Cost of debt and equity

Please use the attached template only.

This competency assessment assesses the following Outcome(s):

MT480M3-3: Calculate the cost of debt and equity to determine capital structure policy.

This assignment combines traditional corporate bond analysis with modern AI learning tools to prepare you for today’s finance industry. You’ll master fundamental concepts, including bond valuation, interest rate risk, default risk, and yield curve analysis, while developing professional skills in AI collaboration. Using Gemini AI as a learning assistant, you’ll clarify complex concepts, verify calculations, explore current market examples, and connect theoretical principles to real-world applications. Your success will be measured on both your understanding of bond concepts and your ability to use AI responsibly as a tool for enhanced learning rather than a shortcut to answers.

Appropriate AI Use:

• Explaining complex concepts in simpler terms
• Checking calculation methods and logic
• Generating practice examples
• Providing feedback on your explanations
• Helping organize thoughts and structure responses

Inappropriate AI Use:

• Having AI write complete answers for you
• Using AI outputs without verification or understanding
• Copying AI responses verbatim without attribution

Part I: Corporate Bond Market and Types (8 points)

Question 1

Describe three key characteristics of the corporate bond market that distinguish it from stock markets. Explain why these characteristics affect bond price volatility and market efficiency.

AI Assist 1: Before answering, ask Gemini AI: “Can you help me understand the difference between OTC markets and exchange-traded markets in simple terms, and why this affects volatility?” Document the response and use it to enhance your understanding.

Question 2

Compare and contrast the following three types of corporate bonds. For each type, explain the payment structure and identify one advantage and one disadvantage for investors:

• a) Vanilla bonds
• b) Zero coupon bonds
• c) Convertible bonds

AI Assist 2: Use Gemini AI to generate a real-world example of each bond type currently available in the market. Ask: “Can you provide current examples of vanilla bonds, zero coupon bonds, and convertible bonds from major corporations, with their key terms?” Verify this information and cite your sources.

Part II: Bond Valuation and Interest Rate Relationships

Question 3

Explain the fundamental principle behind bond valuation. Why do bond prices move inversely to interest rate changes? Use the concept of present value in your explanation.

AI Assist 3: After writing your initial explanation, ask Gemini AI: “Can you help me create an analogy to explain the inverse relationship between bond prices and interest rates to someone with no finance background?” Include this analogy in your response and explain how it helped your understanding.

Question 4

Calculation Problem: A corporate bond has a face value of $1,000, pays a 6% annual coupon rate (paid semiannually), and has 4 years to maturity. If the current market interest rate for similar bonds is 8%, calculate the current market price of this bond. Show all work.

AI Assist 4: Use Gemini AI to:

1. Check your calculation method: “Can you walk me through the steps to calculate a bond’s present value with semiannual payments?”
2. Verify your final answer: “If a bond has [your parameters], what should the approximate market price be?”
3. Request an explanation if there are discrepancies

Part III: Yield Concepts

Question 5 (6 points)

Define and distinguish between the following three yield concepts, providing an example scenario where each would be most relevant to an investor:

• a) Coupon rate
• b) Yield to maturity
• c) Effective annual yield

AI Assist 5: Ask Gemini AI: “Can you create three different investor scenarios where coupon rate, yield to maturity, and effective annual yield would each be the most important consideration for investment decisions?” Use these scenarios to supplement your examples.

Part IV: Interest Rate Risk and Bond Theorems

Question 6

Define interest rate risk and explain why all bond investors face this risk.

Question 7

State and explain the three key bond theorems. For each theorem, provide a specific example of how it would affect an investor’s bond portfolio decisions.

AI Assist 6: Use Gemini AI to create a practical portfolio scenario: “Create a hypothetical bond portfolio with 3 different bonds (varying maturities and coupon rates) and show how each bond theorem would affect an investor’s decisions when interest rates are expected to rise by 2%.” Analyze the AI’s response and incorporate insights into your answer.

Part V: Default Risk

Question 8

Explain the two components of a default risk premium and why risk-averse investors require this premium.

Question 9

Calculation Problem: If a 10-year Treasury bond yields 3.5% and a 10-year corporate bond with a BB rating yields 6.2%, calculate the default risk premium. What does this premium tell us about investor perceptions of the corporate bond?

AI Assist 7: Ask Gemini AI: “What are current credit spreads for BB-rated corporate bonds versus Treasury bonds, and how does this compare to historical averages?” Use this context to enhance your interpretation of the calculated premium.

Part VI: Yield Curve Analysis

Question 10

Identify and explain the three factors that determine the level and shape of the yield curve. Describe how each factor specifically impacts either the level or shape of the curve, and provide an example of market conditions that would cause an upward-sloping yield curve.

AI Assist 8: Request from Gemini AI: “What is the current shape of the U.S. Treasury yield curve, and what economic conditions are driving this shape based on the three factors that determine yield curves?” Compare current conditions to the theoretical framework from your coursework.

Rubric info:

Format: Submit Parts 1-6 as a single Word or PDF file with:

• Clear headers for each question
• Step-by-step calculations
• Complete sentences and professional formatting
• AI documentation is integrated into each relevant section

Format: Professional business report (Word or PDF) including:

• Detailed analysis with calculations
• Clear recommendations and supporting rationale
• References to AI consultations

AI Documentation Requirements: For each section, document:

• Specific questions or requests made to Gemini AI
• Key insights gained from AI interactions
• How AI assistance enhanced your analysis
• Areas where you applied independent judgment

Calculation Standards:

• Show all formulas and step-by-step calculations
• Use consistent rounding (to 2 decimal places for percentages, whole dollars for monetary amounts)
• Verify all calculations independently, even when AI-assisted