Question 1

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

Accepted Answer

The current yield is calculated as the annual coupon payment divided by the current market price of the bond. The annual coupon payment is $1,000 * 12% = $120. The current yield is $120 / $825 = 0.1455 or 14.55%.

Question 2

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 current yield on the bonds is 11.63%.

Accepted Answer

The current yield on the bonds is calculated as Annual Interest Payment / Current Market Price. Using this formula, we can find that the annual interest payment on the bond is $100 (10% of $1,000 par value), and the current yield is ($100 / $875.25) x 100% = 11.42%. Therefore, the statement is false as the current yield on the bonds is 11.42%, not 11.63%.

Question 3

A bond's "spread" refers to the difference between it's Moody's rating and its Standard & Poors rating.

Accepted Answer

A bond's "spread" actually refers to the difference between the yield of the bond and the yield of a comparable risk-free security, such as a Treasury bond.

Question 4

A bond issued by Pomme Computers has a coupon rate of #5 paid semi-annually.If the market's required rate of return on this bond is also 3%,the bond will sell at par value.

Accepted Answer

The bond will sell at par value because the market's required rate of return is equal to the bond's coupon rate.

Question 5

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

Accepted Answer

A bond quoted at 92 1/8 means it is selling at 92.125% of its par value ($1,000), which is $921.25. Therefore, you can buy the bond for $921.25.

Question 6

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

Accepted Answer

The statement is incorrect. The higher the bond rating, the lower the default risk associated with the bond. Bond ratings are given by credit rating agencies to assess the creditworthiness of the issuer and the likelihood of default. The highest bond rating is AAA, which indicates the lowest default risk, while the lowest rating is D, indicating a high likelihood of default.

Question 7

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

Accepted Answer

This is known as duration risk. The longer the time to maturity, the more cash flows are exposed to changes in market interest rates, which makes the bond price more sensitive to interest rate fluctuations.

Question 8

You are considering the purchase of Hytec bonds that were issued 14 years ago.When the bonds were originally sold,they had a 30-year maturity and a 14.375% coupon interest rate that is payable semiannually.The bond is currently selling for $1,508.72.What is the yield to maturity on the bonds?

Accepted Answer

The yield to maturity (YTM) on a bond is the interest rate that equates the present value of all future cash flows from the bond (coupon payments and principal repayment) with its current price. Given that the bond's price is above its par value, we can infer that the current interest rate environment is lower than when the bond was issued, hence the YTM must be lower than the original coupon rate of 14.375%. Among the given options, 8.50% is the only rate that is lower than the original coupon rate and plausible given the bond's premium price, indicating that investors require less return for holding the bond now compared to when it was issued.

Question 9

When a bond's coupon rate is higher than the required rate of return,the bond

Accepted Answer

When a bond's coupon rate is higher than the required rate of return, investors will be willing to pay more for the bond in order to receive the higher coupon payments. This will result in the bond selling at a premium over par.

Question 10

You purchased Photon,Inc.bonds exactly one year ago today for $875.During the latest year,you received $65 in interest on the bonds.The current yield on these bonds is 6.5%.

Accepted Answer

To calculate the current value of the bonds, we need to use the formula:

Current value = Purchase price + Interest earned

Current value = $875 + $65

Current value = $940

To calculate the current yield, we divide the annual interest by the current value and multiply by 100.

Current yield = (Annual interest / Current value) x 100

Current yield = ($65 / $940) x 100

Current yield = 6.91%

Since the current yield (6.91%) is higher than the stated yield (6.5%), the bonds must be selling at a discount. Therefore, it is false that the bonds are worth the same as when they were purchased.

Question 11

Blue's Chips Inc.has a $1,000 par value bond that is currently selling for $1,300.It has an annual coupon rate of 7%,paid semiannually,and has nine years remaining until maturity.What is the annual yield to maturity on the bond? (Round to the nearest whole percentage. )

Accepted Answer

The yield to maturity (YTM) on a bond is the internal rate of return (IRR) for an investor if the bond is held until maturity, assuming that all payments are made as scheduled. The YTM can be found using a financial calculator or spreadsheet software by inputting the current price, the par value, the coupon payment, and the number of periods until maturity. Given that the bond is selling for $1,300, has a $1,000 par value, a 7% annual coupon rate paid semiannually, and nine years to maturity, the YTM calculation would consider these inputs. The correct answer, rounded to the nearest whole percentage, is approximately 3.15%, indicating that the bond's yield to maturity at its current price is about 3.15% per year.

Question 12

A AAA rated bond's yield to maturity will be very close to it's expected yield.

Accepted Answer

This is because AAA rated bonds are considered to be the safest and most creditworthy bonds, therefore their yield to maturity is not expected to deviate significantly from their expected yield.

Question 13

A basis point is equal to one hundredth of a percentage point.

Accepted Answer

A basis point is indeed equal to one hundredth of a percentage point.

Question 14

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

Accepted Answer

The current yield is calculated by dividing the annual interest payment by the market price of the bond. The annual interest payment can be calculated as 6.75% of the face value. Since we do not know the face value, we cannot calculate the exact annual interest payment. However, we can use the fact that the bond was purchased for $865.50 to estimate the face value. If we assume a face value of $1000, then the annual interest payment would be $67.50 (0.0675 x 1000). The current yield would then be calculated as $67.50/$865.50 = 0.078 or 7.8%. Therefore, the correct answer is B.

Question 15

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 16

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

Accepted Answer

This is the fundamental concept of bond valuation. The value of a bond is based on the present value of its future cash flows, which includes both interest payments and the principal repayment at maturity.

Question 17

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%.This bond will at a discount from par.

Accepted Answer

Since the annual market yield of similar bonds is lower than the 8% coupon rate of this bond, it will sell at a premium, not at a discount.

Question 18

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 less than 9%.

Accepted Answer

The fact that the current selling price of the bonds is higher than their par value ($1,125 > $1,000) indicates that the yield to maturity is less than the coupon rate of 9%. This means that investors are willing to pay a premium for the bonds in order to lock in a higher-than-current-market interest rate.

Question 19

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 20

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.The yield-to-maturity of these bonds is 10%.

Accepted Answer

The fact that the bonds are sold at a price lower than their face value ($937.79 vs $1,000) indicates that the market yield is higher than the coupon rate. Therefore, the yield-to-maturity should be higher than 9%, not lower. In this case, the yield-to-maturity is stated to be 10%, which is higher than the coupon rate, so the bonds are priced to yield a return that is in line with current market conditions.

Quiz 9: Debt Valuation and Interest Rates