Question 1. Bond Valuation (4 marks) Procter & Gamble Co. plans to raise $200 million by issuing corporate bonds. The bonds with a term to maturity of 10 years have an 11.5% coupon rate. Coupon is...

Question 1. Bond Valuation (4 marks)

Procter & Gamble Co. plans to raise $200 million by issuing corporate bonds. The bonds with a term to maturity of 10 years have an 11.5% coupon rate. Coupon is paid annually. Bond rating of P&G is expected to rise in the future. As a financial analyst of P&G, you are asked to estimate the total costs that could be reduced from the new issue if the new rating of P&G’s bond were improved by one level.


Requirement:
You need to collect relevant data from Bloomberg. Data that you may need to download includes: Current credit rating for P&G (use credit rating from Standard & Poor’s) U.S. Daily Treasury yield curve Yield spreads for the various bond ratings


*You may find that the yield curve you generate may not cover every year that you need for the new bond; therefore, you need to fill these in by linearly interpolating the given yields and spreads. For example, the four-year spot rate and spread will be the average of the three- and five-year rates. The six-year rate and spread will be the average of the five- and seven-year rates.


Question 2.   Interest Rate Term Structure (4 marks)
Find the term structure and discuss what it might mean.

1.    The following yields (US government bond): a. 3-month b. 6-month c. 12-month d. 2-year e. 5-year f. 10-year g. 30-year

2.    How would you describe this yield curve?

3.    Provide possible explanations for its shape.

4.    According to the expectations hypothesis, what is the expected one-year interest rate next year? Calculate this using the 2 year and 12 month rates – show your work.
Please download the daily data from Bloomberg with the time period from 3/1/2014 to 3/1/2017.

Question 3. Value at Risk (4 marks)


Assume you have a portfolio that is worth $100,000. Your portfolio consists of $15,000 of American Express Company stocks, $20,000 of the Boeing Company stocks, 35,000 of Cisco Company and 30,000 of Caterpillar Inc. stocks.

Please download the daily closing prices of the four companies’ stocks from 3/1/2014 to 3/1/2017.

1.    Calculate daily Value at Risk of your portfolio with both historical method and variance-covariance method under 95% confidence level and explain your answer.
2.    Forecast daily Value at Risk of your portfolio on the 4/1/2017 based on variance-covariance method under 99% confidence level and explain your answer.
3.    Identify events that possibly cause the 1% worst case.


Questions 4. (4 marks)
It is now October 2013. A company anticipates that it will purchase 1 million pounds of copper in each of February 2014, August 2014, February 2015, and August 2015.
The company has decided to use the futures contracts traded in the COMEX division of the CME Group to hedge its risk. One contract is for the delivery of 25,000 pounds of copper.

The initial margin is $2,000 per contract and the maintenance margin is $1,500 per contract. The company’s policy is to hedge 80% of its exposure. Contracts with maturities up to 13 months into the future are considered to have sufficient liquidity to meet the company’s needs.