Background of the Case
Bonds are loans between investors and corporations. Companies issue bonds in order to raise money for ensuring interest payments in exchange (Bond Issuers). The maturity date is the day when a company is obligated to repay its investor the bond (Bond Issuers) fully. In this case, the company Butchery Withoutbones issued the bond with an amount of €125 million, issue price that equals 99.731%, and maturity that equals 7 years (Vernimmen et al., 2014, p. 367). The annual coupon is 5.5% that implies that the investor should receive 5.5% of his investment in interest payments each year. It is possible to discuss the yield to maturity of the bond, its duration, its modified duration and compare the results obtained to the outcomes of the 5% yield to maturity on bonds.
Discussion of the Case
Yield to maturity of the bond on the issue is often referred to as the overall interest rate earned by an investor who bought the bond and held it until maturity. Yield to maturity calculated with consideration of coupon value, face value, price, and the years to maturity equals 5.547% in this case (Bond Yield and Return; Vernimmen et al., 2014, p. 368). Modified duration is the response to a change in the value of a security. It is well-known that values tend to decrease with a flow of time, which is considered by calculating discounted cash flows and using the modified values in the formulas. Thus, the present value (PV) reflecting the mentioned change equals 99.733% instead of 100%. Therefore, the duration of the cash-weighted term to maturity of the bond equals 6 years, while the modified one that includes in the calculations yield to maturity (which is different from the coupon value) equals 5.68 years.
On 21 February 2015 the required yield to maturity was 5% instead of 5.5% compared to the previous situation. Including the changed value in the calculation of PV, the result 102.5% is obtained. However, this value is not realistic as it implies that the assets have more value 6 years later than they had before. With lowering of the coupon value, both the duration and modified duration have changed and are 5.281 and 5.029, respectively.
References
Bond Issuers. (n.d.). Web.
Bond Yield and Return. (n.d.). Web.
Vernimmen, P., Quiry, P., Dallocchio, M., & Le Fur, Y. (2014). Corporate Finance: Theory and Practice (5th ed.). John Wiley & Sons, Incorporated