Week 4 Problems

FIN/402

Case Problem 10.1 A-E (page 422)

A. Since the Shuman family should follow open a long term, diversified portfolio with moderate risk with a passive approach. Since the family is not dependent on the money, and have chosen to use some of the inheritance upfront, they can benefit from some of the riskier bonds that have longer terms.

B.Treasury, agency, and zero-coupon bonds would be the safe choices in the portfolio that will generate lower yields. Corporate bonds both low and high-yield (junk bonds) have high growth potential. Foreign bonds would not have the same economic exposure as domestic bond and bring more diversification.

C.

Treasury bond (5%)- $9,743

Agency bond – $38,805

Zero-coupon bond- 34,840

Corporate (high-quality)- 77,626

Corporate (low-quality)- 29,100

Foreign bond (5%)- 9,674

D.Par values= $1000

E.The key investment attributes would capital preservation and growth through capital gains. The more secure bonds will maintain the capital and the riskier bonds will provide potential growth. The zero-coupon bond income will be redeemed at maturity. Most of the funds can be invested for the Shuman’s target of 20 years.

Case Problem 10.2 A-C (page 423)

A.Companies 2, 3, and 6 carry the investment-grade rating where companies 1,4 and 5 are the junk bonds. Companies 2, 3, and 6 have a higher net profit margin, return on capital, cash flow to debt and lower long term debt to capital. These companies exhibit the qualities of strong financial strength.

B.Company 3 is AAA-rated and company 4 is B-rated. Im terms of ratios, company 3 shows the leads highest in all the ratios except long-term debt to total capital. It has the lowest long term debt which is good. Company 4 is the polar opposite.

C.Company 6 is AA rated and company 2 is A rated. Companies 1 & 5 are BB rated investment bonds.

Case Problem 11.1 A-B (page 463)

A.

Trading on forecasted interest rate behavior.

852.*.09= 76.6876.68/.08= $958.50

8.365

Marlene should purchase the bond. The conditions of the bonds seem to be lucrative if they plan not to sell the bond until it matures. Since the yield may drop, it can be harder to sell the bond if the capital is needed.

B.

Beta Corp= 8.92% / 816.56

Dental Floss= 9.62%. / 807.81

Root Canal= 7.35% / 912.09

KC Dental Ins= 8.42% / 959.83

The Dental Floss and KC Dental Insurance companies offer a higher current income for the Carters. The Dental Floss company has a higher current yield.

If the Carter’s are looking for more current income, the KC Dental Insurance company would offer the highest amount of income.

Case Problem 11.2 A-F (page 464)

A.

1. 8.38 / 8.96%

2. 0 / 9.45%

3. 9.26 / 8.77%

4. 9.44 / 9.5%

B.

8.07 / 7.40 / -5.55

10 / 9.14 / -6.85

6.89 / 6.33 / -4.75

8.62/ 7.87/ -5.90

C.

The weighted duration is 8.4 years and the horizon is 7 years which tells us the the portfolio is not immunized.

D.

The zero-coupon bond has the highest duration and would lengthen her portfolio duration by investing most of the funds into these bonds. The 10%, 10-year bond has the shortest duration and Grace would shorten her portfolio duration by heavily investing into these bonds.

E.

In order to cash out the bonds within Grace’s goal of 7 years her portfolio would need to be weighted to that time frame. In order to immunize her portfolio from interest rate risk, I would invest everything into the 10year, 10% bond.

F.

Interest rate risk is inevitable. Her plan is not to hold any of the bonds to maturity but to use the money for a home.