NEWSWIRE - October 30, 2000
Topic: Bonds and Their Valuation
Source: "Bond Players Warned Early About AT&T,"
by Greg Ip and Gregory Zuckerman, Wall Street Journal,
Monday, October 30, 2000, page C1.
Synopsis of Article:
AT&T’s recent disclosure of lower than expected
growth in the long-distance market was better anticipated
in the bond market than the stock market. While AT&T’s
stock price continued to rise in the early part of this year,
AT&T bond prices began to fall. Why? Much of the expected
growth was financed using an increase in long-term debt. Many
other growth-oriented firms did the same thing. This has resulted
in higher debt-to-equity ratios for U.S. corporations. The
difference in yield to maturity for safe, U.S. Treasury bonds
and high-quality corporate bonds (such as the AT&T bonds)
is now at 2.8%. Other companies, such as Hasbro, have begun
buying back shares of their own stock because they believe
it is undervalued. This strips cash from the balance sheet
or requires the firm to issue new debt to finance the repurchase.
Either technique increases the importance of debt on the firm’s
balance sheet and reduces financial flexibility for the future.
Questions and Teaching Note:
- What is yield to maturity? Why do corporate bonds have
yields to maturity that are significantly higher than yields
on U.S. Treasury bonds?
- What is a share repurchase? Why might this action be viewed
favorably by stockholders and unfavorably by bondholders?
- AT&T has an issue of bonds that mature in October
2029 (29 years from now). These bonds have an annual coupon
rate of 6.5% and pay interest semiannually. The bonds have
a par value of $1,000 and are currently selling for $800.
Determine the annual YTM for these bonds. Assuming that
there is a 2.8% default risk premium on the AT&T bonds
and observing that a U.S. Treasury bond with similar maturity
and par value is currently selling for $1040, can you infer
the coupon rate on the Treasury bond?
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