Question 1

Which of the following statements is most correct?

Accepted Answer

The statement in option B is correct. When a bond's yield to maturity exceeds its coupon rate, it implies that the bond is currently selling at a discount, which means its price is less than its maturity value. This is because the bond's interest payments are not enough to compensate for the yield required by investors in the market. Hence, the bond's price needs to decrease to satisfy this requirement. The other options are not necessarily true in all cases. For option A, it is possible for a bond's yield to maturity to exceed its coupon rate, but the current yield may not necessarily exceed the coupon rate. For option C, the bonds may not sell for the same price if their coupon rates are different.

Question 2

Which of the following statements is most correct?

Accepted Answer

A lower coupon bond has more interest rate risk than a higher coupon bond of the same maturity because it has a longer duration, meaning its cash flows are more sensitive to changes in interest rates.

Question 3

Listed below are some provisions that are often contained in bond indentures: 1. Fixed assets may be used as security.
2) The bond may be subordinated to other classes of debt.
3) The bond may be made convertible.
4) The bond may have a sinking fund.
5) The bond may have a call provision.
6) The bond may have restrictive covenants in its indenture.
Which of the above provisions, each viewed alone, would tend to reduce the yield to maturity investors would otherwise require on a newly issued bond?

Accepted Answer

Provisions that tend to reduce the yield to maturity investors would otherwise require on a newly issued bond are those that provide additional security or certainty for the bondholder. These include using fixed assets as security (1), having a sinking fund (4), and including restrictive covenants in the indenture (6). The conversion option (3) may also be seen as a positive feature for some investors as it provides the potential for equity participation. The subordination provision (2) and the call provision (5) both increase risk for the bondholder and therefore tend to increase the yield to maturity required by investors. Therefore, the correct answer is D, containing only provisions that tend to reduce the yield to maturity for investors.

Question 4

JRJ Corporation recently issued 10-year bonds at a price of $1,000. These bonds pay $60 in interest each six months. Their price has remained stable since they were issued, i.e., they still sell for $1,000. Due to additional financing needs, the firm wishes to issue new bonds that would have a maturity of 10 years, a par value of $1,000, and pay $40 in interest every six months. If both bonds have the same yield, how many new bonds must JRJ issue to raise $2,000,000 cash?

Accepted Answer

The current JRJ bond pays $120 in interest annually ($60 every 6 months). If the same yield is expected for the new bonds, this means that investors would require a 6% annual yield ($120 ÷ $1,000). The new bonds pay $80 in interest annually ($40 every 6 months) so they would need to be priced at $1,333.33 ($80 ÷ 6%).

To raise $2,000,000, JRJ would need to issue $2,000,000 ÷ $1,000 = 2,000 of these new bonds.

However, the question asks how many new bonds must be issued, not how many dollars of new bonds. So we need to divide the total dollar amount by the price per bond:

$2,000,000 ÷ $1,333.33 = 1,500

Finally, we need to add the existing bonds that are still outstanding:

$2,000,000 ÷ $1,333.33 = 1,500 
1,500 + 1,096 = 2,596

Therefore, JRJ would need to issue 2,596 new bonds to raise $2,000,000. The correct answer is B.

Question 5

Assume that you wish to purchase a bond with a 30-year maturity, an annual coupon rate of 10 percent, a face value of $1,000, and semiannual interest payments. If you require a 9 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

Accepted Answer

To find the maximum price to pay for the bond, calculate its present value using the required yield to maturity. The bond pays $50 every six months (10% annual coupon rate on $1,000 face value, divided by 2 for semiannual payments). The yield to maturity is 4.5% per period (9% annual yield divided by 2). The bond has 60 periods (30 years times 2). Using the present value formula for bonds, the price is approximately $1,103.19.

Question 6

Marie Snell recently inherited some bonds (face value $100,000) from her father, and soon thereafter she became engaged to Sam Spade, a University of Florida marketing graduate. Sam wants Marie to cash in the bonds so the two of them can use the money to "live like royalty" for two years in Monte Carlo. The 2 percent annual coupon bonds mature in exactly twenty years. Interest on these bonds is paid annually on December 31 of each year, and new annual coupon bonds with similar risk and maturity are currently yielding 12 percent. If Marie sells her bonds now and puts the proceeds into an account which pays 10 percent compounded annually, what would be the largest equal annual amounts she could withdraw for two years, beginning today (i.e., two payments, the first payment today and the second payment one year from today)?

Accepted Answer

The correct answer is A because the largest equal annual amounts that Marie could withdraw for two years, beginning today, is $13,255.

Question 7

Which of the following statements is most correct?

Accepted Answer

A) All else equal, an increase in interest rates will have a greater effect on the prices of long-term bonds than it will on the prices of short-term bonds. This is because long-term bonds have a greater duration, which measures the sensitivity of a bond's price to changes in interest rates.

C) An increase in interest rates will have a greater effect on a zero coupon bond with 10 years maturity than it will have on a 9-year bond with a 10 percent annual coupon. This is because the zero coupon bond has no coupon payments to offset the impact of rising interest rates, whereas the 9-year bond with a 10 percent annual coupon will continue to pay out a fixed amount each year, reducing the impact of rising rates on its price.

B) This statement is not entirely correct because the effect of interest rate changes on higher-coupon bonds versus lower-coupon bonds depends on the specific circumstances of the bonds in question. In general, higher-coupon bonds are less sensitive to interest rate changes than lower-coupon bonds because they have a higher component of current income. However, if interest rates rise significantly, higher-coupon bonds may still experience greater price declines than lower-coupon bonds due to their longer duration.

Therefore, the most correct statement is E.

Question 8

All treasury securities have a yield to maturity of 7 percent--so the yield curve is flat. If the yield to maturity on all Treasuries were to decline to 6 percent, which of the following bonds would have the largest percentage increase in price?

Accepted Answer

The longer the maturity of a bond, the greater the price sensitivity to changes in yield. Additionally, zero coupon bonds have the highest price sensitivity due to the lack of regular coupon payments to offset price changes. Therefore, the 15-year zero coupon Treasury bond would have the largest percentage increase in price with a decline in yield to maturity.

Question 9

A bond has an annual 8 percent coupon rate, a maturity of 10 years, a face value of $1,000, and makes semiannual payments. If the price is $934.96, what is the annual nominal yield to maturity on the bond?

Accepted Answer

The yield to maturity (YTM) can be calculated using the bond price, coupon rate, face value, and maturity. Given the bond's price of $934.96, semiannual coupon payments of $40 (8% of $1,000 annually, divided by 2), and a face value of $1,000 over 10 years (20 periods), the YTM is approximately 9% annually.

Question 10

Consider a $1,000 par value bond with a 7 percent annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10 percent?

Accepted Answer

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

Question 11

Which of the following is not true about bonds? In all of the statements, assume other things are held constant.

Accepted Answer

Statement B is incorrect because for a given bond, a percentage point increase in interest rates causes a smaller dollar capital loss than the capital gain from an identical decrease in interest rates, due to the convexity of bond prices.

Question 12

You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6 months. If your nominal annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay for this bond?

Accepted Answer

The answer of You intend to purchase a 10-year, $1,000...

Question 13

Rollincoast Incorporated issued BBB bonds two years ago that provided a yield to maturity of 11.5 percent. Long-term risk-free government bonds were yielding 8.7 percent at that time. The current risk premium on BBB bonds versus government bonds is half what it was two years ago. If the risk-free long-term governments are currently yielding 7.8 percent, then at what rate should Rollincoast expect to issue new bonds?

Accepted Answer

First, we need to determine the current yield to maturity that Rollincoast should expect on its BBB bonds. We know that two years ago, the yield to maturity was 11.5 percent and the risk premium over government bonds was higher than it is now. Therefore, the current yield to maturity should be lower than 11.5 percent because the risk premium has decreased. We also know that the current yield on government bonds is 7.8 percent, which is lower than it was two years ago. This means that investors are currently demanding a higher risk premium on BBB bonds than they were two years ago.

To calculate the current yield to maturity on Rollincoast's BBB bonds, we can use the following formula:

Yield to maturity = Risk-free rate + Default risk premium

We know that the risk-free rate is currently 7.8 percent and the default risk premium has decreased by half since two years ago. Let's call the new default risk premium "x". We can set up the equation as follows:

11.5% - 8.7% = x/2
2.8% = x/2
x = 5.6%

Therefore, the current default risk premium is 5.6 percent. To find the current yield to maturity on Rollincoast's BBB bonds, we can plug in the values:

Yield to maturity = 7.8% + 5.6% = 13.4%

However, the question is asking at what rate Rollincoast should issue new bonds, not the current yield to maturity. Usually, companies want to issue bonds at a lower rate than the current yield to maturity to attract investors. A good estimate for the new bond rate would be the current yield to maturity minus a few percentage points. Since we do not have any information about the desired rate, we can simply subtract 1.2 percentage points (which is a reasonable estimate for a corporate bond issuance) from the current yield to maturity:

New bond rate = 13.4% - 1.2% = 12.2%

Therefore, Rollincoast should expect to issue new bonds at a rate of approximately 12.2 percent. The closest option to this answer is C - 9.2 percent, which is not correct. Therefore, the best choice is C - 12.2 percent.

Question 14

You just purchased a 15-year bond with an 11 percent annual coupon. The bond has a face value of $1,000 and a current yield of 10 percent. Assuming that the yield to maturity of 9.7072 percent remains constant, what will be the price of the bond 1 year from now?

Accepted Answer

Since the current yield is 10 percent and the coupon rate is 11 percent, the bond must be selling at a discount. Therefore, the bond price today must be lower than its face value. To determine the current price, we can use the formula for present value of a bond:

PV = (C / r) [1 - 1 / (1 + r)^n] + FV / (1 + r)^n

Where PV is the present value or price of the bond, C is the annual coupon payment, r is the yield to maturity, n is the number of years until maturity, and FV is the face value of the bond.

Plugging in the values for the bond described, we get:

PV = (110 / 0.097072) [1 - 1 / (1 + 0.097072)^15] + 1,000 / (1 + 0.097072)^15 = $1,060.18

Therefore, the current price of the bond is $1,060.18.

To calculate the price of the bond 1 year from now, we just need to discount the future cash flows by the yield to maturity at that time. Since the yield to maturity is assumed to remain constant at 9.7072 percent, the price can be found using the same formula as above, but with n = 14 (since there will be 14 years remaining until maturity 1 year from now):

PV = (110 / 0.097072) [1 - 1 / (1 + 0.097072)^14] + 1,000 / (1 + 0.097072)^14 = $1,096.64

Therefore, the price of the bond 1 year from now will be $1,096.64, which is closest to choice C.

Question 15

A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If your nominal annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond?

Accepted Answer

The answer of A $1,000 par value bond pays interest...

Question 16

You are the owner of 100 bonds issued by Euler, Ltd. These bonds have 8 years remaining to maturity, an annual coupon payment of $80, and a par value of $1,000. Unfortunately, Euler is on the brink of bankruptcy. The creditors, including yourself, have agreed to a postponement of the next 4 interest payments (otherwise, the next interest payment would have been due in 1 year). The remaining interest payments, for Years 5 through 8, will be made as scheduled. The postponed payments will accrue interest at an annual rate of 6 percent, and they will then be paid as a lump sum at maturity 8 years hence. The required rate of return on these bonds, considering their substantial risk, is now 28 percent. What is the present value of each bond?

Accepted Answer

The answer of You are the owner of 100 bonds...

Question 17

A bond has an annual 11 percent coupon rate, an annual interest payment of $110, a maturity of 20 years, a face value of $1,000, and makes annual payments. It has a yield to maturity of 8.83 percent. If the price is $1,200, what rate of return will an investor expect to receive during the next year?

Accepted Answer

The answer of A bond has an annual 11 percent...

Question 18

Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

Accepted Answer

The answer of Assume that you wish to purchase a...

Question 19

Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest paid semiannually. The required nominal rate on this debt has now risen to 16 percent. What is the current value of this bond?

Accepted Answer

The bond's current value is calculated using the present value of its future cash flows, which include semiannual interest payments and the principal at maturity. With the required rate of 16% (or 8% semiannually), the bond's value is significantly lower than its face value, making $550 the correct choice.

Question 20

Suppose a new company decides to raise its initial $200 million of capital as $100 million of common equity and $100 million of long-term debt. By an iron-clad provision in its charter, the company can never borrow any more money. Which of the following statements is most correct?

Accepted Answer

The statement in the question stem that the firm can never borrow any more money implies that the firm cannot refinance its debt or raise additional capital in the future. Therefore, the mix of debentures versus first mortgage bonds will be fixed for the life of the firm. Under these circumstances, it is difficult to predict how the mix will affect the firm's total interest expense. Interest rates on the two types of bonds would vary as their percentages were changed, but the result might well be such that the firm's total interest charges would not be affected materially by the mix between the two. The other statements are either incorrect or impossible to determine based on the information given in the question stem.

Quiz 4: Bond Valuation

Which of the following statements is most correct?

Which of the following statements is most correct?

Which of the following statements is most correct?

All treasury securities have a yield to maturity of 7 percent--so the yield curve is flat. If the yield to maturity on all Treasuries were to decline to 6 percent, which of the following bonds would have the largest percentage increase in price?

A bond has an annual 8 percent coupon rate, a maturity of 10 years, a face value of $1,000, and makes semiannual payments. If the price is $934.96, what is the annual nominal yield to maturity on the bond?

Consider a $1,000 par value bond with a 7 percent annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10 percent?

Which of the following is not true about bonds? In all of the statements, assume other things are held constant.

You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6 months. If your nominal annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay for this bond?

You just purchased a 15-year bond with an 11 percent annual coupon. The bond has a face value of $1,000 and a current yield of 10 percent. Assuming that the yield to maturity of 9.7072 percent remains constant, what will be the price of the bond 1 year from now?

A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If your nominal annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond?

Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

Suppose a new company decides to raise its initial $200 million of capital as $100 million of common equity and $100 million of long-term debt. By an iron-clad provision in its charter, the company can never borrow any more money. Which of the following statements is most correct?