new yield yield is 1.3%, the bond will trade at a discount. The price of the bond = PV(rate,nper,pmt,fv) =PV(0.013/2,3*2, 0.7/2,100) = $98.24
If the coupon rate is less than the yield required by the market, the price of the bond is most likely to be below the par value and the bond will sell at a discount
As the interest rates increase, the yield required by the market will increase, and the price of the bond will decrease. When the yield rises to 1.3%, the price of the bond will decrease by 1.86% (100.1-98.24)/100.1
Yield to call =rate(1*2,0.7/2,-98.24,100)*2 = 2.49% (Option C)
The company will call the bond when the interest rates fall (Option B)
When the interest rates rise, the bonds' value in the fixed-income asset class in the portfolio will most likely decrease; but if the market interest rates fall, the value of the binds in the portfolio will increase