Question 1

A bond is most likely to be called when the market rate is lower than the coupon rate.

Accepted Answer

When the market interest rates fall below the coupon rate of the bond, issuers are more likely to call (or redeem) the bond before its maturity to refinance the debt at a lower interest rate, thus saving on interest expenses.

Question 2

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 yield to maturity (YTM) can be calculated using the formula for bond pricing, which equates the present value of future cash flows to the bond's current price. Given the semiannual coupon payments, the YTM is approximately 9.24% annually.

Question 3

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

When the market yield is lower than the coupon rate (8% > 6%), a bond will trade at a premium, not at a discount. Therefore, the statement is false.

Question 4

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

Accepted Answer

This is the basic concept of bond valuation - the value of a bond is determined by calculating the present value of all future interest and principal payments.

Question 5

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" refers to the difference in yield between a bond and a benchmark, such as the US Treasury bond. It is not related to the ratings given by Moody's and Standard & Poors.

Question 6

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

Accepted Answer

When a bond's coupon rate is lower than the required rate of return, investors are not interested in purchasing the bond at its face value. Therefore, the bond will sell at a discount from par to compensate for the lower interest payments.

Question 7

Reindeer Corp. 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 10.65%.

Accepted Answer

The yield-to-maturity of these bonds cannot be 10.65% if they are sold to net $937.79, as this implies a yield higher than 10.65%.

Question 8

The expected yield of a bond will be less than its yield to maturity when

Accepted Answer

When market interest rates are expected to fall, the bond's price will increase, leading to a capital gain, which can result in an expected yield that is less than the yield to maturity.

Question 9

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

Accepted Answer

This statement is true. A bond with a AAA rating is considered to have a very low risk of default, so its yield to maturity (the rate of return an investor would receive if they held the bond until its maturity date) should be very close to its expected yield (the yield that would be calculated based on the bond's coupon rate and current market price).

Question 10

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 11

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 12

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

Accepted Answer

This statement is true. The longer the time to maturity, the more time the bond has to be affected by changes in market interest rates, making it more sensitive to those changes. This is known as duration risk.

Question 13

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 14

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 15

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 16

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

Accepted Answer

This statement is true. A basis point is equal to 0.01% or one hundredth of a percentage point.

Question 17

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 current market price of the bond, and then multiplying by 100 to get a percentage.

Annual interest payment = coupon rate x face value 
= 6.75% x $1000 
= $67.50

Current market price = $865.50

Current yield = (annual interest payment / current market price) x 100 
= ($67.50 / $865.50) x 100 
= 7.800%

Therefore, the answer is B.

Question 18

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 formula is annual interest payment divided by current market price. We can calculate the annual interest payment as $1,000 x 10% = $100. Therefore, the current yield is $100/$875.25 = 11.43%, which is different from the given 11.63%. Therefore, the statement is false.

Question 19

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 are willing to pay more for the bond in order to receive the higher interest payments. This causes the bond to sell at a premium over par value.

Question 20

Six years ago, Colt, Inc. sold an issue of 30-year, $1,000 par value bonds. The coupon rate of 5.25% is payable annually. Investors presently require a rate of return of 8.375%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.

Accepted Answer

The current market price of the bond is calculated using the present value of future cash flows, which include the annual coupon payments and the par value at maturity, discounted at the current required rate of return (8.375%). The bond has 24 years remaining (30 - 6), and the annual coupon payment is $52.50 ($1,000 * 5.25%). The present value of these cash flows results in a price of approximately $681.

Quiz 9: Debt Valuation and Interest Rates