Investment Bonds/Fixed Income Investments

Investment Bonds/Fixed Income Investments

Part I:

Bond valuation is an important aspect of investment strategies for fixed income securities. To value a security, we discount its expected cash flows by appropriate discount rate.

Suppose Jagdambay manufacturing sells a bond paying a coupon rate of 5% per year with par value (face value) of $200,000 when the market rate is only 4% per year. The bond has 5 years until maturity.
•Based on the above information, please calculate bond's price today.

VB = C1 / (1+r)1 + C2 / (1+r)2 + ... + C5 / (1+r)N + P / (1+r)N

VB = Value of bond

C = Coupon payment (Par value x Coupon rate)

r = Discount rate (The bond's required rate of return)

N = Number of years before the bond matures

P = Par value of the bond


Part I Question
•What is the bond's price today if market rate is 5%? Show your computations.

Part II:

For the purposes of this exercise, assume that you are the manager of a mutual fund specializing in corporate bonds. Your clientele are mostly 45 and older, risk-averse, long-term investors. Remember that there are countless mutual funds your investors can turn to; unless you continuously produce higher returns than other funds without incurring serious risks, your investors will turn elsewhere. Currently your fund includes a wide variety of bonds from different large corporations, but none from the oil and gas sector.

The Woodside Petroleum Ltd. (http://www.woodside.com.au/Pages/default.aspx) is Australia's largest publicly traded oil and gas exploration and production company and one of the world's leading producers of liquefied natural gas. Woodside has entered into an agreement for the issuance of US$ 1 billion in corporate bonds into the United States 144A bond market. Settlement of the offering is subject to certain customary conditions.

The bonds will be issued by Woodside Finance Limited, a wholly owned subsidiary of Woodside Petroleum Ltd, and will consist of US$400 million of 5-year bonds with a coupon of 8 1/8% and US$600 million of 10-year bonds with a coupon of 8 3/4%.

The bonds will be guaranteed by Woodside Petroleum Ltd. and its wholly owned subsidiary, Woodside Energy Ltd.

Funds raised from the issuance will be used to repay short-term debt and for general corporate purposes including capital expenditure (http://www.woodside.com.au/Investors-Media/Announcements/Documents/25.02.2009%20Woodside%20to%20Issue%20US$1%20Billion%20in%20Corporate%20Bonds.pdf).

What if you knew a good deal about the debt/bond market, but not a whole lot about the oil and gas sector and its financing mechanisms. But your investors follow the news as much or sometimes better than you do, and they're quite aware that Woodside Petroleum Ltd. is quite a large company. As it is, many of your investors are wondering why you have not included Woodside Petroleum Ltd.'s bonds as part of your mutual fund's portfolio thus far, and they're calling this to your attention (bond investors tend to have fairly substantial pots of money, a lot of time on their hands, access to the Internet, often a restless curiosity somewhat offset by a general lack of information about finance and financial markets, and an almost indefinite ability to reach you on the telephone at odd hours of day or night).

Woodside Petroleum Ltd. including their financial situation as well as their overall strengths as a corporation. Tell me something about the economic climate in which the corporation operates, its prospects for the future, and its ability to leverage funds as necessary.

•Would you choose to invest in the Woodside Petroleum Ltd.'s bond as part of your investment portfolio? Why or why not? If so, what sort of strategy would you pursue?
•Based on your analysis and findings, would you recommend the Woodside Petroleum Ltd.'s bonds to other investors? Please explain your reasoning.
•Use the current price of the Woodside Petroleum Ltd.'s bond (Use market rate of 6% for Woodside Petroleum Ltd.'s bond to calculate current price of the bond like you did part I.
•Are the Woodside Petroleum Ltd.'s bond overvalued or undervalued? Choose a current date and show computations.
•Does the fluctuation in interest rates impact bond prices? How?

Expectations

Use Excel for computations, tables and graphs. Submit the spreadsheet to show your work. Use Word to write the report and refer to analysis in the spreadsheet.

•Include the purpose of the report, analysis of the issue, and a conclusion or recommendation.
•Use headings and subheadings.
•Length: 5 to 7 pages.
•Provide citations to support your argument
• Type and double-space the paper.