ATLANTIC HEALTHCARE IS an investor-owned hospital chain that owns and operates n
ID: 2729861 • Letter: A
Question
ATLANTIC HEALTHCARE IS an investor-owned hospital chain that owns and operates nine hospitals in Maryland, Virginia and the District of Columbia. Marcia Long, a recent graduate of a prominent healthcare administration program, has just been hired by Washington Medical Center, Atlantic’s largest hospital. Like all new management personnel, Marcia must undergo three months of intensive indoctrination at the system level before joining the hospital.
Marcia began her indoctrination in January 2010. Her first assignment at Atlantic was to review its latest annual report. This was a stroke of luck for Marcia because her father owned several bonds issued by Atlantic, and Marcia was especially interested in whether or not her father had made a good investment. To glean more information about the bonds, Marcia examined Note E to Atlantic’s consolidated financial statements, which lists the company’s long-term debt obligations, including its first mortgage bonds, installment contracts, and term loans. Exhibit 1 contains information on three of the first mortgage bonds listed in Atlantic’s annual report.
Unfortunately, Atlantic’s chief financial officer, Hugo Welsh, found out about Marcia’s interest in the firm’s debt financing. “Because you are so interested in our financial structure,” he said, “here are some questions that I’ve developed as part of a debt financing presentation to our executive committee. See if you can answer them.”
Marcia viewed Hugo’s question as a challenge. As she was convinced that she knew as much about debt financing as most finance MBAs. Apparently Marcia was right because she answered the questions with no difficulty. In fact, Hugo was so impressed that he asked Marcia to give the presentation to the executive committee, which turned out to be a big success.
See if you can do as good a job as Marcia in answering the following questions:
Part 1
Refer to the three bonds listed in Exhibit 1. Note that each bond matures at the end of the listed year, and the remaining term to maturity is also listed in the exhibit. Furthermore, each bond has a $1,000 per value, each had a 30-year maturity when it was issued, and all three bonds currently have a 10 percent required nominal rate of return.
a. What would be the value of each bond if it had annual coupon payments?
b. Atlantic’s bonds, like virtually all bonds, actually pay interest semiannually. What is each bond’s value under these conditions?
c. Are the bonds currently selling at a discount or at a premium?
d. What is the effective annual rate of return implied by the values obtained in Part c?
e. Would you expect a semiannual payment bond to sell at a higher or lower price than an otherwise equivalent annual payment bond? Look at the values calculated in Parts b and c for the five-year bond. Are the prices shown consistent with your expectations? Explain.
Part 2
Now, regardless of your answers to Question 1, assume that on January 1, 2010, the 5-year bond is selling for $800.00, the 15-year bond is selling for $865.49 and 25-year bond is selling for $1,220.00.
a. What is the stated (as opposed to effective annual) yield to maturity (YTM) on each bond? (Note: The stated rate is also called the nominal rate.)
b. What is the effective annual YTM on each issue?
c. In comparing bond yields with the yields on other securities, should the stated or effective YTM be used? Explain.
Part 3
Suppose Atlantic has a second bond series, series D (in addition to the bond series C listed in Exhibit 1), with 25 years left to maturity that has a coupon rate of 7.375 percent and a January 1, 2010, market price of $747.48.
a. What is the current yield on each of the 25-year bonds?
b. What is each of the 25-year bands’ expected price on January 1, 2011, and its capital gains yield for 2010, assuming no change in interest rates?
c. What will happen to the value (and price in an efficient market) of each 25-year bond over time? (Again, assume constant future interest rates.)
Part 4
Consider the riskiness of the three bonds listed in Exhibit 1.
a. Explain the difference between price risk and reinvestment rate risk.
b. Which of the bonds has the most price risk? Why?
c. Which of the bonds has the most reinvestment risk? Why
Part 5
Discuss the basic differences between the bonds issued by investor-owned corporations and those issued by not-for-profit healthcare organizations through municipal financing authorities.
EXHIBIT 1
Atlantic Healthcare Partial Long-Term Bond listing
Bond
Series
Total Face Amount
Coupon Rate
Maturity Date
Years to Maturity
S&P Bond Rating
A
$48,000,000
4.5%
12/31/2014
5
A+
B
$32,000,000
8.25%
12/31/2024
15
A+
C
$100,000,000
12.625%
12/31/2034
25
A+
Bond
Series
Total Face Amount
Coupon Rate
Maturity Date
Years to Maturity
S&P Bond Rating
A
$48,000,000
4.5%
12/31/2014
5
A+
B
$32,000,000
8.25%
12/31/2024
15
A+
C
$100,000,000
12.625%
12/31/2034
25
A+
Explanation / Answer
Part 1 a) Formula: PV=(PMT*((1-(1+i)^-n)/i))+(1000/(1+i)^n) Where, PV is the Presnt Value or the Current Price PMT = Coupon payment ; i= Interest rate or Yield n= no.of periods remaining to maturity With this formula, we calculate , price of the bonds ,for the given data Annual Interest Payments Bond Series A (2160000*((1-(1+0.1)^-5)/0.1))+(48000000/(1+0.1)^5) 37992323 Bond Series B (2640000*((1-(1+0.1)^-15)/0.1))+(32000000/(1+0.1)^15) 27740595 Bond Series C (12630000*((1-(1+0.1)^-25)/0.1))+(100000000/(1+0.1)^25) 123872615 b) Semi-Annual Interest Payments Bond Series A (1080000*((1-(1+0.05)^-10)/0.05))+(48000000/(1+0.05)^10) 37807309.89 Bond Series B (1320000*((1-(1+0.05)^-30)/0.05))+(32000000/(1+0.05)^30) 27695714 Bond Series C (6315000*((1-(1+0.05)^-50)/0.05))+(100000000/(1+0.05)^50) 124006542 c) Selling at Bond Series A Discount 48000000-37992323 10007677 Bond Series B Discount 4259405 32000000-27740595 Bond Series C 123872615-100000000 Premium 23872615 d. Effective Rate=Market interest rate=YTM(Annual Rate) Bond A 10% Bond B 10% Bond C 10% e. A semiannual payment bond is expected to sell at a lower price than an otherwise equivalent annual payment bond because it fetches more cash flows in the form of more fixed interest payments. Part 2 a. Bond Series Stated int or Coupon rate A 4.50% B 8.25% C 12.63% b)Annual YTM/Effective Interest Rate Bond A 800=(45*((1-(1+YTM)^-5)/YTM))+(1000/(1+YTM)^5) Solving online, YTM= 9.74% Bond B 865.49=(82.5*((1-(1+YTM)^-15)/YTM))+(1000/(1+YTM)^15) Solving online, YTM= 10.02% Bond C 1220=(126.3*((1-(1+YTM)^-25)/YTM))+(1000/(1+YTM)^25) Solving online, YTM= 10.17% c. In comparing bond yields with the yields on other securities,effective YTM should be used because YTM is the real yield to the investor in holding the bond until maturity- in respose to market fluctuations Part 3 a) Bond D 747.48=(73.75*((1-(1+YTM)^-25)/YTM))+(1000/(1+YTM)^25) Solving online, YTM= 10.20%(Current Yield) b)Expected price on January 1, 2011 (25-1=24 Years to Maturity) Bond C (126.3*((1-(1+0.1017)^-(25-1))/0.1017))+(1000/(1+0.1017)^(25-1)) $ 1218.22 Capital gains yield for 2010= (( Jan 1. 2011 Stock Price- Jan 1. 2010 Stock Price)/Jan 1,2010 Stock Price)*100 (( 1218.22- 1220)/1220)*100 -0.15 Bond D (73.75*((1-(1+0.1020)^-(25-1))/0.1020))+(1000/(1+0.1020)^(25-1)) $ 749.96 Capital gains yield for 2010= (( 749.96- 747.48)/747.48)*100 0.33 c) Over time, the price or the value of the bond decreases as most of the cash flows in the form of coupon payments have been received. The less the time to maturity the lesser the price. Part 4 a) Both are dependent on interest changes. Price risk is positively correlated to Interest changes whereas Reinvestment risk is inversely correlated. The greater the maturity , the greater is the risk of price change due to interest changes.When interest falls price increase ,when interest rises, price decreases. When interest increases, bonds may not be called back and hence reinvestment risk decreases. When interest rates decreases, bonds may be redeemed and hence reinvestment risk increases. b.)Bonds B, C& D have price risk as the duration is more. Uncertainty about interest rates and market conditions exist. Bond A has the reinvestment risk with low interest rates Part 5 Bonds by investor owned corporations offer highly competitive rates of interest whereas, bonds by municipal authorities may not offer very high interets. The interest on the former is taxable in the hands of the investor. Munis are totally ax exempt. There are the above mentioned price/reinvestment /credit/market risks associated with corporate bonds, but munis are comparatively risk-free as totally backed by the US Government. with absolutely no default risk.
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