Which Bond?

Your cousin Ratnesh Patel has recently joined an CG Motors Standard Auto
insurance company after completing his MBA. Sales 2283 2627
Some days back, when you had met him over COGS 1500 1640
dinner, you got talking about credit rating
D&A 120 150
agencies and their role in assessing the default
Interest 39 54
risk of bond issues. Being a credit analyst you
Tax 35% 35%
had given him some inputs as a guideline based
on historical averages observed in the market. Table4: Key Income Statement Data
Rating AAA AA A BBB BB Ratnesh is considering the purchase of the
recently issued bonds of one of these companies.
Debt/Equity % 9 15 25 35 50
The two specific bonds he is considering are
Current Ratio 4 3 2 1 0.5
CG Motors Rs. 1000 par value AA bond with maturity
Interest Coverage 22 15 10 5 1 of 8 years and coupon rate of 7% paid
annually
Table1: Ratings and Historical Average Ratios Standard Rs. 1000 par value AA bond with maturity
Auto of 8 years and coupon rate of 10% paid
Ratnesh has done ratio analysis on two semiannually
companies in the automobile sector and is not Table2: Bond information
sure how to interpret the results as he feels that
both the companies are very similar. He has He is more inclined towards purchasing the
come to you with the financials of CG Motors Standard Auto bonds as the coupon rate is
and Standard Auto. attractive. The purpose of buying the bond is to
meet an obligation of Rs. 7.5 cr which is due in 8
Liabilities Assets years from now. The current price of the CG
Common Stock 1300 Fixed Assets 1560 Motors bond is Rs.820 while the Standard Auto
Retained Earnings 975 Cash 390 bond is trading at Rs.950. The prevailing market
Debt 325 Inventory 910 interest rate is 7%. You urge him to analyse the
Accounts Payable 520 Accounts Receivable 260 bonds on their yields. You advice him further to
Total Liabilities 3120 Total Assets 3120
consider tax implications given that income is
taxed at 30% and the capital gain is taxed at
Table2: Concise Balance Sheet of CG Motors
10%. You explain the concept of bond duration
Liabilities Assets to Ratnesh and suggest forming a 2 bond
Common Stock 1300 Fixed Assets 1560 portfolio using a five year zero coupon bond
Retained Earnings 975 Cash 390 and a perpetual bond instead to meet his
obligation.
Debt 325 Inventory 910
Accounts Payable 520 Accounts Receivable 260 Discussion Points
Total Liabilities 3120 Total Assets 3120 1) Bond ratings and looking beyond the
Table3: Concise Balance Sheet of Standard Auto ratios.
Year 1 2 3 4 5 6
2) Post tax YTM comparison. Yield variation
if default risk of 5% assumed in the
CG Motors 0 26 104 91 65 39
riskier bond.
Standard Auto 375 45 30 0 0 0 3) Build an immunized bond portfolio as
Table4: Debt Repayment Schedule suggested.