Jagdambay Manufacturing and Bond Evaluation

Case Study
Part I
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.
What is the bond’s price today if market rate is 5%? Show your computations
The issuance of bonds is done with a fixed par value and the dividends paid out to preferred stockholders is done on the basis of a percentage of that par value at a fixed rate. The present day bond price is calculated as follows:
Bond Price = c / (1 + i) + c / (1 + i)2 + …+ c / (1 + i)n + M / (1 + i)n
In this case,
C is the coupon payment = $200,000
I is the interest rate = 5 percent
M is the value at maturity = 4 percent
n is the number of payments = 5 (Investopedia, n.d)
Therefore,
Bond Price = 5% × $200,000 × (1 – (1 + 4%)-5) / 4% + $200,000 / (1 + 4%)5
= 0.05 × $200,000 × 4.4518 + 164,385.42
= $44,518 + $164,385.42
= $208,903.41
Part II
1. 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?
I would choose to make an investment in the bond for Woodside Petroleum Ltd. As part of my investment portfolio. This is for the reason that this particular investment is the most ideal manner of gaining insight into the fast-paced growth of Australia as an international LPG producer. In particular, the product is facing a great deal of demand, especially emanating from the Asian expanses. If Woodside advances and progresses efficaciously with all of its projects, it is expected to generate approximately over 20 million tonnes of LPG every financial year at the turn of the decade. The organization has a great deal of resources and its prevailing trading is done on a price-earnings that is roughly 25 times whereas that of the market at large stands at 12 times. Moreover, Woodside has had great performances and experienced a great deal of success in the preceding financial periods, which makes the bond attractive. Moreover, there has been an incessant increase in the dividend per share of the company. The inference of this is that the corporation purposes to maximize the shareholders’ wealth. It is also imperative to note that the sales revenue generated by the company has been rising in the preceding financial years, which is an indication that the company has a good financial performance and has a great likelihood to have similar or better performances in the forthcoming financial years. Therefore, taking into consideration the financial history as well as its performance in the stock market, it is definitely sensible to invest in the bond (Woodside, 2009).
The main strategy that I would pursue is the laddering strategy. This strategy is selected with the main purpose of portfolio diversification, decrease in price volatility, in addition to spreading out the level of risk in the investment in a variety of prospective interest rate settings. In addition, this strategy is deemed feasible for the reason that it will enhance the general earnings and returns generated from the investment by spreading the maturities of bonds over numerous years (Investopedia, n.d).
2. Based on your analysis and findings, would you recommend the Woodside Petroleum Ltd.’s bonds to other investors? Please explain your reasoning
On the basis of my analysis and findings, I would definitely recommend the Woodside Petroleum Ltd.’s bonds to other investors for investors. The corporation holds an international presence and is deemed to have cutting edge proficiencies and competencies as the oil and gas producer, developer and also retailer. In the recent number of years, Woodside Petroleum has had the capability of raising substantial amounts of money in a short amount of time. This is also impressive taking into consideration that it has been dealing with major projects like Sunshine and Pluto, which necessitate huge capital. Nonetheless, this has given rise to hesitations and qualms regarding the prevailing cash flow of the company, with the fear that there might be a shortage in cash flows for undertaking such projects. However, the financial performance of the company in the past number of years does not give any indications of a shortcoming or problems in the financial cash flows for meeting its short-term obligations. In addition, the company is constantly endeavoring to increase its portfolio through acquisition and at the same time being careful enough to ascertain that there is a maintained rise in the value of the shareholder. Therefore, the risks being faced are well maintained. Notably, with regard to performances, metrics such as return on equity, dividend per share and also annual sales revenue have increased in the past number of financial periods. Therefore, this indicates that the Woodside Petroleum Ltd.’s bonds are a good investment prospect and therefore are recommended.
3. 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
The present day bond price is calculated as follows:
Bond Price = c / (1 + i) + c / (1 + i)2 + …+ c / (1 + i)n + M / (1 + i)n
In this case,
C is the coupon payment
I is the interest rate
M is the value at maturity
n is the number of payments
In this regard, there are two different bonds. One of them consists 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 following spreadsheet indicates the calculation of the present day bond price:
i. $400 million bond
Maturity (Years)
5

Coupon Rate
8.13%

Coupon PMT
$80,000,000

Par Value
$400,000,000

Yield to Maturity
6%

Present Value
($635,892,371.99)



Therefore, according to the calculations above, the present value of this particular bond is set at $635,892.371.89
ii. $600 million bond
Maturity (Years)
10

Coupon Rate
8.75%

Coupon PMT
$60,000,000.00

Par Value
$600,000,000

Yield to Maturity
6%

Present Value
($776,642,089.23)



Therefore, according to the calculations above, the present value of this particular bond is set at $776,642,089.23.
4. Are the Woodside Petroleum Ltd.’s bond overvalued or undervalued? Choose a current date and show your computations
To ascertain whether a bond is overvalued or undervalued, it is imperative to take into consideration the market values of the bond, and make comparisons against the calculations of the bond prices. Notably, if the market price of the bond is below the calculated price, then the bond is deemed to be overvalued. On the other hand, if the market price of the bond is higher than then computed price, then the bond is deemed to be undervalued. In accordance to the markets, the values of the calculated prices are greater in comparison to those in the prevailing markets. As a result, it is considered that the bond is deemed to be overvalued.
5. Does the fluctuation in interest rates impact bond prices? How?
The change in interest rates does have an impact on the bond prices. There is an inverse correlation between the bond prices and interest rates. Therefore, this implies that the price of a bond would increase of the current interest rates were to decline. On the other hand, if there would be an increase in the rates of interest, there would be a decline in the price of a bond. One of the fitting ways of explaining how such fluctuations impact bond prices is to make use of bonds with zero-coupon, which do not play any coupons but rather develop their value via the variance between the buying price of the bond and the value that is paid at maturity.
For example, if a zero-coupon bond is trading at $900 and also has an average value of $1000 with a maturity period of one year, the prevailing rate of return of the bond is calculated as: (1000 – 900) / 900 = 11.11 percent.
This implies that in order to an investor to pay $900 for the bond, it is imperative to be satisfied and content with a return of 11.11 percent. Nonetheless, this is also reliant on the changes within the bond marketplace. In particular, akin to all other kinds of investors, bond investors endeavor to obtain the best and highest return conceivable, If prevailing rates of interest increase, providing newly issues bonds a profit of 15 percent, then it means that the bond with zero-coupon initially discussed yielding 11.11 percent would cease to be appealing and therefore would experience decreased demand from investors (Investopedia, 2017).










References
Investopedia.com (n.d.). Bond basics. Retrieved from: http://www.investopedia.com/university/bonds/
Investopdia. (n.d.). Bond Laddering. Retrieved from: https://www.investopedia.com/terms/b/bondladdering.asp
Woodside. (2009). Woodside to Issue $US 1 Billion in Corporate Bonds. Retrieved from: http://www.woodside.com.au/Investors-Media/Announcements/Documents/25.02.2009%20Woodside%20to%20Issue%20US$1%20Billion%20in%20Corporate%20Bonds.pdf
Investopedia. (2017). Why do interest rates tend to have an inverse relationship with bond prices? Retrieved from: https://www.investopedia.com/ask/answers/04/031904.asp