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B C G 010 Bond Corp
B C G 010 Bond Corp
BondCorp
Answer Keys
Case Context
QUESTION TEXT
Our client, BondCorp, is a leading financial institution specialized in issuing corporate bonds to raise capital for technology companies. In simple terms,
BondCorp acts as a middleman between technology companies needing money and investors willing to lend it. They help these companies create bond and
find people to buy it. The money from selling bonds goes to the tech companies, and they pay it back with interest over time.
The success of their bond offerings depends on accurately assessing the credit risk associated with each issuer. Historically, BondCorp has relied on credit
ratings and financial statements to make these assessments. However, there's an opportunity to enhance their risk evaluation process by considering
environmental, social, and governance (ESG) criteria. To explore this possibility, they are contemplating a new initiative called Project ESG-Bond.
Project ESG-Bond aims to incorporate ESG criteria into their bond assessment process.
Under this initiative, BondCorp will offer a lower yield rate (interest rate) to new bond issuers who meet certain ESG standards and disclosure requirements.
It's important to note that BondCorp will not provide financial incentives to issuers for ESG compliance - in other words, BondCorp pays nothing to help tech
companies to implement ESG procedures in their business operation
Note:
1. Bond issuance is the process of a corporate or government borrows money by selling a papernote called “bonds”. A bond is a loan that an investor
makes to a borrower, in exchange for regular interest payments and the promise of repayment of the original loan amount on a specific date.
2. Credit risk (Default risk) refers to the possibility that a company can go bankrupt in the future
3. ESG, or Environmental, Social, and Governance criteria, are a set of factors that evaluate how a company or organization impacts the environment,
treats people, and is managed. It's a way to measure a company's broader social and ethical responsibilities beyond its financial performance.
4. Yield rate is used as the same meaning as interest rate in this case
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Case Context
EXPLANATION
It is important to take note of the key details of the case context in a scratch paper.
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Question 1 of 8
QUESTION TEXT
Assume that ESP-compliance is strictly audited and BondCorp decides to implement the project.
Note: Decrease in frequency of bond issuances means the number of bond issuances by BondCorp might go down as a result of Project ESG-Bond.
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Question 1 of 8
CORRECT ANSWER: D
EXPLANATION
The implementation of Project ESG-Bond can, even inversely, increase the frequency of bond issuance and volume of issued
B No bonds. By incorporating ESG criteria into their bond selection and management, BondCorp can attract more issuers looking to
align with ESG principles, leading to higher demand for ESG bonds.
C No Same reason as B
Project ESG-Bond aims to stimulate companies in BondCorp's portfolio to implement ESG compliances so that they can utilize
D Yes lower yield rate. This can reduce the average default rate as such companies are better managed and financially stable.
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Question 2 of 8
To determine whether Project ESG-Bond should be implemented, we need to estimate the potential change in BondCorp's annual profit.
Let's focus on one segment of bond issuers: technology companies with a BBB credit rating. Currently, BondCorp offers them bonds with an annual 5% yield
rate and $1000 par value. Project ESG-Bond would offer new bond issuers in this segment (referred to as "opt-ins") a 4% yield rate if they meet ESG criteria.
Yield rate for new bond issuers who "opt out" would remain at 5%.
Assume that
● BondCorp will bear loss at the same amount as the value of the bond issuance at par value if such company defaults.
● All the bonds issued are sold at par and matured after 1 year
● BondCorp's revenue derives only from interest payments on the bonds they issue
Note: Bonds which are sold at par are bonds have price equal to the par value paid at maturity or Price = Par value
Which five of the following factors do we need to forecast for the next year to estimate the potential change in annual profit if Project ESG-Bond were
introduced, versus if it were not?
For an example of how annual profit is calculated, see the formula (image) below
For example, if total value of corporate bond issuance: $100 million, average default rate: 2%, interest rate = 10%. Then
Annual profit = 100 * 10% - 100 * 2% = 8 (million dollar)
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Question 2 of 8
EXPLANATION (part 1 of 3)
EXPLANATION (part 2 of 3)
Step 1: To estimate the potential change in annual profit under Project ESG-Bond, we need to calculate the BondCorp’s annual profit before and
after the project is introduced
Price of Bond (1) Volume (2) Interest Rate (3) Default rate (4)
Before/Old (A) A1 A2 A3 A4
EXPLANATION (part 3 of 3)
D Yes n/a Fits within bucket B1 and B3. Because new interest revenue per bond = new interest rate (B3) * New price of bond (B1)
Fits within bucket B2. Because the new volume (B2) is = old volume (A2) + increase in the total volume of bonds issued
G Yes n/a
under Project ESG-Bond ( option G)
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Question 3 of 8
Based on the data provided below, please answer the subsequent four questions.
Total volume of corporate bonds issued if Project ESG-Bond were not introduced 500,000
Increase in the total volume of bonds issued due to the introduction of Project ESG-Bond 100,000
Default risk (averaged among opt-outs and opt-ins) under Project ESG-Bond 0.070%
1. What is the estimated annual profit next year, if Project ESG-Bond is not introduced ?
2. What is the expected loss that BondCorp must bear if Project ESG-Bond is introduced?
3. What is expected interest revenue if Project ESG-Bond is introduced?
4. What is the estimated increase in annual profit next year if Project ESG-Bond is introduced?
Assume that
● BondCorp will bear loss at the same amount as the value of the bond issuance at par value if such company defaults.
● BondCorp's revenue derives only from interest payments on the bonds they underwrite
Note:
● Bonds which are sold at par are bonds have price equal to the par value paid at maturity or Price = Par value
● Value of bond issuance = Price of bond * Volume
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Question 3 of 8
EXPLANATION (part 1 of 4)
Question 3.1. What is the estimated annual profit next year, if Project ESG-Bond is not introduced ?
Step 1: Form the formula to calculate the estimated annual profit next year, if Project ESG-Bond is not introduced
Annual profit = Interest revenue - Default loss
● Interest revenue = Value of bond issuance * Interest rate = Price of bond * Volume * Interest rate
● Default loss = Value of bond issuance * Default rate = Price of bond * Volume * Default rate
Step 2: Applying the formula to calculate estimated annual profit next year, if Project ESG-Bond is not introduced
Interest revenue = Price of bond * Volume * Interest rate = 1,000 * 500,000 * 5% = 25,000,000 ($)
Default loss = Price of bond * Volume * Default rate = 1,000 * 500,000 * 0.08% = 400,000 ($)
EXPLANATION (part 2 of 4)
Question 3.2. What is the expected loss that BondCorp must bear if Project ESG-Bond is introduced?
Step 1: Form the formula to calculate the expected loss that BondCorp must bear if Project ESG-Bond is introduced
Default loss = Value of bond issuance * Default rate = Price of bond * Volume * Default rate
Step 2: Applying the formula to calculate the expected loss that BondCorp must bear if Project ESG-Bond is introduced
Default loss = Price of bond * Volume * Default rate = 1,200 * 600,000 * 0.07% = 504,000 ($)
EXPLANATION (part 3 of 4)
Step 1: Form the formula to calculate the expected interest revenue if Project ESG-Bond is introduced
Expected interest revenue = Weighted average interest revenue per bond * Volume
● Weighted average interest revenue per bond = (Volume of opt-out * Price of opt-out bond * Opt-out interest rate + Volume of opt-in * Price of
opt-in * opt-in interest rate) / Total volume
Step 2: Applying the formula to calculate the expected interest revenue if Project ESG-Bond is introduced
Weighted average interest revenue per bond = ( 300,000 * 1,000 * 5% + 300,000 * 1,200 * 4%) / 600,000 = 49 ($)
Expected interest revenue = 49 * 600,000 = 29,400,000 ($)
EXPLANATION (part 4 of 4)
Question 3.4. What is the estimated increase in annual profit next year if Project ESG-Bond is introduced?
Step 1: Form the formula to calculate the estimated increase in annual profit next year if Project ESG-Bond is introduced
Estimated increase in annual profit= Estimated interest revenue under Project ESG-Bond - Default loss under Project ESG-Bond - Profit before
Project ESG-Bond
Step 2: Applying the formula to calculate the estimated increase in annual profit next year if Project ESG-Bond is introduced
Estimated increase in annual profit= 29,400,000 - 504,000-24,600,000 = 4,296,000 ($)
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Question 4 of 8
QUESTION TEXT
What are the likely risks that BondCorp needs to consider as it contemplates the introduction of Project ESG-Bond?
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Question 4 of 8
EXPLANATION
B is less likely to be a risk, because BondCorp is not offering lower yield rate to all issuers in their portfolio. Instead, BondCorp is
B No
incentivizing ESG compliance specifically, and issuers who meet these criteria
C is likely to be a risk, because incorporating ESG criteria into bond assessments can cause legal and compliance complexities. If
C Yes ESG compliance assessment is not transparent, consistently applied, or if it unintentionally discriminates against certain issuers,
it could result in legal challenges or regulatory issues ( i.e financial statement fraud,...)
D is less likely to be a risk, because the introduction of ESG criteria is more focused on issuer compliance and sustainability
D No factors, which may not be significantly influenced by short-term economic downturns
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Question 5 of 8
QUESTION TEXT
Which of the following outcomes may occur if higher yields are offered to those who opt out?
Select all that apply. Assume that they either stay in or decline the bond offering (i.e. not partnership with BondCorp) altogether.
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Question 5 of 8
EXPLANATION
B is correct because elasticity of demand for bond issuance is uncertain, because the volume of bond issuance contracts may
B Yes
decrease more or less proportionately with yield rate, leading to a revenue gain or loss
C is correct because elasticity of demand for bond issuance is uncertain, because the volume of bond issuance contracts may
C Yes
decrease more or less proportionately with yield rate, leading to a revenue gain or loss
D is correct because relatively lower-risk issuers will tend to leave opt-out group and join in opt-in group to gain lower yield rate,
D Yes which leads to the higher average default rate among the remaining opt-out
Note: Elasticity of demand is a concept from economics that measures how sensitive the quantity demanded of a product or service is to changes in its price. In
this case context,, it refers to the responsiveness of the quantity of bonds issued to changes in the yield rate 19
Question 6 of 8
QUESTION TEXT
How would offering higher yield rate to the opt-out group impact the absolute amount of profit generated from the opt-out group?
Select one answer only.
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Question 6 of 8
CORRECT ANSWER: C
EXPLANATION
A is too optimistic and assumes that higher yield rate will invariably lead to increased profits. However, it does not consider the
A No
situation that volume can decrease more than the increase in yield rate
B is too pessimistic and assumes that higher yield rate will invariably lead to decreased profits. Similar to A, it oversimplifies the
situation. Some issuers may still find BondCorp's offerings attractive even with higher yield rate, and their participation or
B Yes
willingness to issue bonds may not be solely determined by yield rate (i.e tech companies have received other premium services
such as insurances, financial consulting,...)
C is correct. The impact on profitability generated from the opt-out group is uncertain because the default loss will increase more
C Yes
or less than yield rate
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Question 7 of 8
QUESTION TEXT
Now, assume that for every 1% increase in yield rate for the opt-out group, the average default rate in the opt-out group increases by 0.03% and the price of
bond decreases by $200. We also assume volume does not decrease if yield rate increases.
In this case, how would offering higher yields to the opt-out group impact the absolute amount of profits generated from the opt-out group?
Select one answer only.
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Question 7 of 8
CORRECT ANSWER: B
EXPLANATION
Step 1: To estimate how much offering higher yield to the opt-out-group impact the absolute amount of profits generated from the opt-outgroup, we
formulate to calculate the profit of this group before and after the event of increasing yield
Profit = Interest revenue - Default loss = Price of bond * Volume * Interest rate - Price of bond * Volume * Default rate = Price of bond * Volume * ( Interest
rate - Default rate)
● Before the yield increase: Profit (bef) = 1000 * Volume * ( 5%-0.08%) = 49.2 * Volume
● After the yield increase: Profit (aft) = 800 * Volume * ( 6%- 0.11%) = 47.12 * Volume ( < 49.2 * Volume )
In conclusion, we should expect profits generated from the opt-out group to decrease
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Question 8 of 8
QUESTION TEXT
The CEO of BondCorp is considering whether Project ESG-Bond should also extend the lower yield to existing bond issuers who do not meet the ESG criteria.
EXPLANATION
This is an Intuition question, of the Long-Text format. To answer this question, you need to combine knowledge of business concepts and the case context.
Then concisely present your ideas based on those concepts of context
SUGGESTED OUTLINE
There could be valid arguments both for and against offering the lower yield to existing bond issuers:
On the one hand, offering the lower yield to existing bond issuers who don't meet ESG criteria may reduce revenue from these issuers, particularly if
they are not willing or able to meet the ESG standards. This could have a short-term negative impact on profitability, thus BondCorp should not offer the
lower interest rate
On the other hand, extending the lower yield to existing bond issuers could strengthen BondCorp's reputation as a socially responsible lender and
encourage more issuers to align with ESG criteria. This might lead to improved issuer relationships, and potentially lower default rates over time, which
could positively impact profitability, and thus we should offer the lower interest rate
A reasonable answer would identify the focus on profitability and offer one of the two consideration above.
SUGGESTED ANSWER
Extending the lower yield to existing bond issuers not meeting ESG criteria involves a trade-off. It may reduce short-term revenue if issuers can't comply. This
could impact profitability negatively. Inversely, it could enhance BondCorp's reputation, encouraging ESG alignment and potentially lowering defaults
long-term. The decision hinges on balancing immediate gains versus long-term profitability.
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