Question 1

Assume that interest rates on 20-year Treasury and corporate bonds with different ratings,all of which are noncallable,are as follows:
$\begin{array} { l c } 
\text { T-bond } = 7.72 \% & \mathrm {~A} = 9.64 \% \
\mathrm { AAA } = 8.72 \% & \mathrm { BBB } = 10.18 \%
\end{array}$
The differences in rates among these issues were most probably caused primarily by:

Accepted Answer

The differences in interest rates among these bonds are primarily due to default risk and liquidity differences. Treasury bonds are considered risk-free in terms of default, so they have the lowest interest rate. Corporate bonds are rated based on their default risk, with AAA being the highest rating (lowest default risk among corporates) and BBB being lower (higher default risk), hence their higher interest rates compared to T-bonds. Liquidity can also affect the interest rate, as more liquid securities are generally more desirable and can therefore have lower yields.

Question 2

Tucker Corporation is planning to issue new 20-year bonds.The current plan is to make the bonds non-callable,but this may be changed.If the bonds are made callable after 5 years at a 5% call premium,how would this affect their required rate of return?

Accepted Answer

If the bonds are made callable after 5 years at a 5% call premium, this means that the issuer can redeem the bonds early, which adds risk for the bondholder. Therefore, the required rate of return will increase to compensate for this added risk.

Question 3

Which of the following statements is CORRECT?

Accepted Answer

If a bond is selling at par, its coupon rate equals its yield to maturity, so its current yield also equals its yield to maturity. Further, if a bond is selling at par, its expected capital gains yield is zero because the bond’s price will remain the same, so the total expected return equals the expected coupon payment, which is just the coupon rate times the par value.

Question 4

Which of the following statements is CORRECT?

Accepted Answer

Zero coupon bonds are more sensitive to changes in interest rates compared to coupon-paying bonds of the same maturity because they offer only one payment at maturity. Therefore, a rise in market rates would indeed cause a larger percentage decline in the price of the zero coupon bond compared to a similar coupon bond.

Question 5

Amram Inc.can issue a 20-year bond with a 6% annual coupon at par.This bond is not convertible,not callable,and has no sinking fund.Alternatively,Amram could issue a 20-year bond that is convertible into common equity,may be called,and has a sinking fund.Which of the following most accurately describes the coupon rate that Amram would have to pay on the second bond,the convertible,callable bond with the sinking fund,to have it sell initially at par?

Accepted Answer

The second bond's convertible feature and sinking fund would tend to lower its required rate of return,but the call feature would raise its rate.Given these opposing forces,the second bond's required coupon rate could be above or below that of the first bond.However,the convertible feature generally dominates in the real world,so convertibles' coupon rates are generally less than comparable non-convertible issues' rates.

Question 6

Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?

Accepted Answer

Zero coupon bonds have the highest sensitivity to changes in interest rates, which means that they will experience the greatest percentage increase in value if all interest rates in the economy fall by 1%. Thus, the 20-year, zero coupon bond (choice E) would have the greatest percentage increase in value.

Question 7

A 12-year bond has an annual coupon of 9%.The coupon rate will remain fixed until the bond matures.The bond has a yield to maturity of 7%.Which of the following statements is CORRECT?

Accepted Answer

The answer of A 12-year bond has an annual coupon...

Question 8

Other things equal,a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds.

Accepted Answer

Subordinated debentures are considered a riskier form of debt compared to second mortgage bonds. This is because in the event of default, the claims of subordinated debenture holders rank below those of second mortgage bondholders. Therefore, to compensate for this higher risk, a firm will have to pay a higher coupon rate on its subordinated debentures.

Question 9

A 15-year bond with a face value of $1,000 currently sells for $850.Which of the following statements is CORRECT?

Accepted Answer

Since the bond is selling at a discount (i.e., for less than its face value), its yield to maturity must be greater than its coupon rate. Choice A is incorrect because if the bond is selling at a discount, then its coupon rate must be less than its current yield. Choice B is incorrect because the opposite is true – the bond's yield to maturity is greater than its current yield. Choice D is incorrect for the same reason as choice A. Choice E is also incorrect because if the bond's yield to maturity stays constant, its price will increase over time as it approaches maturity, eventually reaching its face value.

Question 10

Which of the following statements is CORRECT?

Accepted Answer

The answer of Which of the following statements is CORRECT?
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Question 11

Three $1,000 face value,10-year,noncallable,bonds have the same amount of risk,hence their YTMs are equal.Bond 8 has an 8% annual coupon,Bond 10 has a 10% annual coupon,and Bond 12 has a 12% annual coupon.Bond 10 sells at par.Assuming that interest rates remain constant for the next 10 years,which of the following statements is CORRECT?

Accepted Answer

Note that Bond 10 sells at par,so the required return on all these bonds is 10%.Bond 10's price will remain constant;Bond 8 will sell initially at a discount and will rise,and Bond 12 will sell initially at a premium and will decline.Note too that since it has larger cash flows from its higher coupons,Bond 12 would be less sensitive to interest rate changes (i.e. ,it has less price risk.It has more default risk).

Question 12

A 10-year corporate bond has an annual coupon of 9%.The bond is currently selling at par ($1,000).Which of the following statements is CORRECT?

Accepted Answer

When a bond is selling at par, its yield to maturity equals its coupon rate, and there are no expected capital gains or losses, hence a zero capital gains yield.

Question 13

You are considering two bonds.Bond A has a 9% annual coupon while Bond B has a 6% annual coupon.Both bonds have a 7% yield to maturity,and the YTM is expected to remain constant.Which of the following statements is CORRECT?

Accepted Answer

Both bonds have a yield to maturity of 7%, which means their current market value is already discounted at this rate. However, as time passes, Bond A's higher coupon rate will become less attractive to investors, who may demand more than 7% yield for a similar bond, causing its price to decrease. On the other hand, Bond B's lower coupon rate will become more attractive, and investors may be willing to pay a premium above its market value to achieve a 7% yield, causing its price to increase. Therefore, the price of Bond A will decrease over time, but the price of Bond B will increase over time.

Question 14

Assume that all interest rates in the economy decline from 10% to 9%.Which of the following bonds would have the largest percentage increase in price?

Accepted Answer

The longest term zero-coupon bond, in this case the 10-year zero-coupon bond, will have the largest percentage increase in price when interest rates decline. This is because zero-coupon bonds pay no interest until maturity and are therefore more sensitive to changes in interest rates. The bond's price is directly linked to the prevailing interest rate, with lower rates resulting in higher bond prices.

Question 15

Which of the following statements is CORRECT?

Accepted Answer

As the yield to maturity represents the total return of a bond, if it increases, the price of the bond must fall to maintain the same level of return for the investor. Therefore, all else being equal, there is an inverse relationship between a bond's yield to maturity and its price. Option A is incorrect because a zero coupon bond does not have a current yield as it does not pay interest. Option B is incorrect because a bond selling at par means its yield to maturity equals its coupon rate, not the other way around. Option D is incorrect because if a bond's yield to maturity exceeds its coupon rate, the bond will actually sell at a discount, not a premium over par. Option E is incorrect because the current yield of a bond is calculated based on its annual coupon payment as a percentage of its price, and does not depend on changes in the bond's yield to maturity.

Question 16

A 10-year bond pays an annual coupon,its YTM is 8%,and it currently trades at a premium.Which of the following statements is CORRECT?

Accepted Answer

Answers c,d,and e are clearly wrong,and answer b is clearly correct.Answer a is also wrong,but this is not obvious to most people.We can demonstrate that a is incorrect by using the following example. 11ea856c_8bcc_fa4d_9aec_896fa98e7f58_TB1222_00 ?
The current yield is greater than 8%.

Question 17

A 10-year Treasury bond has an 8% coupon,and an 8-year Treasury bond has a 10% coupon.Neither is callable,and both have the same yield to maturity.If the yield to maturity of both bonds increases by the same amount,which of the following statements would be CORRECT?

Accepted Answer

We can tell by inspection that c,d,and e are all incorrect.a is also incorrect because the 10-year bond will fall more due to its longer maturity and lower coupon.That leaves Answer b as the only possibly correct statement.Recognize that longer-term bonds,and ones where payments come late (like low coupon bonds)are most sensitive to changes in interest rates.Thus,the 10-year,8% coupon bond should be more sensitive to a decline in rates.You could also do some calculations to confirm that b is correct.

Question 18

Under normal conditions,which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?

Accepted Answer

Adding a call provision to a bond makes it more risky for investors because the issuer has the option to repay the bond before its maturity if interest rates decline. To compensate for this increased risk, issuers typically have to offer a higher coupon rate for the bond to be issued at par.

Question 19

A bond that is callable has a chance of being retired earlier than its stated term to maturity.Therefore,if the yield curve is upward sloping,an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond.

Accepted Answer

The callable bond will be called if rates fall far enough below the coupon rate,but it will not be called otherwise.Thus,the call provision can only harm bondholders.Therefore,callable bonds sell at higher yields than noncallable bonds,regardless of the slope of the yield curve.

Question 20

Which of the following events would make it more likely that a company would call its outstanding callable bonds?

Accepted Answer

When market interest rates decline sharply, a company is more likely to call its outstanding callable bonds to refinance the debt at a lower interest rate, reducing its interest expenses.

Quiz 7: Bonds and Their Valuation

Tucker Corporation is planning to issue new 20-year bonds.The current plan is to make the bonds non-callable,but this may be changed.If the bonds are made callable after 5 years at a 5% call premium,how would this affect their required rate of return?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?

A 12-year bond has an annual coupon of 9%.The coupon rate will remain fixed until the bond matures.The bond has a yield to maturity of 7%.Which of the following statements is CORRECT?

Other things equal,a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds.

A 15-year bond with a face value of $1,000 currently sells for $850.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

A 10-year corporate bond has an annual coupon of 9%.The bond is currently selling at par ($1,000) .Which of the following statements is CORRECT?

You are considering two bonds.Bond A has a 9% annual coupon while Bond B has a 6% annual coupon.Both bonds have a 7% yield to maturity,and the YTM is expected to remain constant.Which of the following statements is CORRECT?

Assume that all interest rates in the economy decline from 10% to 9%.Which of the following bonds would have the largest percentage increase in price?

Which of the following statements is CORRECT?

A 10-year bond pays an annual coupon,its YTM is 8%,and it currently trades at a premium.Which of the following statements is CORRECT?

A 10-year Treasury bond has an 8% coupon,and an 8-year Treasury bond has a 10% coupon.Neither is callable,and both have the same yield to maturity.If the yield to maturity of both bonds increases by the same amount,which of the following statements would be CORRECT?

Under normal conditions,which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?

A bond that is callable has a chance of being retired earlier than its stated term to maturity.Therefore,if the yield curve is upward sloping,an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond.

Which of the following events would make it more likely that a company would call its outstanding callable bonds?