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Assignment 1 - Finals
Assignment 1 - Finals
San Diego
2 MKTG-2
A. Investment-grade Bond
Example 1:
1. An investor is looking to invest in a floating rate fund. His criterion is that the bonds in the
fund must majority (>50%) consist of investment-grade bonds. The fund follows the credit
rating system of S&P and shows the following credit allocation of the fund:
Does the floating rate fund satisfy the criteria of being comprised of majority investment-
grade bonds?
In the credit rating system by S&P, bonds that are rated BBB- or higher are considered
investment-grade. Therfore, the floating rate fund above shows 62% of its fund invested
in investment-grade bonds. Therefore, the floating rate fund satisfies the investor’s
criterion.
Example 2:
2. As per S&P’s investment-grade rating, the following are few rated bonds in the United
States.
As per S&P’s investment-grade rating, below are few rated bonds in the United Kingdom.
S&P uses capital letters in the order of best rating to the poorest. It follows the pattern of
AAA, AA, A, BBB, BB, B up to D. Bonds having high credit quality (AAA and AA) and medium
credit quality (A and BBB) are known as investment grade. Bonds having low credit quality
rating (BB, B, CCC, etc.) are known as junk bonds or non-investment grade.
B. Junk Bond
Example 1:
1. Tesla Inc.
Tesla Inc. (TSLA) issued a fixed-rate bond with a maturity date of March 1, 2021 and a
fixed semi-annual coupon rate of 1.25%. The debt received an S&P rating of B- in 2014
when it was issued. In October 2020, S&P upgraded its rating to BB- from B+. This is still
in junk bond rating territory. A BB rating from S&P means the rating issue is less vulnerable
to nonpayment, but still faces major uncertainties or exposure to adverse business or
economic conditions.
Also, the current price of the Tesla offering is $577 as of Oct. 2020, much higher than its
2014 $100 face value, which represents the extra yield that investors are getting above
the coupon payment. In other words, despite the BB- rating, the bond is trading at very
large premium to its face value. This is because the bonds are convertible to equity. Thus,
with shares of Tesla soaring 600% over the last twelve months ending Oct. 26, 2020, the
bonds are proving to be valuable surrogates for the equity.
Example 2:
2. Coinbase
Moody’s initiated a Ba2 junk grade on Coinbase after it announced the sale, citing an
“uncertain regulatory environment and fierce competition” for the non-investment grade
rating. While Moody’s noted Coinbase has a leading franchise in crypto, its profits are
almost entirely dependent on highly volatile cryptocurrency trading.
C. Municipal Bond
Example 1:
1. Think of a muni bond as essentially a loan from an investor to the government.
When a government entity needs to raise money to pay for a big project, it sells bonds to
interested investors. Here’s an example of how it can work:
The state decides to issue muni bonds to pay for a new highway.
Investors buy the muni bonds, which provides the government the money it needs.
The government may use funds from the highway (like tolls) or from other sources to
repay investors.
Investors receive interest (usually semiannually) plus the original investment when the
bond matures.
-Muni bonds can be issued by states, cities, countries, or other municipal entities, like a
water district.
Example 2:
2. An investor wants to invest the excess funds lying. He wants to choose one of the
investment options where the first one is a municipal bond, which is yielding him 4%,
while the second one is a corporate bond that is offering a rate of 5.50%. If he currently
falls in a tax bracket of 30%, can you please suggest to him which option suits them best?
Whether the decision changes if the investor is in the tax bracket of 10%?
Solutions
Here,
• RTf = 4%
• T = 30% or 0.3
By formula,
Here, the tax-equivalent yield of the municipal bond (5.71%) is more than the return on a
taxable bond (5.50%). Hence the investment in the muni bond is a better option.
Here,
• RTf = 4%
• T = 10% or 0.1
By formula,
Here, the tax-equivalent yield of the municipal bond (4.44%) fell short of the return on a
taxable bond (5.50%). Hence the investment in a corporate bond is suggested.
D. Foreign Bond
Example 1:
1. Matilda bond
Example 2:
2. Samurai bond