Debt Terms, Yields, Prices, and Credit Ratings Reproduced below is the debt foot
ID: 2653757 • Letter: D
Question
Debt Terms, Yields, Prices, and Credit Ratings
Reproduced below is the debt footnote from the 2013 10-K report from Dell.
Reproduced below is a summary of the market values as of November 2013 of the Dell bonds maturing from 2021 to 2040 (from Morningstar, quicktake.morningstar.com).
Required:
a. Dell’s long-term debt is rated Baa1 by Moody’s, BBB+ by S&P, and BBB+ by Fitch. What factors would be important to consider in attempting to quantify the relative riskiness of Dell compared with other borrowers? Explain.
b. Dell’s $300 million 5.4% notes traded at 69.50 or 69.5% of par, as November 2013. What is the market value of these notes on that date? How is the difference between this market value and the $300 million face value reflected in Dell’s financial statements? What effect would the repurchase of this entire note issue have on Dell’s financial statements? What does the 69.50 price tell you about the general trend in interest rates since Dell sold this bond issue? Explain.
c. Examine the yields to maturity of the three bonds in the table above. What relation do we observe between these yields and the maturities of the bonds? Also, explain why this relation applies in general.
Please answerall parts of the questions, written and math. Thanks You!
Explanation / Answer
A.
Important factors to consider in attempting to quantify the relative riskiness of a comapny with other borrowers are:
1. Creditworthiness : A company that is less likely to default on its outstanding debt, meaning it demonstrates a high level of creditworthiness, generally has a higher credit rating.
2. Future Performance : Companies that have a history of good financial standing and demonstrate that its current financial standing is unlikely to change generally have high credit ratings.
3. Major Corporate events: When a positive major corporate event occurs, such as the launch of an innovative product, or a negative corporate event occurs, such as a corporate scandal, bond rating agencies often place the bond rating of that company on review.
B.
Debt amount = $300 M
Market Value of notes = $300M* 0.695 = $208.5M
Dell has $300M as account payable on its financial statement . The market value of debt is not reflected on financial statement (Neither balance sheet nor income statement).
If Dell repurchases the entire issue, it would pay $208.5M to its bond holders, remove $300M from its accounts payables and record a gain of $300M - $208.5M = $91.5M
The fact that bond trades at 69.50 tells that interest rates have risen since issuance of bond.
C.
Yield to maturity for bonds with longer maturity is higher than that of Bonds with shorter maturity. This trend follows in general because of maturity risk premium. Maturity risk is the potential for interest rates to change while your money is tied up in a bond until it matures. Buying a bond with a longer time to maturity increases the likelihood that interest rates could rise over that period. Bond holder has to be compensated for this risk and hence higher yield.
Name Time to Maturity YTM Dell 5.4% ~27 years 8.24% Dell 6.5% ~25 years 8.77% Dell 4.625% ~7 years 6.07%Related Questions
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