In chapter three, we learnedabout the structures of the of interest rates and why that interest rates vary.
I learned that the risk is associated with the variability of return and thatthe security yields and prices are affected by levels and changes in credit(Default) risk, liquidity, Tax status, term of maturity, call feature,conversion feature and many more. In this paper, I will be analyzing the bondlisting for Coca Cola Enterprises Inc. Credit(Default) RiskCoca cola has a Fitch rating ofAA which is means its stronger than a Fitch rating of A but less strong than aFitch rating of AAA.
I learned in chapter three that the risk premiumcorresponds to the chances that a particular bond rating can change over time. Thisbond is selling at a discount now that the YTM is lesser than when initiallyissued. However, despite been rate a Fitch AA, and that these rating usuallyserves as reasonable indicators of the likelihood of defaults, the creditrating agencies are not always accurate in detecting the financial problems ofa firm. The coca cola bond is a high grade corporate bond thereby implying thatit has a higher risk of default compared maybe to the U.S Government bond orthe Agency Bonds. LiquidityLiquidity describes the degreeto which an asset or security can be quickly bought or sold without affectingthe asset’s price.
1 In other words, liquid investment can quickly beconverted to cash at a minimum transaction cost thereby leading to investors payingmore for liquid investment. In chapter three I learned that liquidity isassociated with short term, low default risk and marketable securities. In thecase of the coca cola bond, the bonds which are non-callable are said to have amaturity date set on 15th September 2028.
Taking into considerationthat this bond was originally issued on September 11, 1998, thus a 30-yearbond, we can say that this bond is a long term bond since it still has 11 yearsto its maturity (short term bonds are bonds that are mature within 90 days orthree months.) Thus, this coca cola bond which has a relative high default riskand fails to be a short term bond could be said to be non-liquid or lessliquid. TaxStatusInvestors are concerned withafter tax return or yield. That said, tax status of income or gain on securityimpacts the security yield leading to investors requiring higher yields forhigher taxed securities. The case about the Coca cola bond doesn’t give me moreinformation to elaborate or explain more about the Tax Status.
Yat = Ybt(1 – T)Where Yat = after-tax yield,Ybt = before-tax yield and T = investor’s marginal taxrate Termof MaturityIt is very normal to seeinterest vary due to the term of maturity. The yield curve is a good indicatorto investors as it shows them their yields over a maturity period. For the Cocacola bond in this case, the yield to maturity is said to be 3.507% while thecurrent yield is 4.993 % thus a difference of 1.
486%. The YTM is lesser thanthe current yield by 1.486% implying that the bond is trading at a premium asof date. However, to know if this will be an investment worth making, we willhave to calculate the YTM over the amount of time considering that the bondwill not be sold before the maturity. CallfeatureCall features are some form ofaid to the investors as call features are exercised when interest rates havedeclined. Investors most at time demand higher risk on callable bonds,especially when the bonds are expected to fall in the future.
In this case ofthe Coca cola bond, there is said to be no callable feature. This could be becausethe bonds are not expected to fall any time soon. Therefore, the maturity dateof this bond is to be honored on the 15 September 2028ConversionfeatureThe convertible feature on theother hand allows investors to convert the bond in a specified number of commonstock shares. This characteristic mostly pushes investors to accept a loweryield because investors returns include expected return on equityparticipation. Beneath the table about the coca cola case, we see that thequantity of bond available is 14 and that the minimum trade quantity is 5. Ifthe minimum trade quantity represents the number of bonds that can be traded bythe investors for common stock shares, then we can conclude that these Cocacola bonds are convertible. If the contrary is true, that will imply that thesecoca cola bonds are non-convertible.
Inchapter 3 I learned that theappropriate yield to be offered on a debt security is based on the risk-freerate for the corresponding maturity plus adjustments to capture varioussecurity characteristics. Yn = Rf,n + DP + LP + TA + CALLP + COND. In the coca cola case, ifwe were given the risk free rate I would have been able to estimate theappropriate yield with the calculation above. Reference: