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FIN4002-Fixed Income Securities

Question

Answered

Assignment

Case Background

Ah Lee, a financial manager at a US based mid-sized manufacturing firm, has been caught off-guard before. To earn the most on excess cash, Ah Lee once bought five-year coupon Treasury bonds (a maturity longer than the firm’s liabilities) only to see interest rates rise. The loss when the Treasury bonds were sold did not make Ah Lee’s supervisor, Carlo, Chief Financial Officer, very happy. 

Ah Lee is now in a similar situation - Carlo has asked for a recommendation on the investment of another $10 million in excess cash. 

Case Task

"Carlo will accept a recommendation different than his own only if it is justified by analysis," advises Ah Cheung. "Well-reasoned analysis is an opportunity to gain back some of Carlo’ trust, which was lost after your last bond investment." Ah Cheung also adds, “If you follow Carol’s view, he also wants to see the reasons behind your agreement.” 

Ah Lee’s problem is to recommend the best investment strategy among the four different US Treasury bonds. The $10 million investment will be liquidated in three years to help repay a bank loan charging a fixed rate interest at 8.50% per year. The bonds, each with a $1,000 par value and annual convention, are described as following: 

Case Questions 

Q1. Would Ah Lee go by Carol’s view on interest rate remain unchanged for the next 3 years? Why or why not?

Q2. Risk and Return analysis

(i) Analyse the durations of the 4 bonds. (you need to show details of your calculation) 

(ii) Explain why duration matters in the analysis.  

(i) Perform RCY analysis on the 4 bonds. (you need to show details of your calculation) 

FIN4002-Fixed Income Securities

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