Question 1

Deltona Motors just issued 225,000 zero coupon bonds. These bonds mature in 20 years, have a par value of $1,000, and have a yield to maturity of 7.45 percent. What is the approximate total amount of money the company raised from issuing these bonds? (Assume semi-annual compounding)

Accepted Answer

Total amount raised = $231.56 × 225,000 = $52.10 million

Question 2

If Treasury bills are currently paying 4.2 percent and the inflation rate is 2.6 percent, what is the approximate real rate of interest? The exact real rate?

Accepted Answer

The approximate real rate of interest can be calculated by subtracting the inflation rate from the nominal rate: 4.2% - 2.6% = 1.6%. The exact real rate can be calculated using the Fisher equation: (1 + nominal rate) / (1 + inflation rate) - 1. Plugging in the values gives us (1 + 0.042) / (1 + 0.026) - 1 = 0.0156 or 1.56%. Therefore, the best choice is A.

Question 3

The Outlet needs to raise $3.2 million for an expansion project. The firm wants to raise this money by selling zero coupon bonds with a par value of $1,000 that mature in 20 years. The market yield on similar bonds is 7.8 percent. How many bonds must The Outlet sell to raise the money it needs? (Assume semi-annual compounding.)

Accepted Answer

The answer of The Outlet needs to raise $3.2 million...

Question 4

If your nominal rate of return is 14.38 percent and your real rate of return is 3.97 percent, what is the inflation rate?

Accepted Answer

The inflation rate can be calculated using the Fisher equation: (1 + nominal rate) = (1 + real rate) * (1 + inflation rate). Solving for the inflation rate gives approximately 10.01 percent.

Question 5

A bond yielded a real rate of return of 3.87 percent for a time period when the inflation rate was 4.75 percent. What was the actual nominal rate of return?

Accepted Answer

The answer of A bond yielded a real rate of...

Question 6

Arts and Crafts Warehouse wants to issue 15-year, zero coupon bonds that yield 7.5 percent. What price should it charge for these bonds if the face value is $1,000? (Assume semi-annual compounding.)

Accepted Answer

We can use the formula for calculating the present value of a bond:

PV = FV / (1 + r)^n

where PV is the present value, FV is the face value, r is the semi-annual yield, and n is the number of semi-annual periods (i.e. years x 2).

In this case, the semi-annual yield is 7.5%/2 = 3.75% and the number of periods is 15 x 2 = 30.

Plugging these values into the formula, we get:

PV = 1000 / (1 + 0.0375)^30
PV = $331.40

Therefore, the price that Arts and Crafts Warehouse should charge for these bonds is $331.40. Option B is the correct answer.

Question 7

A $100,000 Treasury bond has a bid price quote of 115:21 and an asked quote of 115:22. In dollars, what is the value of the bid-ask spread on this bond?

Accepted Answer

To calculate the bid-ask spread, we subtract the bid price from the ask price:
$115,220 - $115,210 = $10.
However, since bond prices are quoted in 32nds, we need to convert this to a dollar value:
$10 / 32 = $0.3125 per bond.
Since there are 100 bonds in a $100,000 treasury bond, the total bid-ask spread is:
$0.3125 x 100 = $31.25.

Question 8

Last year, you earned a rate of return of 11.29 percent on your bond investments. During that time, the inflation rate was 4.6 percent. What was your real rate of return?

Accepted Answer

The answer of Last year, you earned a rate of...

Question 9

Over the next three years, you expect the rate of inflation to decrease, but yet remain positive. After that, you expect inflation to increase steadily for the next several years. Draw a term structure of interest rates graph based on this assumption and identify all the components of that structure.

Accepted Answer

The answer of Over the next three years, you expect...

Question 10

You are buying a bond at a clean price of $1,140. The bond has a face value of $1,000, an 8 percent coupon, and pays interest semiannually. The next coupon payment is 1 month from now. What is the dirty price of this bond?

Accepted Answer

Since the next coupon payment is only 1 month away, we need to add the accrued interest to the clean price to get the dirty price. The semiannual coupon payment is 8%/2 = 4%. Thus, the accrued interest for 1 month is 4%/6 = 0.67%. 
Dirty price = clean price + accrued interest = $1,140 + $1,000 x 0.0067 = $1,173.33.

Question 11

Today, you are buying a $1,000 face value bond at an invoice price of $987. The bond has a 6 percent coupon and pays interest semiannually. There are 2 months until the next coupon date. What is the clean price of this bond?

Accepted Answer

To find the clean price, we need to subtract the accrued interest from the invoice price. 
First, we need to find the amount of accrued interest: 
Coupon payment = (6% x $1,000)/2 = $30 (since it pays semiannually)
Days since last coupon = 2 months x 30 days/month = 60 days
Accrued interest = ($30/6 months) x (60 days/ 180 days) = $10
Now we can find the clean price: 
Clean price = Invoice price - Accrued interest = $987 - $10 = $977.

Question 12

Explain how a zero coupon bond can create taxable income during a year in which the bond pays no interest payments. Also, explain how the annual taxable amount can be computed.

Accepted Answer

The answer of Explain how a zero coupon bond can...

Question 13

Explain what a mortgage backed security (MBS) is and how it functions. Also, explain why these securities were such a problem during 2008.

Accepted Answer

The answer of Explain what a mortgage backed security (MBS)...

Question 14

Smiley Industrial Goods has bonds on the market making annual payments, with 13 years to maturity, and selling for $1,095. At this price, the bonds yield 6.4 percent. What must the coupon rate be on these bonds?

Accepted Answer

The answer of Smiley Industrial Goods has bonds on the...

Question 15

List the various determinants of bond yields and indicate the type of situation that would cause each determinant to increase the yield on a bond.

Accepted Answer

The answer of List the various determinants of bond yields...

Question 16

Jeffries, Inc. has 6 percent coupon bonds on the market that have 11 years left to maturity. The bonds make annual payments. If the YTM on these bonds is 7.4 percent, what is the current bond price?

Accepted Answer

The answer of Jeffries, Inc. has 6 percent coupon bonds...

Question 17

A corporate bond pays 7 percent interest. How much would a municipal bond have to pay to be equivalent to this on an after-tax basis if you are in the 28 percent tax bracket?

Accepted Answer

To find the equivalent municipal bond yield, use the formula: Municipal Yield = Corporate Yield * (1 - Tax Rate). Here, it would be 7% * (1 - 0.28) = 5.04%.

Question 18

Keyser Materials has 8 percent coupon bonds on the market with 19 years to maturity. The bonds make semiannual payments and currently sell for 102 percent of par. What is the current yield on Keyser Materials bonds? The YTM? The effective annual yield?

Accepted Answer

Current yield = (0.08 × $1,000)/(1.02 × $1,000) = 7.84 percent Effective yield = [1 + (0.0779648/2)]² - 1 = 7.95 percent

Question 19

The Deltona Instrument Company has 9 percent coupon bonds on the market with 6 years left to maturity. The bonds make annual payments. If the bond currently sells for $974.60, what is its YTM?

Accepted Answer

The answer of The Deltona Instrument Company has 9 percent...

Question 20

Explain the difference between a bid price and an asked price and also explain why the prices are different.

Accepted Answer

The answer of Explain the difference between a bid price...

Quiz 6: Interest Rates and Bond Valuation