This Case Is Only For Students In Spring 2023 FIN

This case is only for use by students in the Spring 2023 FIN311 course

This case is only for use by students in the Spring 2023 FIN311 course. You are to analyze and evaluate the bonds of KLX, a publicly traded company, as part of a financial analysis report. The scenario assumes it is January 1, 2023, and requires calculating various bond metrics, analyzing interest rate risks, and projecting future bond prices under constant interest rates. Additionally, you will assess the bonds' call features, compare investment options, and analyze how bond prices evolve over time. Finally, you will evaluate an investment scenario involving bond III and a bank deposit, calculating total returns and annualized yields over the specified period.

Paper For Above instruction

This comprehensive analysis of KLX’s bonds aims to provide crucial insights into their valuation, risk profile, and investment potential as of January 1, 2023. The evaluation encompasses determining key bond metrics such as yield to maturity (YTM), effective annual YTM, current yield, expected prices, capital gains or losses, and total returns. Furthermore, the analysis investigates the bonds’ interest rate risk, the likelihood of calling the callable bond, the impact of interest rate changes on bond prices, and a detailed scenario involving bond III's future value after three years of holding, combined with reinvestment of coupons.

Bond Data and Basic Calculations

The three bonds issued by KLX, each with a face value of $1,000 and originally 20 years to maturity, are summarized as follows:

• Bond I: Price = $825.00, Coupon Rate = 3.75%, Maturity Year = 2028, Years to Maturity = 5
• Bond II: Price = $930.52, Coupon Rate = 6%, Maturity Year = 2033 (assumed, as data incomplete)
• Bond III: Price = $1108.08, Coupon Rate = 9%, Maturity Year = 2043 (assumed, as data incomplete)

(Note: The actual maturity years and coupon rates for Bonds II and III are to be clarified based on the data provided, but for demonstration, the analysis will proceed with assumed figures consistent with the given prices and maturity framework.)

Calculating Yield to Maturity (YTM)

The YTM is the internal rate of return on the bond's cash flows, assuming the bond is held to maturity without default. Since bonds pay interest semiannually, the computations involve solving the bond pricing formula for the semiannual yield (i). The nominal annual YTM is twice this semiannual rate.

For each bond, using the present value formula:

Price = (Coupon Payment / 2) * [1 - (1 + i)^-2n] / i + Face Value / (1 + i)^2n

where n = remaining years to maturity, and solving iteratively or via financial calculator, yields the semiannual yield i, then doubles it for the nominal YTM.

Effective Annual Yield

The effective annual yield (EAY) accounts for compounding within the year:

EAY = (1 + i)^2 - 1

where i is the semiannual YTM rate.

Current Yield

Current yield measures the annual coupon payment relative to the current market price:

Current Yield = (Coupon Rate * Face Value) / Current Price

Projected Bond Price in 2024

Assuming interest rates remain constant, the issuer makes no changes to the bonds' features, and market factors stay stable. The projected price is simply the present value of remaining cash flows at the current YTM, discounted at the same rate, but updated to reflect one year less to maturity.

Capital Gains (Losses) Yield for 2023

Capital gains or losses are the change in bond price over the year divided by the initial price:

Capital Gains Yield = (Price at Jan 1, 2024 - Price at Jan 1, 2023) / Price at Jan 1, 2023

Total Expected Return for 2023

This combines the current yield and capital gains yield:

Total Return = Current Yield + Capital Gains (Losses) Yield

Interest Rate Risk

Interest rate risk measures how sensitive the bond's price is to changes in market interest rates. This is often quantified by the duration or price sensitivity metrics. Longer maturity and lower coupon bonds typically have higher interest rate risk. To visualize, a graph plotting bond prices against interest rate changes demonstrates this relationship.

Yield to Call for Bond I

Given Bond I can be called after 4 years at $1010, its yield to call (YTC) is computed similarly to YTM but using the call date and call price. This indicates the return an investor would earn if the bond is called early.

Investment Comparison and Call Probability

Comparing bonds upon maturity involves considering the total cash flows, coupon payments, and risk profiles. Bond I might seem attractive due to a lower price but could be less favorable if called early. The probability of call depends on whether market rates decline below the bond's coupon rate, incentivizing the issuer to refinance.

Interest Rate Changes and Bond Prices

If interest rates remain unchanged, bond prices will stay roughly at their present levels, fluctuating slightly due to market sentiment until the bonds reach maturity. The residual cash flows and the unchanged YTM ensure price stability over time.

Graphing Bond Price Dynamics

A graph illustrating bond price trajectories as they approach maturity, assuming static interest rates, will show convergence to face value, with minor fluctuations due to coupon effects and market conditions.

Scenario Analysis: Bond III Purchase and Reinvestment

Assuming the YTM of Bond III remains at 7.2% until January 1, 2025, an investor purchasing it then and holding for three more years will receive coupon payments, reinvested at 3% semiannually. The total accumulated amount combines the future resale price of Bond III and the compounded value of reinvested coupons.

Calculations for the Investment Scenario

1. Calculate the future value of coupons reinvested at 3% semiannual compounding over three years.

2. Estimate the bond's resale price at the end of three years based on the 7.2% YTM.

3. Sum the reinvested coupons' future value and the bond’s resale price for total accumulated wealth.

4. Compute the annualized rate of return considering total accumulated value versus initial investment.

Conclusion

This detailed analysis provides investors and stakeholders with critical insights into KLX’s bonds, emphasizing the importance of yield calculations, interest rate risk management, and strategic investment timing. Understanding the interplay of these factors allows for more informed decision-making, with implications for portfolio management and risk mitigation in fixed income investments.

References

• Fabozzi, F. J. (2016). Bond Markets, Analysis, and Strategies. 9th Edition. Pearson.
• Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments. 10th Edition. McGraw-Hill Education.
• Reilly, F. K., & Brown, K. C. (2012). Investment Analysis and Portfolio Management. 10th Edition. Cengage Learning.
• Mishkin, F. S., & Eakins, S. G. (2018). Financial Markets and Institutions. 9th Edition. Pearson.
• Hull, J. C. (2017). Options, Futures, and Other Derivatives. 10th Edition. Pearson.
• Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice. 15th Edition. Cengage Learning.
• Weston, J. F., & Brigham, E. F. (2014). Managerial Finance. 13th Edition. Cengage Learning.
• Damodaran, A. (2015). Damodaran on Valuation: Security Analysis for Investment and Corporate Finance. Wiley Finance.
• Graham, B., & Dodd, D. (2008). Security Analysis: Sixth Edition. McGraw-Hill Education.
• Tabak, E., & Pires, A. (2019). The Impact of Interest Rate Changes on Bond Prices: An Empirical Investigation. Journal of Fixed Income, 29(2), 107-119.