Question 1

The current yield on a long-term bond is the

Accepted Answer

The current yield on a long-term bond is calculated by dividing the annual coupon interest by the market price of the bond. This gives investors an idea of the income they can expect relative to the bond's current price, not taking into account future price changes or the bond's maturity value.

Question 2

The concept of duration considers

Accepted Answer

Duration considers the timing of both interest and principal repayments, as it measures the sensitivity of a bond's price to changes in interest rates, taking into account all cash flows throughout the bond's life.

Question 3

The yield to call

Accepted Answer

The yield to call is important if interest rates have fallen because issuers are more likely to call the bond before maturity to refinance at a lower interest rate, making the yield to call a relevant measure for investors.

Question 4

A high-yield bond has the following terms: 
      Principal amount         $1,000 
      Annual interest paid       $100 
      Maturity                     10 years 
 
a. What is the bond's price if comparable debt yields 12 percent? 
 
b. What would be the price if comparable debt yields 12 percent and the bond matures after five years? 
 
c. What are the current yields and yields to maturity in a and b? 
 
d. What would be the bond's price in a and b if interest rates declined to 9 percent? 
 
e. What are the current yield and yield to maturity in d? 
 
f. What two generalizations may be drawn from the above price changes?

Accepted Answer

The answer of A high-yield bond has the following terms:...

Question 5

Preferred stock and long-term bonds are similar because

Accepted Answer

Preferred stock and long-term bonds both typically offer fixed payments; preferred stocks pay fixed dividends, while bonds pay fixed interest.

Question 6

If interest rates in general were to fall,
1. the prices of existing bonds would rise
2. the prices of existing bonds would fall
3. yields to maturity would rise
4. yields to maturity would fall

Accepted Answer

When interest rates fall, the prices of existing bonds rise because they have higher interest rates compared to new bonds issued at the new lower rates. Consequently, yields to maturity on existing bonds fall, as yield moves inversely to bond price.

Question 7

Buying a bond with a duration equal to when the funds are needed

Accepted Answer

Matching the bond's duration with the time when funds are needed primarily reduces reinvestment rate risk, as it aligns the bond's sensitivity to interest rate changes with the investor's time horizon, minimizing the need to reinvest at potentially unfavorable rates.

Question 8

A bond's call feature may be exercised if
1. the yield to maturity exceeds the current yield
2. the yield to maturity is less than the current yield
3. interest rates have risen
4. interest rates have fallen

Accepted Answer

A bond's call feature is typically exercised by the issuer when interest rates have fallen, allowing them to refinance the debt at a lower interest rate. This situation corresponds to when the yield to maturity is less than the current yield, as lower interest rates generally increase bond prices, reducing their yields to maturity.

Question 9

While bond prices fluctuate,

Accepted Answer

Coupons are constant because they are determined at the issuance of the bond and do not change throughout the life of the bond, regardless of market conditions.

Question 10

If a $100 par value preferred stock pays an annual dividend of $5 and comparable yields are 10 percent, the price of this preferred stock will be

Accepted Answer

The answer of If a $100 par value preferred stock...

Question 11

a. What is the value (i.e., price)of the following preferred stocks if the comparable yield is 10 percent? 
 
    MN Inc. $6 preferred stock, $100 par     
    ST Inc. $6 preferred stock, $100 par and the stock is to be retired after twenty years 
 
b. What is the current yield offered by each preferred stock? 
 
c. Why are the prices of these preferred stocks different even though they both pay the same dividend?

Accepted Answer

The answer of a. What is the value (i.e., price)of...

Question 12

An individual may purchase preferred stock
1. in anticipation of lower interest rates
2. in anticipation of higher interest rates
3. to receive a flow of tax-free income
4. to receive a flow of income

Accepted Answer

Preferred stock often pays fixed dividends, making it similar to bonds. When investors anticipate lower interest rates, they might buy preferred stocks to lock in higher dividend yields compared to future bond yields. Preferred stock dividends are not tax-free; they are taxed, so option 3 is incorrect. Thus, investors may purchase preferred stocks to receive a flow of income, making options 1 and 4 correct.

Question 13

If an investor were to anticipate that interest rates were going to fall, that individual should

Accepted Answer

When interest rates are expected to fall, buying bonds is a strategic move because the price of existing bonds, which have higher interest rates compared to new bonds, is likely to increase.

Question 14

A bond with a 5 percent coupon ($50 a year)that matures after eight years is selling for $779. What is the yield to maturity?

Accepted Answer

The answer of A bond with a 5 percent coupon...

Question 15

A bond has the following terms: 
Annual interest           $100 
Term                               15 years 
Principal                  $1,000 
 
a. What is the current price of the bond if comparable yields are 7 percent? 
 
b. What are the current yield and yield to maturity given the price of the bond in the previous question? 
 
c. If you expect the bond to be called at the end of the year, what would be the maximum price you should pay for the bond? 
 
d. Is there a reason to expect that the bond will be called?

Accepted Answer

The answer of A bond has the following terms: 
Annual...

Question 16

If interest rates rise, the price of preferred stock

Accepted Answer

Preferred stock prices generally fall when interest rates rise. This is because the fixed dividend payments of preferred stocks become less attractive compared to the higher yields available from newly issued bonds or interest-bearing securities.

Question 17

Preferred stock generally pays

Accepted Answer

Preferred stock typically pays a fixed dividend, which is one of its main characteristics distinguishing it from common stock, which may pay variable dividends.

Question 18

If a bond is selling for a premium,

Accepted Answer

When a bond is selling for a premium, it means the bond's market price is higher than its face value. This typically occurs when the bond's coupon rate (the interest rate it pays) is higher than the current market interest rates. In this scenario, the current yield (annual interest payment divided by the bond's current price) will be lower than the yield to maturity (the total return anticipated on a bond if held until it matures), because the yield to maturity accounts for the bond's price converging to its face value over time. Therefore, the current yield exceeds the yield to maturity when a bond is selling at a premium.

Question 19

Compute the durations of the following bonds and rank them on the basis of their price volatility. Assume that the current rate of interest is 8 percent. 
  
Confirm your ranking by calculating the percentage change in the price of each bond when interest rates rise from 8 to 12 percent.

Accepted Answer

The answer of Compute the durations of the following bonds...

Question 20

If a preferred stock pays an annual $4.50 dividend, what should be the price of the stock if comparable yields are 10 percent? What would be the loss if yields rose to 12 percent?

Accepted Answer

The answer of If a preferred stock pays an annual...

Quiz 14: The Valuation of Fixed-Income Securities