Bond Yields for Johnson & Johnson

Solution to Minicase 5 Bond Yields for Johnson & Johnson Objective: The case enables the student to gain insight into the financing activities of large corporations and to practice calculating bond prices and yields. Computations are carried out for annual and semiannual interest periods, and for fractional periods. Case Discussion: Johnson & Johnson is one of the leading pharmaceutical firms in the world. It is large and financially sophisticated. When it needs to borrow money, it sells bonds where it can get the best deal. Sometimes that means selling bonds to U. S. investors. Other times it means issuing Eurodollar bonds to investors outside the United States. (The text discusses the Eurobond market in more depth in Chapters 20 and 27. ) The student is asked in this case to use the techniques developed in Chapter 5 to calculate the yields of domestic bonds and Eurobonds. The main difference between the two is that domestic bonds pay interest semiannually, whereas Eurobonds pay annually. Due to this difference in the frequency of compounding, the student must be careful to compare the APYs of domestic and Eurobonds when trying to find the lower-cost alternative. Exhibit S-5-1 provides information concerning five Johnson & Johnson debt issues. Answers to Questions: 1. Calculate the APY for each of Johnson & Johnson’s bonds and identify which one has the lowest APY, assuming today is January 15, 2009. Answer: Bond 1, calculate the APY of the 7. 375s23 eurobond. There are 15 coupon ayments left, and the last one was made 2 months plus 6 days ago (66 days ago). Use annual payment analysis; CPN=7. 375% x 1000 = $73. 75. Solve the equation using a spreadsheet with N=15, and f=(66/360)=0. 183333 to find the APY = 7. 3001%: |[pic] | | Bond 2, calculate the APY of the 7. 375s22 domestic bond. There are 27 coupon payments left and the last one was made 17 days ago on 12/29/08. Use semiannual payment analysis; CPN/2=7. 75% x 1000 / 2 = $36. 875. Solve the equation using a spreadsheet with N=(2 x 13. 5)=27 semiannual periods, and f=(17/180) = 0. 094444 to find r = 3. 5198%, so the APY = 7. 1635%: |[pic] | | Bond 3, calculate the APY of the 8. 25s31 eurobond. There are 23 coupon payments left, and the last one was made 8 months and 15 days ago (255 days ago). Use annual payment analysis; CPN=8. 25% x 1000 = $82. 50. Solve the equation with N=23 years, and f = (255)/360) = 0. 708333 to find APY = 7. 8288%: |[pic] | | | | | Bond 4, calculate the APY of the 6. 73s20 domestic bond. There are 24 coupon payments left, and the last one was made 4 months ago (120 days ago). Use semiannual payment analysis; CPN/2=6. 3% x 1000 / 2 = $33. 65. Solve the equation using a spreadsheet with N=2 x 12=24 semiannual periods, and f = 120/180 = 0. 666667 to find r = 3. 6269%, so the APY = 7. 3854%: |[pic] | | Bond 5, calculate the APY of the 6. 85s35 domestic bond. There are 52 coupon payments left, and the last one was made 14 days ago. Use semiannual payment analysis; CPN/2=6. 85% x 1000 / 2 = $34. 25. Solve the equation using a spreadsheet with N=2 x 26=52 semiannual periods, and f = 14/180 = 0. 077778 to find r = 3. 5616%, so the APY = 7. 2500%: [pic] | | The 7. 375s22 have the lowest APY, 7. 1635%. 2. The 8. 25s28 can be called in 2021 at par. Calculate the YTC (yield to call) assuming today is January 15, 2009. Does this change your answer to question 1? Answer: There are 13 coupon payments left, and the last one was made 8 months and 15 days ago (255 days ago). Use annual payment analysis; CPN=8. 25% x 1000 = $82. 50. Solve the equation with N=13 years, and f = (255)/360) = 0. 08333 to find APY = 7. 6871%: |[pic] | | | | | The APY of 7. 6871% is less than the APY of 7. 8288% found for Bond 3 in question 1, but is more than the other bonds. So the answer to question 1 does not change, the 7. 375s22 have the lowest APY, 7. 1635%. Exhibit S-5-1 Terms of Johnson & Johnson Debt Issues ISSUE |MARKET |COUPON |FREQUENCY |MATURITY |PRICE1 | | | | | | |(% OF PAR) | |73/8s 20 |Eurobond |73/8% |Annual |11/09/20 |101. 9785 | |73/8s 19 |Domestic |73/8% |Semiannual |06/29/19 |103. 288 | |81/4s 28 |Eurobond |81/4% |Annual |04/30/28 |110. 1563 | |6. 73s 17 |Domestic |6. 73% |Semiannual |09/15/17 | 98. 1535 | |6. 85s 32 |Domestic |6. 85% |Semiannual |01/01/32 | 97. 0501 | 1 Including accrued inter est.