Bus 379 Week 3 Course Project Part 1

...

Task 3: Bond Evaluation

AirJet Best Parts, Inc. would like to issue 20-year bonds to obtain remaining funds for the new Mexico plant. The company currently has 7.5% semiannual coupon bonds in the market that sell for $1,062 and mature in 20 years.

- What coupon rate should AirJet Best Parts set on its new bonds to sell them at par value? (10 pts)

6.92%

- What is the difference between the coupon rate and the YTM of bonds? (10 pts)

A coupon rate is a fixed rate that is based on projections of what the coupon payment will be. The yield to maturity rate is a determination of what the worth of the bond will be, as its value fluctuates over time.

- What factors will contribute to the riskiness of these bonds? Explain in detail your rationale. (20 pts)

With the YTM bonds there is always a massive risk of deflation or of a company never making the profits they’ve projected at the time the bond was issued. Fixed rate bonds also share a bit of risk in the form of a default risk causing the bond to lose its value if the company has to default during the running value of the bond.

- What type of positive and negative covenants may AirJet Best Parts, Inc. use in future bond issues? (10 pts)

Positive covenants would reduce the coupon rate, forcing a bank to take actions that would assure the value of the bond stays consistent; this protects the value but also limits what a company can decide to do with its investments and resources.

Negative covenants would also reduce the coupon rate and force a company to take more protective actions, but only in the backing of financial worth of the bond, allowing a more diverse selection of choices concerning core aspects of the business. This, however, also keeps the company from increasing dividends beyond a certain level or allowing bonds of the same worth to be issued to investors that come in later, regardless of how well they’re doing.