3b) Bonds are subjected to risks such as default risk, interest risk and liquidity risk.

Default
risk refers to the risk investors face of not being able to receive the coupon payments or his
matured value. Interest rate risk is the risk of falling interest rates after having bought a bond
at a high interest rate. Liquidity risks are the inability to sell off the bonds at a fair value
(Saunders & Cornett, 2015). With these risks inherent in the bonds, it is difficult for firms to
raise investments as investors would be unwilling to purchase without a form of guarantee.

Bond ratings guide the investors to choose which firm they wish to invest wisely. Companies
such as Fitch, Standard & Poor’s and Moody’s rate bonds of companies to help the investors
make calculated risks when investing. Conventionally, bonds are rated from A to D. Within
each band, there are different strata – AAA, AA+, AA, AA-, A+ etc. These ratings descend
with the credibility of the issuers. Band A bonds are of higher quality and holds the least risks
amongst all the other bands. Band B suggests that the bonds are of quality however there are
some risks that the investors may have to bear. Band C and D bonds are bonds that bear the
most risks and investors would refrain from investing in bonds in this band (Saunders &
Cornett, 2015).

A change in bond rating suggests a change in the firm’s financial status. An upgrade would
mean that the firm is improving financially and they are abler to make the coupons payments.
This would lead to an increase in investors who are willing to purchase their bonds. On the
other hand, a downgrade would mean that the firm is facing some financial issues and that they
would face difficulties paying out their coupon payments (Kenny, 2017). This means that the
investors would be more vulnerable to the default risk. As such investors must evaluate their
willingness and capabilities to bear the possible risks or sell their bonds away. As such, bond
ratings are necessary for both the investors and the issuers.

3h) Commercial papers are short term notes issued by firms to raise cash to fund the firm’s
working capital. Commercial papers are unsecured (Saunders & Cornett, 2015). This means
that investors are subjected to the risks of not receiving the payments. Therefore, firms that
issue commercial papers would need a good credit rating for them to attract investors. One
reason commercial papers may not be as popular in Singapore’s money market is because firms
may find the process of credit rating to be tedious and costly. Therefore, they would seek
alternate forms of funding such as bank loans. As such, the firms would be able to save on the
rating costs. Credit rating also acts as a double edge sword. Low rating would put the firm in a
negative light. This would lead to investors would be more vulnerable to the default risk. As
such investors must evaluate their willingness and capabilities to bear the possible risks or sell
their bonds away. As such, bond ratings are necessary for both the investors and the issuers.

1
1−
(1+𝑟)𝑡 𝐹
3f) Bond value = 𝐶 ( ) + (1+𝑟)𝑡
𝑟

1
1−
(1+0.028)8 $50,000,000
$50,000,000 = (3%)(𝑃𝑎𝑦𝑚𝑒𝑛𝑡) ( )+
0.028 (1+0.028)8

$50,000,000
$50,000,000−
(1+0.028)8
(3%)(𝑃𝑎𝑦𝑚𝑒𝑛𝑡) = 1
1−
(1+0.028)8
( 0.028
)

0.03(𝑃𝑎𝑦𝑚𝑒𝑛𝑡) = $1,400,000
Payment = $1,400,000 ÷ 0.03
= $46,666,666.67
≈ $46,666,667
This price is the present value of the $50 million dollar I will receive once this bond matures.

𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒−𝑃𝑟𝑖𝑐𝑒 360

3g) 𝐵𝑜𝑛𝑑 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡 𝑦𝑖𝑒𝑙𝑑𝑠 = ( )×( )
𝑃𝑟𝑖𝑐𝑒 𝑛
$50,000,000−$46,666,666.67 360
ibey = ( ) × (360×8)
$46,666,666.67
$50,000,000−$46,666,666.67 360
ibey = ( ) × (360×8)
$46,666,666.67

= 0.008929

ibey 360/𝑛
Effective Annual Rate (EAR) = (1 + 360/𝑛) −1

0.008929 360/(360×8)
Effective Annual Rate (EAR) = (1 + 360/(360×8)) −1

EAR =0.00866180
= 0.866%
When this bond matures I will receive $50 million and the effective annual rate is 0.866%
which is lower than the quoted rate of 2.8%