Question 1

Which of the following statements is true of the yield to maturity for a bond?

Accepted Answer

Yield to maturity (YTM) is the total return anticipated on a bond if it is held until it matures. For a bond selling at par value, the YTM comprises only the interest yield and has zero expected capital gains yield since the bond will be redeemed at par value. Therefore, option B is correct while options A, C, D, and E are incorrect.

Question 2

The percentage rate of return that investors earn on a bond consists of a(n):

Accepted Answer

The percentage rate of return on a bond is made up of both the interest yield and any capital gains yield. The interest yield is the annual interest payment divided by the bond's price, while the capital gains yield is the change in the bond's price over a given period of time. Together, these two yields make up the total return earned by investors on a bond.

Question 3

The interest rate on a 10 percent, 10-year zero-coupon bond with a $1,000 face value falls from 8 percent to 7 percent. Which of the following is true of the value of the bond? (Round the answer to two decimal places.)

Accepted Answer

The answer of The interest rate on a 10 percent,...

Question 4

The current market interest rate declines from 10 percent to 8 percent. Due to interest rate reinvestment risk, the bondholders will:

Accepted Answer

Interest rate reinvestment risk refers to the risk that when a bond's cash flows are reinvested at a lower interest rate, it will result in a lower return than expected. As the market interest rate declines, the reinvestment risk increases as the cash flows from the bond will have to be reinvested at a lower rate. Therefore, bondholders will earn a lower return on the reinvested cash flows.

Question 5

If a bond's yield to maturity exceeds its coupon rate, the bond's:

Accepted Answer

When the yield to maturity exceeds the coupon rate, it means the bond is selling at a discount to its par value. This is because investors require a higher yield to compensate for the lower coupon payments. Therefore, the bond's price must be less than its par value in order to provide the higher yield.

Question 6

All else being equal, an increase in the yield to maturity of a bond will result in:

Accepted Answer

An increase in the yield to maturity of a bond will result in a decrease in the market price of the bond. This is because investors will demand a higher return to compensate for the increased risk. As a result, the interest rate price risk will be greater on a long-term bond than on a short-term bond. The maturity value of the bond and the reinvestment rate of the cash flows are not directly affected by the yield to maturity, while the risk of suffering losses in the market values of the bond portfolios will actually increase as the yield to maturity increases. Therefore, B is the best choice as it directly addresses the impact on interest rate price risk.

Question 7

Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10.65 percent currently have a yield to maturity (YTM) equal to 15.25 percent. Based on this information, it is understood that BB&C's bonds must currently be selling at _____ in the financial markets.

Accepted Answer

The YTM is higher than the coupon rate, indicating that the bond is selling at a discount.

Question 8

Omega Inc. holds a 12-year bond that has a 12 percent coupon rate and a marginal tax rate of 40 percent. It is currently selling for $1,000, which is the bond's face value. If interest is paid semiannually, the bond's yield to maturity is:

Accepted Answer

The bond's yield to maturity (YTM) is equal to its coupon rate when the bond is selling at its face value. Since the bond has a 12 percent coupon rate and is selling for its face value of $1,000, its YTM is also 12 percent. The semiannual payments and tax considerations do not affect the calculation of YTM in this context.

Question 9

Stephanie purchased a corporate bond that matures in three years. The bond has a coupon interest rate of 9 percent and its yield to maturity is 6 percent. If market interest rates remain constant and Stephanie sells the bond in 12 months, her capital gain from holding the bond will be:

Accepted Answer

The bond has a coupon rate higher than its yield to maturity, indicating it was purchased at a premium. As the bond approaches maturity, its price will converge towards its face value, resulting in a capital loss if sold before maturity.

Question 10

If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be:

Accepted Answer

When the yield to maturity of a bond is less than its coupon rate, investors are willing to pay more for the bond than its face value because it offers interest payments that are higher than the current market rate. This causes the bond to sell at a premium.

Question 11

The risk that income from a bond portfolio will vary because cash flows must be reinvested at current market rates is called:

Accepted Answer

Interest rate reinvestment risk refers to the possibility that the income from a bond portfolio may fluctuate because the cash flows must be reinvested at the prevailing market rates. This risk is especially relevant for those who rely on income from their investments, such as retirees, and may need to reinvest their cash flows to maintain their level of income.

Question 12

Omega Software Corporation's bond with a face value of $1,000 is currently selling at a premium in the financial markets. If the bond's yield to maturity is 11.5 percent, then the bond's:

Accepted Answer

When a bond sells at a premium, its coupon rate is higher than the yield to maturity.

Question 13

Assuming other things are held constant, which of the following is true of bonds?

Accepted Answer

As a bond's maturity increases, its duration also increases, making it more sensitive to interest rate changes.

Question 14

Which of the following statements is true of the price of a bond that is less than the bond's face value?

Accepted Answer

As a bond approaches maturity, its price tends to converge towards its face value, assuming no default risk, because it will be redeemed at face value at maturity.

Question 15

Which of the following mathematical expressions is used to compute the percentage rate of return on a bond?

Accepted Answer

The percentage rate of return on a bond is calculated using the formula:

Percentage Rate of Return = Current Yield + Capital Gains Yield

where the Current Yield is the ratio of the annual interest payment to the current market price of the bond, and the Capital Gains Yield is the change in the market price of the bond over a period of time, expressed as a percentage of the initial market price.

Question 16

An increase in interest rates will increase the future value of a portfolio because the cash flows produced by the portfolio:

Accepted Answer

When interest rates increase, the cash flows (interest and principal payments) generated by the portfolio can be reinvested at higher rates of return, increasing the future value of the portfolio. Therefore, choice B is correct. The other choices (A, C, D, and E) are either incorrect or not directly related to the question.

Question 17

If interest rates decline, bondholders will earn:

Accepted Answer

When interest rates decline, bond prices will increase, reducing the yield to maturity. As a result, any cash flows that are reinvested will earn a lower rate of return.

Question 18

GP&L sold $1,000,000 of 12 percent, 30-year, semiannual payment bonds 15 years ago. The bonds are not callable, but they do have a sinking fund which requires GP&L to redeem 5 percent of the original face value of the issue each year ($50,000), beginning in Year 11. To date, 25 percent of the issue has been retired. The company can either call bonds at par for sinking fund purposes or purchase bonds in the open market, spending sufficient money to redeem 5 percent of the original face value each year. If the yield to maturity (15 years remaining) on the bonds is currently 14 percent, what is the least amount of money GP&L must put in to satisfy the sinking fund provision? (Round the answer to the nearest whole number.)

Accepted Answer

To satisfy the sinking fund provision, GP&L needs to redeem 5% of the original face value of the issue each year, which is $50,000. Since 25% of the issue has been retired, the remaining amount to be redeemed each year is 5% x 75% x $1,000,000 = $37,500.

GP&L can either call bonds at par for sinking fund purposes or purchase bonds in the open market. Since the yield to maturity on the bonds is currently 14%, it is more expensive to call the bonds at par because they would have to be called at a premium to the par value. Therefore, GP&L should purchase bonds in the open market.

The least amount of money GP&L must put in to satisfy the sinking fund provision is the amount required to purchase bonds with a total face value of $37,500 at a yield to maturity of 14% and 15 years remaining. Using a financial calculator, the present value of this annuity is $43,796. Therefore, the answer is D, $43,796.

Question 19

Which of the following statements is true of a zero coupon bond?

Accepted Answer

A zero coupon bond is issued at a discount and pays no interest, so when interest rates drop, its price increases, potentially above its par value, causing it to sell at a premium.

Quiz 6: Bonds Debtcharacteristics and Valuation