Business Finance Homework Help

1. Create the two synthetic bonds described in the case. Explain the financial construction and motivate any assumptions you wish to make.

2. Analyze the callables. What do they consist on in terms of financial instruments? How could you unbundle their cash flows?

One synthetic bond is the one that is created by combining more than one noncallable bonds and as a result of this, the final product of this will be a synthetic bond that has a semi-annual interest payment and thus this means that the owner will not have to wait until the final day to get his profits or losses (Aquilina et al., 2020). If it reaches the middle of the year and the owner wants his money back then most definitely this particular synthetic bond the owner can call his bond and get away with his money rather than waiting for a long period that could most definitely lead to losses or even take a long duration before the owner witnesses his long-awaited interest.

The second synthetic bond is the one that is established by combining noncallable bonds that mature in the year 2000 with additional STRIPS maturing in the same year. This kind of synthetic bond should be worth more than the original used callable bonds. The most important thing about this kind of synthetic bond is the fact that the investor who does not own the original callable bonds can still benefit and make profits from this particular synthetic bond but on the other hand, this particular synthetic bond can easily be manipulated and thus this means that the investor might end up not getting what they waited from their original investment.

The financial construction in this particular case is made possible by combining either callable bonds or noncallable bonds depending on where the money. On the other hand, the most important thing to know is the fact that the financial construct that is established by combining callable bonds is the most satisfactory of all and the main reason for this is because an investor can easily withdraw his interest in the middle of the and thus this means that he does not have wait for a long period before getting his money unlike in a situation where noncallable bonds are used to establish the financial construct (Aquilina et al., 2020). As we see, the financial construct designed using noncallable bonds is vulnerable to manipulations that could easily make an investor incur losses and thus is the main reason why I believe callable bonds should always be used when it comes to financial construction.

Callable Bonds

Treasury Bonds

The treasury bonds are debt securities that are given by the US government and normally investors are given a period of 20 or more years to pay back the money (Schumacher, 2020). As we can see this is a kind of government-issued funds and thus this means that the government is the one that controls everything about it and as a result of this, the New Stock Exchange is normally the organization that deals with securing treasury bonds.

Most of the times treasury bonds are vulnerable to manipulation mainly because an investor might invest his money only to find later that the government has changed some policies when it comes to debt security and thus this might affect the overall investment in a positive manner or a negative approach based of the updates.

Municipal Bonds

Municipal bonds are debt security that is given out by the local government and normally the main beneficiary of this kind of funds are local hospitals, schools, and even the community but most of the times the loans are offered for local development purposes whereby the amount can be used to construct such things as local parks, water distribution centers and also to construct damages on roads.

Corporate Bonds

The corporate bond if a kind of debt security or loan that is provided by a firm and then it is distributed to investors that are willing to take the money for investment purpose (Schumacher, 2020). In this particular case, we can take such kind of debt security as another investment opportunity for firms because they are offering the money to people and later on make some profits out of the investment. The distribution and all matters concerning the investment are left on the hand of the corporate company at hand.

Callables/Financial Instruments

Callables are debt security financial instruments in the sense that they are just loans that are given out to people, the community, investors, and firms for development purposes or investment purposes (Willer et al., 2020). As we all know, once you are given a loan, this is not your money. You take the money for investment purposes and repay the money to the owner by following the guidelines and deadlines given out to him and thus all the above-mentioned callables operate using this same principle.

As we can see the Treasury bond is a form of callable that is given out by the US government and thus this means that the investor will have to adhere to all the policies given out by the US government when it comes to paying back the money given to out. This means that the Treasury bond is not the investor’s money but the US government’s money and thus the investor will have to pay the money to the US government.

On the other hand, a municipal bond is a form of a callable that is offered by the local government which is a clear indication that the money given out is a form of investment for the local government (Willer et al., 2020). The investor will have to pay back the money to the local government by adhering t all the principles given out by the local government.

Finally, corporate bonds are forms of callables that are debt security provided by a corporate organization and thus this means that an investor will have to pay back the amount of money given to them to the corporate organization. As we can see, it is clear that callables are just loans that are given out to communities and investors for investment purposes and we can appreciate them mainly because they normally come with a long duration of payment.

Cash Flows

When it comes to unbundling the cash flow of callables, it mainly depends on the organization that has issued the money out. When it comes to the Treasury bond, then most definitely its cash flow will begin from the US government then it will be distributed to the other lower-level investors and after the investment period is over, most definitely it will be the time for the investors to pay back the money to the US government.

When it comes to the municipal bonds then its cashflow will begin from the local government mainly because this kind of callable is offered by the local government of every region (Willer et al., 2020). The fund will then be distributed to the respective investors and then they will be given the duration of time they need to pay back the money given to them and once the duration is over the respective investors will have to pay back their money to the local government.

Finally, when it comes to the corporate bond, the cashflow begins from the corporate companies that offer the money which will be distributed to the respective investors according to the agreement, and later on when the agreement has expired the investors will have to pay back the money.

All in all, the point behind the distribution of callables is the fact that it normally begins with the organization that is responsible for providing the debt financial instrument which will later be distributed to the respective investors, and after term agreed term has expired each respective investor will have to pay back his debt with the required interest and at the end of the day this means that the cash flow will be returning to the original organization that gave out the investment (Willer et al., 2020). The cash flow is back to back kind of repetitive approach.