Question 1

Which one of the following statements about convertibles is true?

Accepted Answer

The value of the conversion feature in a convertible security (such as a convertible bond or convertible preferred stock) increases with the volatility of the underlying stock. This is because the conversion feature provides an option to convert the bond or preferred stock into a specified number of shares of the company's common stock. Higher volatility increases the potential upside of this option, making it more valuable.

Question 2

The yield to maturity of a 20-year zero-coupon bond that is selling for $372.50 with a value at maturity of $1,000 is

Accepted Answer

The yield to maturity is the annual rate of return an investor can expect to receive if they hold the bond until maturity. It is calculated as follows:YTM = (FV / PV)^(1/n) - 1where:FV = face value of the bondPV = present value of the bondn = number of years to maturityIn this case, the FV is $1,000, the PV is $372.50, and the n is 20. Plugging these values into the formula, we get:YTM = (1000 / 372.50)^(1/20) - 1 = 0.051 = 5.1%Therefore, the yield to maturity of the bond is 5.1%.

Question 3

Consider a 5-year bond with a 10% coupon that has a present yield to maturity of 8%. If interest rates remain constant, one year from now, the price of this bond will be

Accepted Answer

The answer of Consider a 5-year bond with a 10%...

Question 4

The ________ is used to calculate the present value of a bond.

Accepted Answer

The yield to maturity (YTM) is used to calculate the present value of a bond. It represents the total return anticipated on a bond if the bond is held until it matures, taking into account both current interest payments and the bond's face value repayment.

Question 5

The yield to maturity on a bond is

Accepted Answer

The yield to maturity (YTM) is indeed the discount rate that equates the present value of the bond's future cash flows (payments) to its current price. This definition does not depend on the bond selling at a premium or discount, nor does it assume reinvestment at the coupon rate.

Question 6

TIPS are

Accepted Answer

TIPS, or Treasury Inflation-Protected Securities, are government bonds whose par value is adjusted based on changes in the Consumer Price Index, effectively linking the bond's value to the general level of prices to protect investors from inflation.

Question 7

Which one of the following statements about convertibles are false?I) The longer the call protection on a convertible, the less the security is worth.II) The more volatile the underlying stock, the greater the value of the conversion feature.III) The smaller the spread between the dividend yield on the stock and the yield-to-maturity on the bond, the more the convertible is worth.IV) The collateral that is used to secure a convertible bond is one reason convertibles are more attractive than the underlying stock.

Accepted Answer

Statement I is false because longer call protection generally increases the value of a convertible. Statement III is false because a smaller spread between the dividend yield and yield-to-maturity does not necessarily increase the convertible's worth. Statement IV is false because convertibles are not typically secured by collateral, unlike some bonds.

Question 8

Consider a $1,000-par-value 20-year zero-coupon bond issued at a yield to maturity of 10%. If you buy that bond when it is issued and continue to hold the bond as yields decline to 9%, the imputed interest income for the first year of that bond is

Accepted Answer

The answer of Consider a $1,000-par-value 20-year zero-coupon bond issued...

Question 9

Using semi-annual compounding, a 15-year zero-coupon bond that has a par value of $1,000 and a required return of 8% would be priced at approximately

Accepted Answer

The price of a zero-coupon bond is calculated using the formula: Price = Par Value / (1 + r/n)^(nt), where r is the annual interest rate, n is the number of compounding periods per year, and t is the number of years. For this bond: Price = $1,000 / (1 + 0.08/2)^(2*15) = $308.32, approximately $308.

Question 10

A bond with a 12% coupon, 10 years to maturity, and selling at $88.00 has a yield to maturity of

Accepted Answer

The yield to maturity (YTM) is higher than the coupon rate when the bond is selling at a discount (below its face value), which is the case here. Since the bond is selling for less than its face value and has a coupon rate of 12%, its YTM must be higher than 12%. Given the significant discount (selling at $88.00), the YTM would be substantially higher, making "over 14%" the correct choice.

Question 11

Altman's Z scores are assigned based on a firm's financial characteristics and are used to predict

Accepted Answer

Altman's Z scores are a financial tool used to measure a company's financial health and predict its likelihood of bankruptcy. This scoring system evaluates various financial ratios from a company's financial statements to determine the risk of bankruptcy.

Question 12

The bond indenture includes

Accepted Answer

The bond indenture is a legal document that outlines all the critical features of a bond, including the coupon rate (interest rate), the par value (face value), and the maturity date (when the principal amount is due to be paid back). Therefore, all the options provided are correct components of a bond indenture.

Question 13

When a bond indenture includes a sinking fund provision,

Accepted Answer

A sinking fund provision allows the issuer to repurchase bonds before maturity, potentially at below-market prices, which may not benefit bondholders.

Question 14

A bond has a par value of $1,000, a time to maturity of 20 years, a coupon rate of 10% with interest paid annually, a current price of $850, and a yield to maturity of 12%. Intuitively and without using calculations, if interest payments are reinvested at 10%, the realized compound yield on this bond must be

Accepted Answer

The realized compound yield will be between the coupon rate (10%) and the yield to maturity (12%) because the reinvestment rate is equal to the coupon rate, which is lower than the yield to maturity.

Question 15

A bond will sell at a discount when

Accepted Answer

A bond sells at a discount when its coupon rate is less than the yield to maturity, which implies the current yield is also less than the yield to maturity.

Question 16

Convertible bonds

Accepted Answer

Convertible bonds allow holders to convert the bond into a predetermined number of shares of the issuing company, thus sharing in the stock's price appreciation. They typically offer lower coupon rates than similar nonconvertible bonds due to the added value of the conversion option.

Question 17

You purchased an annual-interest coupon bond one year ago with six years remaining to maturity at the time of purchase. The coupon interest rate is 10%, and par value is $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold the bond after receiving the first interest payment and the bond's yield to maturity had changed to 7%, your annual total rate of return on holding the bond for that year would have been

Accepted Answer

The bond's price increased due to the decrease in yield to maturity from 8% to 7%, resulting in a capital gain. Combined with the coupon payment, this results in an annual total rate of return of 11.95%.

Question 18

A 10% coupon bond maturing in 10 years that requires annual payments is expected to make all coupon payments but to pay only 50% of par value at maturity. What is the expected yield on this bond if the bond is purchased for $975?

Accepted Answer

The answer of A 10% coupon bond maturing in 10...

Question 19

Most corporate bonds are traded

Accepted Answer

Most corporate bonds are traded over the counter (OTC) by bond dealers who are linked by a computer quotation system, rather than on a formal exchange. This system allows for direct trading between parties without the need for a centralized exchange.

Question 20

The process of retiring high-coupon debt and issuing new bonds at a lower coupon to reduce interest payments is called

Accepted Answer

Refunding is the process where an entity retires its existing debt by issuing new bonds, usually at a lower interest rate, to reduce the overall interest payments.

Quiz 14: Bond Prices and Yields