FIN 534 Homework Set 2

Homework Set #2: Chapters 4 & 5
Due Week 4 and worth 100 points

Directions: Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link above.

A. You have just won the Strayer Lottery jackpot of $11,000,000. You will be paid in 26 equal annual installments beginning immediately. If you had the money now, you could invest it in an account with a quoted annual interest rate of 9% with monthly compounding of interest. What is the present value of the payments you will receive?

FV = 11,000,000

N = 26

I = 9%

PV = 11,000,000/(1+0.09)26

= 11,000,000/1.0926

= 11,000,000/9.40

PV = $1,170,212.77

B. In your own words and using various bond websites, please locate one of each of the following bond ratings: AAA, BBB, CCC, and D. Please describe the differences between the bond ratings. Identify the strengths and weaknesses of each rating.

Bond ratings are used to measure the credit quality of the various bonds. The rating is used to measure the financial strength of the company as well as its ability to repay the principal amount and pay the interest amounts by the time the bond is due. Generally, the higher the bond rating, the more favorable the terms will be and the stronger the company is seen as being able to repay their debts. AAA is seen as the highest rating possible. They have the smallest risk of defaulting, and due to such low risk, they tend to offer the lowest yields to investors. As of 2016, Johnson & Johnson and Microsoft were two examples of AAA companies. BBB bonds have adequate capacity to meet their financial commitments but are subject to more risk due to economic conditions and changing circumstances. It is also the last bond rating to be considered an investment grade bond. According to Fitch, Allegion US Holding Company Incorporated and Campbell Soup Company are BBB rated companies. CCC rating indicates that they are extremely vulnerable right now. They rely heavily on financial and economic conditions as well as favorable business to meet their commitments. A D rating is the worst possible rating and means that the bond is in default, meaning they are extremely unlikely to be able to meet their payments. Kmart and Sears are both rated as being D companies.

References

Fitch Ratings. (2018). FitchRatings. Retrieved from

https://www.fitchratings.com/site/search?content=entity&filter=DATE%20RANGE%5ELast%2030%20Days%2BMARKET%20SECTOR%5ECorporate%20Finance%2BGEOGRAPHY%5EAmericas%5ENorth%20America#page=1.

Investopedia. (2018). AAA. Retrieved from

https://www.investopedia.com/terms/a/aaa.asp.

Kenny, T. (2018). Bond Credit Ratings. Retrieved from

https://www.thebalance.com/what-are-bond-credit-ratings-417074.

The Motley Fool. (2018). What Is a Bond Rating? Retrieved from

https://www.fool.com/knowledge-center/what-is-a-bond-rating.aspx.