Question 1

You purchased Photon,Inc.bonds exactly one year ago today for $875.During the latest year,you received $65 in interest on the bonds.What is your current yield on these bonds?

Accepted Answer

To calculate the current yield, we divide the annual interest payment by the bond's current price. Since the bond was purchased a year ago and nothing is stated about its current market price, we assume that it is still $875. Therefore, the current yield is:

Current yield = ($65 annual interest payment / $875 market price) x 100%
Current yield = 7.4%

Therefore, the best choice is B.

Question 2

Marshall Manufacturing has a bond outstanding that was issued 20 years ago at a coupon rate of 9%.The $1,000 par value bond pays interest semiannually and was originally issued with a term of 30 years.If today's interest rate is 14%,what is the value of the bond today?

Accepted Answer

The value of a bond is calculated using the present value of its future cash flows, which include the semiannual interest payments and the principal amount to be received at maturity. The formula for the present value of an annuity (for the interest payments) and the present value of a lump sum (for the principal repayment) are used. Given a 9% annual coupon rate on a $1,000 bond, the semiannual interest payment is $45 ($1,000 * 9% / 2). There are 20 years left until maturity, which means 40 semiannual periods. The current market interest rate is 14% annually, or 7% per semiannual period. Using the present value formulas:- Present value of the semiannual interest payments (Annuity): PV = Pmt * [(1 - (1 + r)^-n) / r] = $45 * [(1 - (1 + 0.07)^-40) / 0.07] ≈ $435.15- Present value of the principal amount (Lump Sum): PV = F / (1 + r)^n = $1,000 / (1 + 0.07)^40 ≈ $300Adding these two components gives the total current value of the bond: ≈ $435.15 + $300 ≈ $735.15.

Question 3

Aurand,Inc.has outstanding bonds with an 8% annual coupon rate paid semiannually.The bonds have a par value of $1,000,a current price of $904,and will mature in 14 years.What is the annual yield to maturity on the bond?

Accepted Answer

The answer of Aurand,Inc.has outstanding bonds with an 8% annual...

Question 4

When referring to bonds,expected rate of return and yield to maturity are often used interchangeably.

Accepted Answer

The answer of When referring to bonds,expected rate of return...

Question 5

Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and a coupon interest rate of 8%,paid semiannually.If you require a 10% rate of return on this investment,what is the maximum price that you would be willing to pay for this bond?

Accepted Answer

Firstly, let's calculate the coupon payment:
Coupon rate = 8%
Maturity value = $1,000
Coupon payment = Coupon rate x Maturity value / Number of payments per year
Coupon payment = 8% x $1,000 / 2
Coupon payment = $40

Now, we can use the formula for the present value of a bond:
PV = Coupon payment x [1 - 1/(1+r)^n]/r + Maturity value/(1+r)^n

Where:
r = semiannual discount rate = 10%/2 = 5%
n = number of semiannual periods = 20 years x 2 = 40 periods

PV = $40 x [1 - 1/(1+5%)^40]/5% + $1,000/(1+5%)^40
PV = $828.29

Therefore, the maximum price that you should be willing to pay for this bond is $828.29, which is choice D.

Question 6

A $1,000 par value bond with a 12% coupon rate currently selling for $825 has a current yield of:

Accepted Answer

The answer of A $1,000 par value bond with a...

Question 7

You purchased Gibraltar Corp.bonds exactly one year ago today for $1,075.During the latest year,you received $85 in interest on the bonds.What is your current yield on these bonds?

Accepted Answer

The answer of You purchased Gibraltar Corp.bonds exactly one year...

Question 8

Dry Seal plans to issue bonds to expand operations.The bonds will have a par value of $1,000,a 10-year maturity,and a coupon interest rate of 9%,paid semiannually.Current market conditions are such that the bonds will be sold to net $937.79.What is the yield-to-maturity of these bonds?

Accepted Answer

Using a financial calculator or Excel, we can calculate the yield-to-maturity (YTM) of these bonds as follows:
N = 20 (10 years x 2 semiannual periods)
PMT = $45 (9% of $1,000 divided by 2)
PV = -$937.79
FV = $1,000
Solving for I/Y, we get 4.99% (rounded to two decimal places). Since this is a semiannual rate, we need to double it to get the annual yield, which is 9.98% (rounded to two decimal places).
Therefore, the closest answer choice is B, which is 10%.

Question 9

A $1,000 par value bond is currently listed as selling at 92 1/8.This means:

Accepted Answer

The bond is currently listed as selling at 92 1/8 or 92.125% of its par value. Therefore, you can buy the bond for $92.125% x $1,000 = $921.25.

Question 10

Lambda Co.has bonds outstanding that mature in 10 years.The bonds have $1,000 par value,pay interest annually at a rate of 9%,and have a current selling price of $1,125.The yield to maturity on the bonds is:

Accepted Answer

The yield to maturity (YTM) is the internal rate of return (IRR) on the bond's cash flows, which include the annual coupon payments and the repayment of the par value at maturity. Given the bond's current price of $1,125, a coupon rate of 9% on a $1,000 par value, and a 10-year maturity, the YTM is calculated to be approximately 7.20%.

Question 11

Bond ratings measure the interest rate risk of a given bond issue.

Accepted Answer

Bond ratings measure the credit risk of a given bond issue, not the interest rate risk. Interest rate risk is the risk that the value of a bond will decline due to changes in the interest rate environment.

Question 12

Miller Motorworks has a $1,000 par value,8% annual coupon bond with interest payable semiannually with a remaining term of 15 years.The annual market yield on similar bonds is 6%.What is the bond selling for today? (Round to the nearest whole dollar. )

Accepted Answer

The bond's price is calculated using the present value of its future cash flows, which include semiannual coupon payments and the par value at maturity. With a coupon rate of 8% and a market yield of 6%, the bond sells at a premium, resulting in a price of approximately $1,196.

Question 13

The higher the bond rating,the more default risk associated with the bond.

Accepted Answer

This statement is incorrect - the higher the bond rating, the less default risk associated with the bond.

Question 14

A bond's value equals the present value of interest and principal the owner will receive.

Accepted Answer

This is the fundamental principle of bond valuation. The value of a bond is calculated by discounting the future cash flows (i.e. interest and principal payments) at a discount rate that reflects the bond's risk and time to maturity.

Question 15

You paid $865.50 for a corporate bond that has a 6.75% coupon rate.What is the bond's current yield?

Accepted Answer

To find the current yield, we need to divide the annual coupon payment by the current price of the bond. 
Annual coupon payment = $865.50 x 6.75% = $58.39 
Current yield = $58.39 / $865.50 = 0.0675 or 6.75% 
Therefore, the current yield is 7.800%, which is closest to option B.

Question 16

The longer the time to maturity,the more sensitive a bond's price to changes in market interest rates.

Accepted Answer

This is because the longer the time to maturity, the more future cash flows (interest payments and return of principal) are uncertain, and therefore subject to greater risk from changes in interest rates. This higher risk leads to greater price sensitivity to changes in market interest rates.

Question 17

Bond ratings are favorably affected by:

Accepted Answer

A greater reliance on equity financing means that there is less debt, which reduces the risk of default and increases the likelihood of bond repayment. Large firm size also indicates that the company has the financial resources necessary to meet its debt obligations. High variability in past earnings can be seen as a negative factor, as it suggests instability or unpredictability in the company's financial performance, which can increase the risk of default. Therefore, the correct answer is D, as A and C are both factors that positively affect bond ratings.

Question 18

Beta,Inc.has bonds outstanding that mature in 10 years.The bonds have $1,000 par value and pay interest annually at a rate of 10%,which is also the current required rate of return on the bonds.The bonds' duration is:

Accepted Answer

The duration of the bond can be calculated using the formula:

Duration = (Present value of bond's cash flows weighted by the time until receipt) / Bond's current market price

Since the bond's required rate of return is the same as its coupon rate, the bond's price will be equal to its par value of $1,000.

Using the formula:

Duration = [(Time until receipt of each cash flow * Present value of the cash flow)/ Bond price]

Duration = [(1*1000*(0.1)) + (2*1000*(0.1/(1+0.1)^2)) + ... + (10*1000*(0.1/(1+0.1)^10))] /1000

Duration = 6.76

Therefore, the correct choice is B.

Question 19

Generic,Inc.has bonds outstanding that mature in 20 years.The bonds have $1,000 par value,pay interest annually at a rate of 10%,and have a current selling price of $875.25.The yield to maturity on the bonds is:

Accepted Answer

The yield to maturity (YTM) is the total return anticipated on a bond if the bond is held until it matures. It takes into account not only the interest income but also the difference between the purchase price of the bond and the par value. To calculate YTM, we need to find the discount rate that makes the present value of future cash flows equal to the price of the bond.

Using a financial calculator, we can solve for YTM as follows: 
N = 20 (number of years to maturity)
I/Y = ? (YTM)
PV = -875.25 (negative because it represents the cash outflow at t = 0)
PMT = 100 (annual interest payment)
FV = 1000 (par value at maturity)
Solving for I/Y gives us 11.63%.

Therefore, the best choice is C) 11.63%.

Question 20

Assume that you wish to purchase a 30-year bond that has a maturity value of $1,000 and a coupon interest rate of 9.5%,paid semiannually.If you require a 6.75% rate of return on this investment,what is the maximum price that you should be willing to pay for this bond?

Accepted Answer

Using the bond valuation formula:
P= C/(1+r)^1 + C/(1+r)^2 + ... +C/(1+r)^n + M/(1+r)^n

Where:
P = Price of bond
C = Coupon payment
r = Required rate of return
n = Number of periods
M = Maturity value

Substituting the given values:
P = 47.50/(1.035)^1 + 47.50/(1.035)^2 + ... + 47.50/(1.035)^60 + 1,000/(1.035)^60
P = 47.50[1-(1/(1.035)^60)]/0.035 + 1,000/(1.035)^60
P = $1,351.90

Therefore, you should be willing to pay a maximum of $1,351.90 for this bond. Answer C is the closest choice to this value.

Quiz 9: Debt Valuation and Interest Rates