Tony worked for Hilton Hotels previously and ended his career on a high note, retiring as the CEO of Hilton Hotels. On the 31st December 2017, the board of directors proceeded an issue of a 10-year Hilton-Hotels corporate bonds with a coupon of 6.0% payable semi-annually and offered the chance to Tony to subscribe to it. The level of credit risk associated with the corporate bond is measured by using credit ratings given by credit rating agencies. The bond was rated by Moody’s rating agency and obtained a rating Baa3. Accordingly, Tony invested Rs10 million into the bond. While doing your research, your credit analysis team informed you that Hilton-Hotel corporate bonds may be downgraded to Ba1. He heard from a friend that he should only invest in investment grade bonds.
(a) Tony is not well versed with credit ratings. Prepare a statement to explain Moody’s credit ratings system to Tony, its importance on the international stage and the impact of a downgrade on the bond’s yields (interest rate) and credit risk. (10 Marks/ 300 words max.)
(b) Given that the bond is currently trading at a market interest rate of 4% (assume that today is the 31st December 2020 such that there are 7 years remaining till the maturity of the bond) , what is the price of the bond? (5 Marks)
(c) In another scenario, market expectations point towards a cut in the Key Repo Rate (interest rate) to the tune of 50bps (0.5%) in 3 weeks’ time. Discuss whether Tony is better-off disposing of the bond immediately or should he wait for the cut in the Key Repo Rate and then sell the bond?
