Atlas Investment Management

FM-1 Assignment

By: Abhishek Prakash (B18065)

26 November 2018
 Atlas Investment Management
Background:
Atlas investment management is looking into the the investment strategies on the behalf of
Green Hills Endowments as the later lacked any financial expertise in its team. Atlas has been
managing the fixed income portfolio for Green Hills Endowments for around $600 million for
years. To meet the goals of the trustees of Green Hills Endowments, Atlas would recommend the
bonds in which Green Hills Endowment used to invest. The trustees of Green Fields Endowment
were conservative in nature and did not take much risk.

After the Fed aggressively cut the rates 11 times during the year 2001, bringing the target federal
funds rate down to 1.75% from 6.50%, the trustees were leaning towards taking a more
aggressive stance and to invest in bonds which were safer and yielded high returns.

The analysts at Atlas had looked into four different bonds i.e. GE Capital fund, Motorola, Trump
Atlantic City and government T notes. These bonds matured in range of 4.5 to 6 years. Most of
the investments (80%) by Green Hills was done in government T bills in the last 5 years. So, now
it was the job of Atlas to recommend a bond to Green Hills Endowments to invest into which was
safer and high yielding.
Critical Financial Problems:

1. Yield to Maturity:

Yield to maturity depends on the maturity period, prices and the coupon rate of the
bonds. In this case, since all these factors are different for each of the bonds, the yield to
maturity will be different for each of the bonds. YTM basically represents the return which
an investor will get on the maturity of the bond. Higher the YTM, higher is the return on
the bond. Coupons rate is the fixed amount which the investor keeps on getting until the
maturity of the bond. Therefore, coupon rates also affect the YTM. Generally, bonds
which have higher YTM are considered good for investing.

2. Impact of credit ratings of the bonds on investment:

Credit ratings represents the ability of the borrower to repay the borrowed amount. It
signifies the credit risk of the borrower. Higher the credit rating means there are good
chances that the borrower will repay the borrowed amount.

In case of bonds, the credit ratings signify how safe a bond is for investment. In this case,
GE Capital bonds are rated AAA and the Motorola bonds have been rated BBB+.

3. Analyzing the available bonds:

There are four different bonds in discussion. Atlas has to give a solution from these
available bonds to Green Hills to invest into. They have to analyse the bonds in such a way
that the bond is risk free and high yielding. The available bonds are GE Capital, Motorola
bonds, Trump Atlantic City bonds and T- bills. Over the year Green Hills has invested
majorly into the T bills. T bills are considered to be the safest option to invest into. Also,
the YTM of all these bonds are different and their credit ratings are different.
Now, the Atlas has to decide a solution which Green Hills will accept and is high yielding
and has high returns.
4. Impact of interest rates on bond prices:
Interest rates are inversely related to the bond prices. As the interest rates increase and
become greater than the return on the bonds, then those bonds become unattractive.
Therefore, the prices of the bonds need to be decreased in order to increase the return.
Therefore, the bonds become volatile in case of interest rate changes. So, an investor
must be aware of the interest rate environment while investing in the bond market.

5. Finding a mix of safe and high yielding bonds:

The bonds which have good credit ratings are considered safe. For example, in this case
GE Capital bond is rated AAA. This bond is relatively safer than the bonds which have BBB
ratings. Also generally, the bonds which are safe to invest have relatively lower YTM. For
example, T bills are safe to invest into but have relatively lower return for the investors.
Analysis:
Let us take the face value of the bonds to be $100. Now, we will calculate the YTM of all
the available bonds from the data provided into Exhibit 3.

Formula:

Price=[(Coupon/(1+YTM))+(coupon/(1+YTM)^2)………]+(coupon+face value)/(1+YTM)^n

Using the above formula, we get the following values:

Bonds GE Capital Motorola

Issued Dec 91 Jan 92
Expiration Jan 07 Jan 07
Coupon Rate 7.875 7.600
Coupon payment Semiannually Semiannually
Rating AAA BBB+
Price 112.8 103.46
Yield 5% 6.5%
Duration (years) 4.3 4.3

Bonds T bills Trump Atlantic City

Issued Jan 1998 May 1996
Expiration Jan 08 Jun 06
Coupon Rate 3.625 11.250
Coupon payment Semiannually Semiannually
Rating AAA CC
Price 101.062 62.750
Yield 3.4% 25%
Duration (years) 5.5 3.3
In the above calculations, Trump Atlantic City has the highest YTM ie of 25%. But the
problem with this bond is that, the credit rating is CC. Lower credit rating means risky
bond for investment.

But as required by Green Hills Endowments, the bond should be safe and at the same
time high yielding. Therefore, although the return on the Trump Atlantic City bond is
maximum, it can be an unsafe alternative to invest into. Therefore, Atlas cannot
recommend only the Trump bond to Green Hills for investment.

Similarly, the GE capital has the highest credit rating. It has been rated AAA by Standards
and Poors. Therefore, this bond can be considered safe for investment. But the issue with
this bond is lower than all the bonds except the T bills. Therefore, Atlas cannot
recommend only this bond to Green Hills for investment because Green Hills want the
bonds which are high yielding and safe to invest.

T bills are considered to be the safest bonds to invest into. Also, the US T bills have a credit
rating of AAA. But the issue with this bond is that it has the least return on investment.
Also, the duration of this bond is the highest. Since the Green Hills wants a bond which is
safe but at the same time high yielding, Atlas cannot recommend only this bond to Green
Hills.

We have used the following formula to calculate the duration of the bonds

Duration= sum of weighted discounted cash flows/sum of discounted cash flows

Motorola has the second highest return on investment. But again the problem with this
bond is that it is rated BBB+ by SnP. The T bills and GE Capital bonds have been rated AAA
by SnP. So T bills and GE Capital bonds are safe to invest as compared to Motorola bonds.
From the above, analysis we can observe that not a single unique bond is suitable for
Green Hills Endowments to invest into. Therefore, it is very unlikely that Atlas should
recommend a single bond to Green Hills.

Atlas should recommend a mixture of bonds based on credit rating, duration and yield to
maturity to the Green Hills.
Recommendation:
Based on the above analysis Green Hills should invest into more than one bond such that
the risk can be mitigated while maintaining the desirable return. Atlas should recommend
a mixture of bonds so that Green Hills can invest partly in one bond and partly in another
bond.