Financial analysis

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1)- Corporate bonds

For many major corporate bonds, finding the correct discount rate to use requires simply to look up the rating given by different services and finding a recent list of bond yields published by these rating services. As noted in Chapter 1 Section D-1c, the two major bond rating services in the U.S. are Moody's and Standard & Poor, and there are other services which grade smaller issues. For very small companies, Dun & Bradstreet sells information on virtually all businesses for a fee. How rating services arrive at their ratings is outlined in Section D-4 of next chapter with an example of the method used by Standard & Poor. The rating methods used by Moody's and S&P differ slightly, and individual companies are not always rated by the two services exactly in the same manner.

The meaning of Moody's corporate bond ratings are listed in Table T-3.1 below.

Table T-3.2 presents the equivalency between S& P and Moody' rating, as well as an indication how these ratings correspond to generic ratings.

In Moody's classification bonds rated Aaa to Baa, and in Standard & Poor's classification bonds rated AAA to BBB, are said to be investment grade. This confers on a bond a mark of quality which allows certain institutional investors (such as pension funds and trusts) to invest in them. Because this requirement has originally been instituted by the SEC, and recently proposed changes in the rating process would put even more importance on ratings, the services have objected to an excessive reliance on their ratings and have emphasized that it should be up to investors to make their own interpretation.

Table T-3.3 below shows an example of corporate bond yields presented for different ratings for the months indicated. This chart is published by S&P monthly.

Table T-3.4 shows that yields in different industries are not the same for identical grade bonds.

Differences in yields are naturally the consequence of differences in profitability, sales growth and other conditions particular to each industry (see Chapter 14 Section A-3). Even for a given company, the rating may differ according to particular forms of protection offered in various separate bond issues (see Chapter 12 Section D). Because it takes a few weeks for the latest publication of Moody's (or Standard & Poor) bond yields to be available, it is usually necessary to find the most recent yields of comparable securities from newspapers. < /A>For example, one may find in a box called "Active Bond Issues," appearing daily in the New York Times, yields to maturity on newly issued bonds, with rating and industry group also shown for each of these listings.

Most financial publications (such as N.Y .Times, Wall Street Journal and Financial Times) which report bond quotes, also show total yield. This total yield (as defined in Chapter 2 Section F-2) is also known as the yield to maturity or total rate of return: it combines the current yield (i.e. coupon divided by latest quote) with return from appreciation or depreciation of principal if held to maturity. If that yield to maturity is used as discount rate, one would obtain exactly the quoted price because yield to maturity is calculated on the basis of the quoted price in the first place. This means that all the information contained in a quoted price is also contained in the yield to maturity. Thus, it is not necessary to calculate the dollar value of a bond in order to compare it to quoted price. One can just as well compare reported yield to maturity to yields to maturity of comparable bonds that have same rating, same coupon rate and same maturity. How to deal with situation where coupon rates and maturity are different is touched upon in Section 2F-3b of preceding chapter and in Secion 4D-1 of next chapter.

See review questions Q-3A.1 through Q-3A1.12

See research assignments R-3.1, R-3.2 and R-3.3.

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