Chapter 11, Problem 4CP

Summary Introduction

(a)

To Discuss:

1. Recommend purchase of either Aaa or Aa bonds for a one year investment horizon given a goal of maximizing expected returns.

The following table represents data relating to corporate/government spread relationship (in basis points,bp) at the given date:

CURRENT AND EXPECTED SPREADS AND DURATIONS OF HIGH-GRADE CORPORATE BONDS(ONE YEAR HORIZON)

Bond Rating	Initial spread over Governments	Expected Horizon spread	Initial Duration	Expected Duration One year from Now
Aaa	31bp	31bp	4 years	3.1 years
Aa	40bp	50bp	4 years	3.1 years

Introduction:

A bond is a security that creates an obligation on the issuer to make a specified payment to the holder for a specified time. The face value of the bond is the amount the holder will receive on maturity along with the coupon rate which is also known as the interest rate of the bond. Yield to maturity is defined as the discount rate that makes the present payments from the bond equal to its price, in simple terms it is the average rate of return a holder can expect from a bond. A corporate bond is a bond issued to raise finance by a corporation for reasons such as for ongoing operations, Mergers &Acquisitions or to expand business. A government bond is a bond issued by a national government in which generally periodic interest payments are made and the face value on the maturity date is repaid. It is also called sovereign bond.

Summary Introduction

(b)

To Discuss:

(b) Ames chooses not to rely solely on initial spread relationships. His analytical framework considers a full range of other key variables likely to impact realized incremental returns, including call provisions and potential changes in interest rates. Describe other variables that Ames should include in his analysis and explain how each of these could cause realized incremental returns to differ from those indicated by initial spread relationships.

The following table represents data relating to corporate/government spread relationship (in basis points, bp) at a given date:

CURRENT AND EXPECTED SPREADS AND DURATIONS OF HIGH-GRADE CORPORATE BONDS (ONE YEAR HORIZON)

Bond Rating	Initial spread over Governments	Expected Horizon spread	Initial Duration	Expected Duration One year from Now
Aaa	31bp	31bp	4 years	3.1 years
Aa	40bp	50bp	4 years	3.1 years

Introduction:

A bond is a security that creates an obligation on the issuer to make a specified payment to the holder for a specified time. The face value of the bond is the amount the holder will receive on maturity along with the coupon rate which is also known as the interest rate of the bond. Yield to maturity is defined as the discount rate that makes the present payments from the bond equal to its price, in simple terms it is the average rate of return a holder can expect from a bond. A corporate bond is a bond issued to raise finance by a corporation for reasons such as for ongoing operations, Mergers &Acquisitions or to expand business. A government bond is a bond issued by a national government in which generally periodic interest payments are made and the face value on the maturity date is repaid. It is also called sovereign bond. Basis points, otherwise known as bps are a unit of measure used to describe the percentage change in the value or rate of a financial instrument.