Homework Set4

Homework Assignment Set 2: Chapters 4 & 5

Name

University

FIN 534 Financial Management

Professor

28 April 2019

You have just won the Strayer Lottery jackpot of $11,000,000. You will be paid in 26 equal annual installments beginning immediately. If you had the money now, you could invest it in an account with a quoted annual interest rate of 9% with monthly compounding of interest. The present value of the payments you will receive as below;

Strayer Lottery Jackpot

Jackpot $11,000,000

Annual Installments 26

Interest Rate 9%

PV ?

Present value computation

PV = A

A = = 423,076.92

R = (1 + )^12 -1 = 1.3555-1 = 0.3555

N = 26

Then, PV = 423,076.92 * [1 - (1+0.3555) ^ (-26)] / (0.3555)

PV = 4,453,789.94

The present value of the payments you will receive is $4,453,789.94.

According to Henry (2015), bond rating refers to the grade assigned to a bond by the bond rating agencies; such as Moody's and Standard and Poor. The bond rating has an influence on the price and demand of the bond; for example, a lower bond rating shows that a bond is riskier but also has a higher yield of return. Thus, investee will consider various parameters before purchasing a bond. Some of the parameters are returned yield, level of riskiness and creditworthiness of the issuer company. The bond rating depends on the analysis of the financial statements and financial ratios. Bond ratings are graded according to AAA, BBB, CCC and DDD rating.

AAA bond rating refers to the highest rating assigned to an issuers bond by the oversight authority responsible for rating bonds. AAA bond rating shows the impeccable creditworthiness of the issuer since the issue is perceived to have the ability to meet its financial commitments on time. AAA bond rating gives the issuer a competitive advantage because the issuer can borrow at a lower cost any preferable amount. However, the AAA bond rating is less risky and thus has lower yields of return.

BBB bond rating shows the adequate capacity of the issuer to meet its financial obligations. BBB bond rating indicates that the issuer has the proper capacity to meet its financial requirements and thus can be considered by the investee. However, BBB bond rating is subject to the effects of adverse economic conditions; for example, its financial strength is affected by periods of recession, depression, recovery, and boom of the economic conditions.

CCC bond rating shows that the bond has a high risk. Some institutions such as banks are not supposed to invest through the bond because the bond issuer’s ability to meet financial commitments is questionable as shown by the longer cash conversion cycle. The bond rating has the advantage of producing a higher rate of return. DDD bond rating refers to the worst rating assigned to bonds that are already in default. The bond rating carries the possibility of recovery and also has a higher rate of return. However, the ability of the issuer to meet financial obligations is under question.

Reference

Henry, T. R., Kisgen, D. J., & Wu, J. J. (2015). Equity short selling and bond rating downgrades. Journal of Financial Intermediation, 24(1), 89-111.