Reference no: EM132565693

You are the financial manager of PQR Company's pension fund. Over 80% of the fund is invested in fixed rate long-term bonds and the remaining is invested in other investments including common stock and preferred stock of other companies. Interest rates are expected to be quite volatile for the next few years. It is now January 1, 2019 and you are now reviewing strategy regarding the fund and also considering new investment in the bond issued by the Hong Kong Airport Authority.

The Hong Kong Airport authority issued a series of 4.0 percent coupon 30-year bonds in January 2003. The par value of each bond is $1,000. Interest rate decrease substantially in the years following the issue, and as they did, the price of the bonds increased. In January 2019, 16 years later, the price of the bonds had increased from $1,000 to $1,242.15. Assume the bond pay coupon annually.

Required:

Question a. What are price risk (interest rate risk) and reinvestment risk? How might these two risks affect the investment strategy on fixed rate long-term bonds?

Question b. Each bond originally sold at par value. What was the yield to maturity of these bonds when they are issued?

Question c. Calculate the yield to maturity in January 2019.

Question d. Assume that interest rates stabilized at the 2019 level and stayed there for the remainder of the life of the bonds. What would be the bond's price in January 2030, when they had 3 years remaining to maturity?

Question e. In 2019, the bond was classified as "premium bonds". What happens to the price of a premium bond as it approaches maturity?

Question f. The coupon interest payment divided by the market price of a bond is called the bond's current yield. Calculate the current yields and capital gains yields of the bond (1) in January 2019 and (2) in January 2030?

Question g. Why is a call provision advantageous to a bond issuer? When would the issuer be likely to initiate a refunding call? Explain.