Case 4:

Gilda Sears (Coupon & Maturity)

GROUP 4

Angga Prasetya (29118161) | Sekar Ayu Savitri (29118190)

Segha Relangga Kriswandi (29118210) | Bimly Akbar S (29118226)
Wicaksono T Leksono (29118008)
 SUMMARY OF CASE

Gilda Sears who is enrolled in an investments class has

picked a project on bond price theorems. The two main
theorems that she decided to illustrate dealt with coupon
rate and term-to-maturity and how these factors influence
the price. Thus she included 2 bonds with the same rating
and term with a different coupon rate, as well as two bonds
with the same rating and coupon rate with different terms.
She thought that if the bond markets were efficient, bonds
with similar characteristics would be priced so that there
would be little difference in the YTM.
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 Table 1
Coupon Interest S&P Yield-to-Maturity
Bond Rate Payment Date Maturity Date Rating 11/1/1984 11/1/1985 11/1/1986
1. Boston Edison 4 1/4 June 1, Dec. 1 Sep. 15, 1992 A+ 12.30% 10.78% 8.67%
2. AT&T 7 Feb. 15, Aug. 15 Feb. 15, 2001 AA 12.09% 9.81% 8.70%
3. American Brands 5 7/8 Jan 1, July 1 Jul. 1, 1992 A+ 11.50% 9.20% 7.86%
4. Baltimore Gas and Electric 7 June 15, Dec. 15 Dec. 15, 1998 AA 12.12% 10.85% 9.02%

Table 2
Price for 11/1

Bond 1984 1985 1986

1. Boston Edison 592.29 679.79 789.79

2. AT&T 626.67 699.17 847.92
3. American Brands 699.51 781.92 896.95
4. Baltimore Gas and Electric 631.25 707.50 826.25

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Bond Price Theorem Fundamentals
1. Bond price move inversely to market
interest changes.
2. The variability in bond price and term to
maturity are positively related.
3. The sensitivity to changes in market
interest rates and subsequent bond price
increase at diminishing rate as the time
remaining until the bond’s maturity
increase. 4
Bond Price Theorem Fundamentals
4. Absolute increase in market interest rates
and subsequent bond price changes are
not symmetrical.
5. Bond price volatility is related to its
coupon rate. The percentage change in a
bond’s price due to a change in the
market interest rate will be smaller if its
coupon rate is higher.
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The amount of price variation necessary to adjust to a given
change in interest rates is a function of the number of years to
maturity. In the case of a long-maturity bond, a change in
market interest rate results in a relatively large price change
when compared to a short-maturity bond. Long-term bond is
more sensitive to interest rate changes than the short-term
bond. This is why short-term bonds generally possess less
exposure to interest rate risk. Theorems of Bond Pricing.
 1.
Using the prices given in table 18.2, calculate the percentage price changes from
November 1, 1984, to November 1, 1985, from November 1, 1985, to November 1, 1986;
and from November 1, 1984, to November 1, 1986, for the Boston Edison and american
Brands bonds. Explain the differences between the changes for the two bonds.
 Price for 11/1 ($) Price Change
Bond 1984 1985 1986 1984-1985 1985-1986 1984-1986
1. Boston Edison 592.29 679.79 789.79 14.77% 16.18% 33.35%
2. American Brands 699.51 781.92 896.95 11.78% 14.71% 28.23%

Both bonds have same rating (A+) and slightly same maturity date but
different in coupon rates. In term of coupon rate, American Brands have
higher (5.87%) over Boston Edison(4.25%). Bond price change is inversely
proportional to the YTM and the coupon rate. It is more significant for the
second and third periods. We can see significant increase difference
when the bond with a lower coupon rate was much higher. This is inline
with the Bond Price Theorem.
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 2.
Using the prices given in table 18.2, calculate the percentage price changes from
November 1, 1984, to November 1, 1985, from November 1, 1985, to November 1, 1986;
and from November 1, 1984, to November 1, 1986, for the AT&T and Batimore Gas and
Electric Bonds. Explain the differences between the changes for the two bonds.
 Price for 11/1 ($) Price Change
Bond 1984 1985 1986 1984-1985 1985-1986 1984-1986
1. AT&T 626.67 699.17 847.92 11.57% 21.28% 35.31%
2. Baltimore Gas and Electric 631.25 707.50 826.25 12.08% 16.78% 30.89%

AT&T and Baltimore Gas and Electric have the same rating (AA) and the
same coupon rates (7%), but they have a different maturity dates. The
percentage of price increase was far more significant in the first period,
where bonds with a longer YTM almost doubled the ties with the shorter
YTM. The percentage reduction in interest rates is also slightly higher for
bonds with longer maturity dates, because longer maturities make bond
prices more sensitive to interest rates.

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 3.
Assuming that you anticipate a significant decline in
interest rates, which of four bonds would provide the
largest potential capital gain? discuss.
 Price for 11/1 ($) Price Change
Bond 1984 1985 1986 1984-1985 1985-1986 1984-1986
1. Boston Edison 592.29 679.79 789.79 14.77% 16.18% 33.35%
2. AT&T 626.67 699.17 847.92 11.57% 21.28% 35.31%
3. American Brands 699.51 781.92 896.95 11.78% 14.71% 28.23%
4. Baltimore Gas and Electric 631.25 707.50 826.25 12.08% 16.78% 30.89%

By calculating the term of the bond to make the decision of the bond with
the highest potential capital gain when anticipated interest rates go
down. In spite of the fact that shorter duration minimizes the risk of active
bond trading, the longer the bond duration are less prove to volatility.
Therefore we can see also from the price change for all for that the
maximum potential capital gain is AT&T.

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THANK YOU
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