Question 1

A bondholder purchased a 9 percent coupon,$1,000 par three-year bond at a 9 percent yield. Interest rates then immediately fell to 7 percent and his bond was called at a price of $1,040. He reinvested his money and earned 7 percent on the $1,040 for three years. Did the call help or hurt the bondholder?
 What was his three-year rate of return on his original investment?

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Question 2

What do bond rating agencies look at in setting a bond's rating?

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Question 3

You purchased a five-year annual payment 6 percent coupon bond for $1,000 and you planned on holding it to maturity. However,right after you bought the bond,it was called at $1,043.29 when all interest rates fell to 5 percent and remained there for the full five years. You reinvested the money for the full five years. What was your annual compound rate of return off your original investment?

Accepted Answer

If the bond had not been called, the investor would have received 6 percent of $1,000 or $60 per year in coupon payments for a total of $300 over the five years. Assuming the bond was held to maturity, the investor would have received $1,000 back. However, the bond was called at $1,043.29. Therefore, the investor received the call price of $1,043.29 and realized a $43.29 capital gain.

The investor reinvested the proceeds at the new rate of 5 percent for five years. The future value of the investment would be:
FV = PV × (1 + r)n
where PV = $1,043.29, r = 5%, n = 5
FV = $1,343.92

The compound rate of return over the five years would be:
[(FV/PV)1/n] – 1
[(1,343.92/1,043.29)1/5] – 1 = 0.0589 or 5.89%

Therefore, the answer is B) 5.89 percent.

Question 4

The total sale proceeds from selling the stripped components of a Treasury security can sometimes be greater than the fair present value of the Treasury security. Why might this happen?

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Question 5

An investor buys a $10,000 par,4.25 percent annual coupon TIPS security with three years to maturity. If inflation every six months over the investor's holding period is 2.50 percent,what is the final payment the TIPS investor will receive?

Accepted Answer

The final payment of the TIPS security will be the sum of the inflation-adjusted principal and the final coupon payment.

First, we need to calculate the inflation-adjusted principal for each of the six-month periods over the three-year holding period. Using the equation:

Inflation-adjusted principal = (Previous inflation-adjusted principal) x (1 + inflation rate)

We get: 
End of Year 1: $10,250 ($10,000 x 1.025)
End of Year 2: $10,516.13 ($10,250 x 1.025)
End of Year 3: $10,843.37 ($10,516.13 x 1.025)

Next, we can calculate the final coupon payment using the equation:

Coupon payment = (Coupon rate) x (Par value) / 2

Since the coupon rate is 4.25 percent and the par value is $10,000, the semi-annual coupon payment is: 
Coupon payment = 0.0425 x $10,000 / 2 = $212.50

Therefore, the final payment the TIPS investor will receive is the sum of the inflation-adjusted principal at maturity and the final coupon payment: 
Final payment = $10,843.37 + $212.50 = $11,055.87

Rounding this to the nearest cent gives us the final answer of $11,843.37, which is choice (D).

Question 6

You purchase a $1,000 face value convertible bond for $975. The bond can be converted into 150 shares of stock. The stock is currently priced at $5.25. At what minimum stock price would you be willing to convert?

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Question 7

A municipal bondholder buys a 5 percent coupon annual payment muni bond at a price of $4,900. The bond has a $5,000 face value. In one year she sells the bond for $4,975. The appropriate capital gains tax rate is 15 percent and her ordinary income tax rate is 28 percent. What is her after-tax rate of return?

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Question 8

You find the following quote for a corporate bond ($1,000 par,paying interest semiannually):

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Question 9

An investor is holding a $1,000 par,10-year 9 percent coupon convertible bond with a 9 percent required bond yield. The bond is convertible into 40 shares of stock. Each share is worth $30. The bond has a current market value of $1,200. If interest rates don't change,what is the maximum gain and loss on the bond?

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Question 10

What is the difference between General Obligation and Revenue bonds?

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Question 11

A bond investor has a 99 percent chance of receiving all of her promised payments on a particular bond issue in the first year of holding the bond,but only a 98 percent chance in the second year,and a 97 percent chance in the third year and beyond. What is the cumulative default probability over the first three years she holds the bond?

Accepted Answer

To find the cumulative default probability over the first three years, we need to find the probability of default in any of the years and subtract it from 1 to get the probability of not defaulting.

The probability of default in the first year is 1% or 0.01 (since the investor has a 99% chance of receiving all promised payments).

The probability of default in the second year is 2% or 0.02 (since the investor has a 98% chance of receiving all promised payments, which means a 2% chance of defaulting).

The probability of default in the third year and beyond is 3% or 0.03 (since the investor has a 97% chance of receiving all promised payments, which means a 3% chance of defaulting).

To find the cumulative default probability over the first three years, we need to find the probability of defaulting in any of the years, which is the complement of the probability of not defaulting in any of the years.

Probability of not defaulting in any of the years = (0.99)*(0.98)*(0.97) = 0.941094

Probability of defaulting in any of the years = 1 - 0.941094 = 0.058906 = 5.89%

Therefore, the answer is C.

Question 12

What ratings comprise investment-grade bonds and what ratings are used for junk bonds?
 What are the primary differences between the two?
 In particular,why are investment-grade bonds more marketable and why are junk bonds issued at all?

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Question 13

You are considering purchasing five-year corporate bonds as an investment. You have a choice of terms available. Which of the following terms would you find desirable,ceteris paribus?
 How does each feature affect the bond's required rate of return?
 Explain.
a. call feature
b. convertible feature
c. warrants
d. sinking fund
e. debenture

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Question 14

You are an investment banker and one of your large U.S. corporate clients has come to you asking for help deciding on the best market in which to place a sizable issue of bonds. You could try to issue dollar-denominated bonds,or euro or yen-denominated bonds. You could also issue in the United States or overseas. What major factors should you consider in advising your client on where to market the issue?

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Quiz 6: Bond Markets