Case 14: AMR - American Airlines

Valuation: Valuing a Corporate Bond Issue

Questions

1. Ignoring floatation costs, what will the bonds sell for today if American decides to issue
the bonds with a maturity of 10 years? What will the price be if the bonds have a maturity
of 20 years? 30 years?

We should calculate here the price of the bond and for this we need this formula:

I will
explain
I now all
B 0 = ( PVIFA k ,2 n ¿( PVIFk d/2 ,2 n ¿ the
2 d /2

elements from this formula:

B0=value of the bond at time zero
I=annual bond coupon payment
I/2=semi-annual bond coupon payment
PVIFAkd/2,2n=present value of the coupon payments
M=par value of bond
PVIFkd/2,2n=present value of par which will be received by the bondholder when the bond
matures
Now I can substitute our numbers into the equation:
B0=$100/2x12.642+$1,000x0.377=$632.10+$377=$999.10$1,000
Numbers can be different but using the calculator we will get the same answer as here, even
exactly $1000.
Also after the increase of maturity from 20 to 30, answer will stay the same - $1000.

2. If the bonds are issued with 10 years to maturity and the day after they are issued, the
market interest rates increase to 12%, what will be the price of American Airline's bonds?
What if interest rates drop to 8%?
3. If the bonds are issued with 20 years to maturity and the day after they are issued, the
market interest rates increase to 12%, what will be the price of American Airline's bonds?
What if interest rates drop to 8%?
4. If the bonds are issued with 30 years to maturity and the day after they are issued, the
market interest rates increase to 12%, what will be the price of American Airline's bonds?
What if interest rates drop to 8%?
To understand more deeply the answer on the questions number 2, 3 and 4, it will be better to
look on them in a table which I will show you know. Important to note and know here that
calculations are exactly the same as they were in the question number 1.

Interest rates
Maturit 8% 10% 12%
y
10 years $1,135.90 $1,000 $885.30
20 years $1,197.93 $1,000 $849.54
30 years $1,226.23 $1,000 $838.39

5. Based on your answers to questions 2 through 4, what is the relationship between time to
maturity and the price of the bond?

How we see, the time to maturity can increase and from here we can conclude that the sensitivity
of a bond's price to changes in interest rates increases. It is not actually the time to maturity that
is driving the bond's sensitivity. It is the bond's duration. The longer a bond's duration, the more
sensitive its price will be to changes in interest rates.

6. Based on your answer to question 1, what is the relationship between current interest
rates, the coupon rate, and time to maturity?

If in the current market interest rate equals to the coupon rate, bonds in such case always will be
sold at par. And in such case the time to maturity will have nothing to do with the price of the
bond.