WESTMINSTER INTERNATIONAL UNIVERSITY IN TASHKENT
FS CLASS TEST – MARKING SCHEME
Uzbekistan Airways Company (UzAirways) plans to expand its international operations. The
company would like to raise funds by issuing and selling a non-callable Eurodollar bond. They
plan to issue 200,000 units at par (face) value of $1,000 each and 5% fixed coupon rate over 5-
year term to maturity. The bond pays coupon semi-annually. The current market yield for an
equivalent corporate bond is 8%. Also, the company plans to hedge its USD currency exposure.
You work as an investment analyst at RedRock Capital Partners, a European fixed-income
investment manager that represents the interests of several globally-oriented mutual funds.
RedRock Capital is currently reviewing bond investment opportunities in Central Asia. Your
manager asks you to assess the potential investment opportunity (as presented above).
RedRock’s minimum required rate of return for investing in emerging markets corporate bonds
is 6%. When investing in firms that operate in the transportation industry, they require an
additional risk premium of 300 basis points. Based on the above, answer the questions presented
to you below.
Question 1 (20 marks)
a) Given the above face value, maturity, coupon and yield, estimate the value (price) of the
$1,000 bond in the marketplace upon issuance. Use the traditional bond valuation and
assume the bond carries no embedded options. (10 marks)
5 marks for showing/using the correct formula to price a vanilla bond
5 marks for correctly calculating the bond price
Ignore small rounding errors
Bond price = (50/0.08)*(1 – (1+0.04)^(-10) + 1,000*(1+0.04)^(-10) = $878.34
b) By considering the relationship between the yield and coupon, explain why the value of this
bond is below its par value? (5 marks)
3 marks for correctly explaining by referring to the yield-coupon relationship
2 marks for accurate illustration using a price-yield graph
The relationship exists among coupon (c), yield (r), par value (M) and price (P):
If r < c, then P > M this is called a premium bond or a bond selling at a premium
If r > c then P < M this is called a discount bond or a bond selling at a discount
If r = c then P = M this is called a par-value bond or a bond selling at par
In this case, r > c i.e. 8% > 5% therefore P < M i.e. the bond price is below its par value (it
is a bond selling at a discount).
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, WESTMINSTER INTERNATIONAL UNIVERSITY IN TASHKENT
c) If the bond yield remained the same, would the price of the same bond increase or decrease
after 1 year? What about 2 years? Explain by considering the price-maturity relationship (5
marks)
3 marks for correctly explaining by referring to the price-maturity relationship
2 marks for accurate illustration using a price-maturity graph
Bonds (with fixed coupon) selling at a discount tend to increase in value (price) over time if
the yield remains unchanged. So the current bond would increase in value after 1, 2 etc
years and eventually reach its par value at maturity (i.e. when the bond is due for
redemption).
Question 2 (15 marks)
a) Given their required yield specific to the transportation industry, what is the maximum
amount that RedRock Capital is likely to offer per bond issued by UzAirways? Show your
computations and explain. (10 marks)
3 marks for showing/using the correct bond pricing formula (shown above in Q1)
2 marks for using the correct yield (9%)
5 marks for correctly calculating RedRock’s likely offer price
Ignore small rounding errors
Maximum price RedRock is likely to offer is based on the yield that includes extra risk
premium they demand for investing in transportation companies which is 3%. It is added to
the minimum yield of 6% they typically require from emerging markets corporate bonds.
The total yield i.e. discount rate will be 6% + 3% = 9%.
Bond Price = (50/0.09)*(1 – (1+0.045)^(-10) + 1,000*(1+0.045)^(-10) = $841.75
b) What is the difference between RedRock’s valuation and the expected market valuation
(based on the yield on an equivalent bond) of the entire UzAirways bond issue (200,000
units)? Show your computations. (5 marks)
FS 2017-2018 Page 2 of 7
FS CLASS TEST – MARKING SCHEME
Uzbekistan Airways Company (UzAirways) plans to expand its international operations. The
company would like to raise funds by issuing and selling a non-callable Eurodollar bond. They
plan to issue 200,000 units at par (face) value of $1,000 each and 5% fixed coupon rate over 5-
year term to maturity. The bond pays coupon semi-annually. The current market yield for an
equivalent corporate bond is 8%. Also, the company plans to hedge its USD currency exposure.
You work as an investment analyst at RedRock Capital Partners, a European fixed-income
investment manager that represents the interests of several globally-oriented mutual funds.
RedRock Capital is currently reviewing bond investment opportunities in Central Asia. Your
manager asks you to assess the potential investment opportunity (as presented above).
RedRock’s minimum required rate of return for investing in emerging markets corporate bonds
is 6%. When investing in firms that operate in the transportation industry, they require an
additional risk premium of 300 basis points. Based on the above, answer the questions presented
to you below.
Question 1 (20 marks)
a) Given the above face value, maturity, coupon and yield, estimate the value (price) of the
$1,000 bond in the marketplace upon issuance. Use the traditional bond valuation and
assume the bond carries no embedded options. (10 marks)
5 marks for showing/using the correct formula to price a vanilla bond
5 marks for correctly calculating the bond price
Ignore small rounding errors
Bond price = (50/0.08)*(1 – (1+0.04)^(-10) + 1,000*(1+0.04)^(-10) = $878.34
b) By considering the relationship between the yield and coupon, explain why the value of this
bond is below its par value? (5 marks)
3 marks for correctly explaining by referring to the yield-coupon relationship
2 marks for accurate illustration using a price-yield graph
The relationship exists among coupon (c), yield (r), par value (M) and price (P):
If r < c, then P > M this is called a premium bond or a bond selling at a premium
If r > c then P < M this is called a discount bond or a bond selling at a discount
If r = c then P = M this is called a par-value bond or a bond selling at par
In this case, r > c i.e. 8% > 5% therefore P < M i.e. the bond price is below its par value (it
is a bond selling at a discount).
FS 2017-2018 Page 1 of 7
, WESTMINSTER INTERNATIONAL UNIVERSITY IN TASHKENT
c) If the bond yield remained the same, would the price of the same bond increase or decrease
after 1 year? What about 2 years? Explain by considering the price-maturity relationship (5
marks)
3 marks for correctly explaining by referring to the price-maturity relationship
2 marks for accurate illustration using a price-maturity graph
Bonds (with fixed coupon) selling at a discount tend to increase in value (price) over time if
the yield remains unchanged. So the current bond would increase in value after 1, 2 etc
years and eventually reach its par value at maturity (i.e. when the bond is due for
redemption).
Question 2 (15 marks)
a) Given their required yield specific to the transportation industry, what is the maximum
amount that RedRock Capital is likely to offer per bond issued by UzAirways? Show your
computations and explain. (10 marks)
3 marks for showing/using the correct bond pricing formula (shown above in Q1)
2 marks for using the correct yield (9%)
5 marks for correctly calculating RedRock’s likely offer price
Ignore small rounding errors
Maximum price RedRock is likely to offer is based on the yield that includes extra risk
premium they demand for investing in transportation companies which is 3%. It is added to
the minimum yield of 6% they typically require from emerging markets corporate bonds.
The total yield i.e. discount rate will be 6% + 3% = 9%.
Bond Price = (50/0.09)*(1 – (1+0.045)^(-10) + 1,000*(1+0.045)^(-10) = $841.75
b) What is the difference between RedRock’s valuation and the expected market valuation
(based on the yield on an equivalent bond) of the entire UzAirways bond issue (200,000
units)? Show your computations. (5 marks)
FS 2017-2018 Page 2 of 7
