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(Difficulty: E = Easy, M = Medium, and T = Tough)

**True-False Easy:
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Discounted cash flows Answer: b Diff: E 1 . The market value of any real or financial asset, including stocks, bonds, or art work, may be found by determining future cash flows and then discounting them back to the present. a. True b. False Issuing bonds Answer: b Diff: E 2 . If a firm raises capital by selling new bonds, the buyer is called the "issuing firm," and the coupon rate is generally set equal to the required rate. a. True b. False Interest rate risk Answer: b Diff: E 3 . A 20-year original maturity bond with 1 year left to maturity has more interest rate risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates.) a. True b. False Interest rate risk Answer: b Diff: E 4 . Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, be subject to much more interest rate risk if you purchased a 30-day bond than if you bought a 30-year bond. a. True b. False Bond prices and interest rates Answer: a Diff: E 5 . For bonds, price sensitivity to a given change in interest rates generally increases as years remaining to maturity increases. a. True b. False

Chapter 6 - Page 1

Mortgage bond Answer: a Diff: E 6 . Typically, debentures have higher interest rates than mortgage bonds primarily because the mortgage bonds are backed by assets while debentures are unsecured. a. True b. False Debt coupon rate Answer: a Diff: E 7 . Other things equal, a firm will have to pay a higher coupon rate on a subordinated debenture than on a second mortgage bond. a. True b. False Call provision Answer: b Diff: E 8 . A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates. a. True b. False Sinking fund Answer: a 9 . Many bond indentures allow the company to acquire bonds for a fund either by purchasing bonds in the market or by a administered by the trustee for the purchase of a percentage issue through a call at face value. a. True b. False Zero coupon bond Answer: b Diff: E 10 . A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells) at par, therefore providing compensation to investors in the form of capital appreciation. a. True b. False Floating rate debt Answer: a Diff: E 11 . The motivation for floating rate bonds arose out of the costly experience of the early 1980s when inflation pushed interest rates to very high levels causing sharp declines in the prices of long-term bonds. a. True b. False Diff: E sinking lottery of the

Chapter 6 - Page 2

Junk bond Answer: a Diff: E 12 . A junk bond is a high risk, high yield debt instrument typically used to finance a leveraged buyout or a merger, or to provide financing to a company of questionable financial strength. a. True b. False Bond ratings and required returns Answer: a Diff: E 13 . There is an inverse relationship between bond ratings and the required return on a bond. The required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower. a. True b. False

Medium:

Bond value Answer: a Diff: M 14 . If the required rate of return on a bond is greater than its coupon interest rate (and rd remains above the coupon rate), the market value of that bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.) a. True b. False Bond value - annual payment Answer: a Diff: M 15 . You have just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. If the coupon rate is 10 percent, with annual interest payments, and there are 10 years to maturity, you should make the purchase if your required return on investments of this type is 12 percent. a. True b. False Prices and interest rates Answer: a Diff: M 16 . The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things equal and held constant. a. True b. False

Chapter 6 - Page 3

Bond premiums and discounts 17 . A bond with a $100 annual interest payment with five (not expected to default) would sell for a premium were below 9 percent and would sell for a discount were greater than 11 percent. a. True b. False

Answer: a Diff: M years to maturity if interest rates if interest rates

Callable bond Answer: b Diff: M 18 . 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. a. True b. False Indexed bond Answer: b Diff: M 19 . An indexed bond has its value tied to an inflation index. As inflation increases the value of the bond increases and the issuer is responsible for the accumulated value which may become much greater than the original face value. a. True b. False Income bond Answer: b Diff: M 20 . Income bonds pay interest only when the amount of the interest is actually earned by the company. Thus, these securities cannot bankrupt a company and this makes them safer than regular bonds. a. True b. False Restrictive covenants Answer: a Diff: M 21 . Restrictive covenants are designed so as to protect both the bondholder and the issuer even though they may constrain the actions of the firm's managers. Such covenants are contained in the bond's indenture. a. True b. False Sinking fund Answer: b Diff: M 22 . You are considering two bonds. Both are rated double A (AA), both mature in 20 years, both have a 10 percent coupon, and both are offered to you at their $1,000 par value. However, Bond X has a sinking fund while Bond Y does not. This is probably not an equilibrium situation, as Bond X, which has the sinking fund, would generally be expected to have a higher yield than Bond Y. a. True b. False Chapter 6 - Page 4

Floating rate debt Answer: b Diff: M 23 . Floating rate debt is advantageous to investors because the interest rate moves up if market rates rise. Floating rate debt shifts interest rate risk to companies and thus has no advantages for issuers. a. True b. False Bond ratings Answer: a Diff: M 24 . A firm with a low bond rating faces a more severe penalty when the Security Market Line (SML) is relatively steep than when it is not so steep. a. True b. False

**Multiple Choice: Conceptual Easy:
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Interest rates Answer: e Diff: E 25 . One of the basic relationships in interest rate theory is that, other things held constant, for a given change in the required rate of return, the the time to maturity, the the change in price. a. b. c. d. e. longer; smaller. shorter; larger. longer; greater. shorter; smaller. Answers c and d are correct. Answer: e Diff: E

Interest rate and reinvestment risk 26 . Which of the following statements is most correct?

a. All else equal, long-term bonds have more interest rate risk than short term bonds. b. All else equal, higher coupon bonds have more reinvestment risk than low coupon bonds. c. All else equal, short-term bonds have more reinvestment risk than do long-term bonds. d. Statements a and c are correct. e. All of the statements above are correct. Callable bond Answer: a Diff: E 27 . Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds? a. b. c. d. e. A reduction in market interest rates. The company's bonds are downgraded. An increase in the call premium. Answers a and b are correct. Answers a, b, and c are correct. Chapter 6 - Page 5

e. if a bond’s yield to maturity increases. c. its current yield will fall. d. Which of the following statements is most correct? a. None of the answers above (all may reduce the required coupon rate). Change in rating from Aa to Aaa. d. Restrictive covenant. the yield to maturity that would exist without such a call provision will generally be _________________ the YTM with it. Both a and c are correct. None of the answers above is correct. None of the answers above is correct. All else equal. e. All of the following may serve to reduce the coupon rate that would otherwise be required on a bond issued at par. a. than unrelated to Bond coupon rate Answer: c Diff: E 29 . c. the relative price change of a 10-year coupon bond will be greater than the relative price change of a 10year zero coupon bond. Bond concepts 31 . if a bond’s yield to maturity increases. its price will fall. except a a.Call provision Answer: b Diff: E 28 . b. b. then the bond will be trading at a premium. Sinking fund. the bond will sell at a premium over par. If interest rates increase. Which of the following statements is most correct? Answer: c Diff: E a. All of the answers above are correct. depending on the level of call premium.Page 6 . its current yield equals its yield to maturity. If a bond’s yield to maturity exceeds the coupon rate. All else equal. c. Other things held constant. d. c. b. If a coupon bond is selling at par. Answer: a Diff: E Bond concepts 30 . e. higher than lower than the same as either higher or lower. e. Chapter 6 . b. if a bond indenture contains a call provision. If a bond’s yield to maturity exceeds its annual coupon. d. Call provision.

b.Bond concepts Answer: e Diff: E 32 . None of the statements above is correct.Page 7 . All of the statements above are correct. If interest rates have increased since the time a company issues bonds with a sinking fund provision. b. c. c. e. Which of the following statements is most correct? Answer: e Diff: E a. The bond’s yield to maturity is 9 percent. All of the answers above are correct. b. as opposed to calling them in at the sinking fund call price. b. Sinking fund 33 . e. Which of the following statements is most correct? a. Sinking fund provisions sometimes work to the detriment of bondholders – particularly if interest rates have declined over time. Under a sinking fund. d. Types of debt 35 . Sinking fund provision 34 . they only establish “targets” for the company to reduce its debt over time. All of the statements above are correct. c. If the bond’s yield to maturity remains constant. Statements a and b are correct. The sinking fund provision makes a debt issue less risky to the investor. The bond’s current yield is 9 percent. Statements b and c are correct. e. d. d. the company is more likely to retire the bonds by buying them back in the open market. Which of the following statements is most correct? Answer: d Diff: E a. Subordinated debt has less default risk than senior debt. e. Chapter 6 . Both answers a and c are correct.000). Junk bonds typically have a lower yield to maturity relative to investment grade bonds. Both statements a and c are correct. A debenture is a secured bond which is backed by some or all of the firm’s fixed assets. Which of the following statements is most correct? Answer: e Diff: E a. The bond is currently selling at par ($1. Sinking fund provisions do not require companies to retire their debt. Retiring bonds under a sinking fund provision is similar to calling bonds under a call provision in the sense that bonds are repurchased by the issuer prior to maturity. the bond’s price will remain at par. A 10-year corporate bond has an annual coupon payment of 9 percent. d. c. bonds will be purchased on the open market by the issuer when the bonds are selling at a premium and bonds will be called in for redemption when the bonds are selling at a discount.

Medium: Bond yield 36 . 10 percent coupon bond with annual interest payments. Answer: c Diff: M Price risk 39 . A 10-year bond with a 10 percent coupon. A 1-year bond with a 15 percent coupon. therefore. the yield to call is a better measure of return than the yield to maturity. $1. The market value of a bond will always approach its par value as its maturity date approaches. its current yield equals its yield to maturity.Page 8 . c. $1. e. e. Bond yield 37 . A 10-year. Both a and b are correct. Rising inflation makes the actual yield to maturity on a bond greater than the quoted yield to maturity which is based on market prices. b. All of the above have the same price risk since they all mature in 10 years. If a bond is selling at a discount. it has a zero expected capital gains yield. Which of the following statements is most correct? Answer: c Diff: M a. A 10-year. 10 percent coupon bond with semiannual interest payments. A 10-year $100 annuity. Which of the following bonds will have the largest percentage increase in price? a. Which of the following statements is most correct? Answer: b Diff: M a. Both b and c are correct. An 8-year bond with a 9 percent coupon. zero coupon bond. A 10-year zero coupon bond. c. Chapter 6 . b. b. c.000 face value.000 face value. Which of the following has the greatest price risk? a. Price risk Answer: c Diff: M 38 . A 10-year. d. The yield to maturity for a coupon bond that sells at its par value consists entirely of an interest yield. If a coupon bond is selling at par. The current yield on Bond A exceeds the current yield on Bond B. All of the statements above are false. Assume that all interest rates in the economy decline from 10 percent to 9 percent. b. the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.000 face value. c. Bond A must have a higher yield to maturity than Bond B. d. e. On an expected yield basis. This holds true even if the firm enters bankruptcy. $1. d. e. A 3-year bond with a 10 percent coupon. d.

zero coupon bond were issued at a price which gave investors a 10 percent rate of return. and if interest rates then dropped to the point where rd = YTM = 5%. 10-year bond with a 12 percent coupon.Page 9 . e. Price risk Answer: a Diff: M 41 . A A A A A 10-year zero coupon bond. 5-year bond with a 12 percent annual coupon. All of the statements above are correct. b. a corporation would rather issue noncallable bonds than callable bonds. The market value of a bond will always approach its par value as its maturity date approaches. e. d. d. Bond concepts 43 . Other things held constant. zero coupon bond were issued at a price which gave investors a 10 percent rate of return. b. Other things held constant. 10-year bond with a 10 percent semiannual coupon. d. Answer: e Diff: M Bond concepts 42 . If a 10-year. c. which of the following bonds would have the largest percentage increase in value? a. 10-year zero-coupon bond.000 par. If the Federal Reserve unexpectedly announces that it expects inflation to increase. d. which of the following bonds will have the largest percentage increase in its value? a. b. Reinvestment rate risk is worse from a typical investor's standpoint than interest rate risk. c. If interest rates fall from 8 percent to 7 percent. Which of the following statements is most correct? Answer: d Diff: M a. c. A A A A A 1-year bond with an 8 percent coupon. Chapter 6 .000 par. If a 10-year. 10-year bond with a 10 percent annual coupon.000 par value. e. 10-year bond with an 8 percent coupon. e. 1-year zero-coupon bond. we could be sure that the bond would sell at a discount below its $1. a callable bond would have a lower required rate of return than a noncallable bond. Statements a and c are correct. If the yield to maturity decreased 1 percentage point. then we would probably observe an immediate increase in bond prices.000 par value. provided the issuer of the bond does not go bankrupt. $1. b.Price risk Answer: c Diff: M 40 . and if interest rates then dropped to the point where rd = YTM = 5%. 5-year zero coupon bond. we could be sure that the bond would sell at a premium over its $1. $1. c. The total yield on a bond is derived from interest payments and changes in the price of the bond. Which of the following statements is most correct? a.

Debentures generally have a higher yield to maturity relative to mortgage bonds. b. Statements b and c are correct. c. The bond’s yield to call is less than 12 percent. a zero coupon bond could trade for an amount above its par value. Both answers a and c are correct. b. If a coupon bond is selling at par. Both b and c are correct. b. d. Bond concepts 45 .000. All else equal. d.Bond concepts 44 . Chapter 6 . The price of a discount bond will increase over time. The bond’s current yield is greater than 10 percent. Which of the following statements is most correct? a. If there are two bonds with equal maturity and credit risk. The bond can be called in 5 years at a call price of $1. this implies that the bond’s yield to maturity exceeds its coupon rate.Page 10 . e. the bond which is callable will have a higher yield to maturity than the bond which is noncallable. c. A 10-year bond has a 10 percent annual coupon and a yield to maturity of 12 percent. d. e. a bond that has a coupon rate of 10 percent will sell at a discount if the required return for a bond of similar risk is 8 percent. Answers a and c are correct. Which of the following statements is most correct? Answer: e Diff: M a. Bond concepts 46 .050 and the bond’s face value is $1. e. If rates fall after its issue. d. e. All else equal. The bond is selling at a price below par. The total return on a bond for a given year consists only of the coupon interest payments received. c. a bond that has a coupon rate of 10 percent will sell at a discount if the required return for a bond of similar risk is 8 percent. Which of the following statements is most correct? Answer: b Diff: M a. Which of the following statements is most correct? Answer: b Diff: M a. b. its current yield equals its yield to maturity. assuming that the bond’s yield to maturity remains constant over time. Answers b and c are correct. All of the statements above are correct. None of the statements above is correct. c. None of the above answers is correct. If a bond is selling for a premium. Bond concepts Answer: d Diff: M 47 .

Two bonds have the same maturity and the same coupon rate. other things held constant. Therefore. the required rate of return will be lower on the callable bond. if the yield curve is upward sloping. Two bonds have the same maturity and the same coupon rate. The actual life of a callable bond will be equal to or less than the actual life of a noncallable bond with the same maturity date. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used. c. However. A callable 10-year. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate. Chapter 6 . Further.Callable bond 48 . Distant cash flows are generally riskier than near-term cash flows. than an otherwise similar noncallable 20-year bond.Page 11 . d. one is callable and the other is not. 10 percent bond should sell at a higher price than an otherwise similar noncallable bond. d. However. Statements a and b are false. Callable bond 49 . assuming other characteristics are similar. investors should require a lower rate of return on the callable bond than on the noncallable bond. Statements a and b are correct. Therefore. Which of the following statements is most correct? Answer: d Diff: M a. Moreover. one is callable and the other is not. Therefore. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate. callable bonds expose investors to less interest rate risk than noncallable bonds. a 20-year bond that is callable after 5 years will have an expected life that is probably shorter. and certainly no longer. Which of the following statements is most correct? Answer: b Diff: M a. b. b. the interest rate risk faced by investors is greater the longer the maturity of a bond. e. A noncallable 20-year bond will generally have an expected life that is equal to or greater than that of an otherwise identical callable 20-year bond. c.

One disadvantage of zero coupon bonds is that issuing firms cannot realize the tax savings from issuing debt until the bonds mature.000.000 bond with $100 annual interest payments with five years to maturity (not expected to default) would sell for a discount if interest rates were below 9 percent and would sell for a premium if interest rates were greater than 11 percent. Chapter 6 . e. A 10-year 10 percent coupon bond has less reinvestment rate risk than a 10-year 5 percent coupon bond (assuming all else equal). e. If debt is used to raise the million dollars. these securities cannot bankrupt a company and this makes them safer to investors than regular bonds. the cost of the debt would be lower if the debt is in the form of a bond rather than a term loan. d. c. The total return on a bond for a given year arises from both the coupon interest payments received for the year and the change in the value of the bond from the beginning to the end of the year. The price of a 20-year 10 percent bond is less sensitive to changes in interest rates (i.e. and c are correct statements.000 is raised as a first mortgage bond on the new plant and $500. Miscellaneous concepts 52 . e. All of the statements above are false. Thus. If debt is used to raise the million dollars. All of the above statements are false. the cost of the debt would be lower if the debt is in the form of a fixed rate bond rather than a floating rate bond. The company would be especially anxious to have a call provision included in the indenture if its management thinks that interest rates are almost certain to rise in the foreseeable future. but $500. callable bonds should have a lower yield to maturity than noncallable bonds. A $1. Other things held constant.Types of debt Answer: c Diff: M 50 . b.000 to finance a new plant. the interest rate on the first mortgage bond would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds. If debt is used to raise the million dollars. Which of the following statements is most correct? Answer: b Diff: M a.000 as debentures. c. A company is planning to raise $1. Which of the following statements is most correct? Answer: b Diff: M a.Page 12 . A firm with a sinking fund payment coming due would generally choose to buy back bonds in the open market. b. Income bonds pay interest only when the amount of the interest is actually earned by the company. if the price of the bond exceeds the sinking fund call price. d. b. Which of the following statements is most correct? a.. Answers a. b. Miscellaneous concepts 51 . d. has lower interest rate price risk) than the price of a 5-year 10 percent bond. c.

10 percent coupon bond which matures in 10 years. 12-year Treasury bond with a 10 percent annual coupon. d.. Chapter 6 . Statements a and b are correct. b. If a callable bond is trading at a premium. 10 percent coupon bonds. c. e. Interest rate risk Answer: a Diff: M 55 . All treasury securities have a yield to maturity of 7 percent--so the yield curve is flat. c. Answer: e Diff: M Current yield and yield to maturity 56 . If a bond sells at par. c. A 20-year bond with semiannual interest payments has higher price risk (i. e. b. better) bond rating than a 20-year bond. b. a bond selling for more than par with ten years to maturity will have a lower current yield and higher capital gain relative to a bond that sells at par.Page 13 . d. Assuming that both bonds are held to maturity and are of equal risk. d.. 9 percent coupon bond which matures in 10 years. 12 percent coupon bond which matures in 7 years. which of the following bonds would have the largest percentage increase in price? a. Which of the following statements is most correct? Answer: e Diff: M a.Miscellaneous concepts 53 .e. 15-year zero coupon Treasury bond. 15-year Treasury bond with a 12 percent annual coupon. Interest rate risk Answer: a Diff: M 54 . then its current yield will be less than its yield to maturity. e. e. a 1-year bond will have a higher (i. then its yield to maturity is less than its coupon rate. 10-year zero coupon bonds have higher reinvestment rate risk than 10-year. Which of the following Treasury bonds will have the largest amount of interest rate risk (price risk)? a.e. If a bond sells for less than par. c. Which of the following statements is most correct? a. Answers a and c are correct. If the yield to maturity on all Treasuries were to decline to 6 percent. None of the answers above is correct. then you would expect to earn the yield-to-maturity. All else equal. A A A A A 7 percent coupon bond which matures in 12 years. interest rate risk) than a 5-year bond with semiannual interest payments. d. b. 2-year zero coupon Treasury bond. 2-year Treasury bond with a 15 percent annual coupon. 7 percent coupon bond which matures in 9 years.

Chapter 6 . b. Which of the following statements is most correct? a. Default risk 59 . b. secured debt is considered to be less risky than unsecured debt. e. Answers a and c are correct. All else equal. Corporate bonds and default risk 58 . All of the answers above are correct. e. Statements a and c are correct. The expected return on corporate bonds will generally exceed the yield to maturity. Which of the following statements is most correct? Answer: b Diff: M a. the bond’s price will be the same one year from now. this is likely to reduce the default premium on its existing bonds. All else equal. None of the answers above is correct. c. e. this is likely to reduce the default premium on its existing bonds. b. Both a and b are correct. An indenture is a bond that is less risky than a subordinated debenture.Current yield and yield to maturity Answer: a Diff: M 57 . d.Page 14 . The bond’s current yield is greater than 10 percent. Statements a and c are correct. All else equal. You just purchased a 10-year corporate bond that has an annual coupon of 10 percent. Default risk 60 . Which of the following statements is most correct? Answer: d Diff: M a. If a company increases its debt ratio. An indenture is a bond that is less risky than a subordinated debenture. None of the answers above is correct. All of the answers above are correct. c. b. The bond’s yield to maturity is less than 10 percent. e. Which of the following statements is most correct? Answer: c Diff: M a. d. d. d. If the bond’s yield to maturity stays constant. senior debt will generally have a lower yield to maturity than subordinated debt. The bond sells at a premium above par. The expected return on a corporate bond is always less than its promised return when the probability of default is greater than zero. c. If a company increases its debt ratio. c. senior debt has less default risk than subordinated debt.

b. c. assume other things are held constant. If two bonds have the same maturity. If a company is retiring bonds for sinking fund purposes it will buy back bonds on the open market when the coupon rate is less than the market interest rate. Bond concepts Answer: b 63 . the bond's current yield must also exceed its coupon rate. Answers b and c are correct. Both a and c are correct. All of the statements above are correct. Tough: Bond yields and prices 62 . d. A 20-year zero coupon bond has less reinvestment rate risk than a 20-year coupon bond. d. the bonds should sell for the same price regardless of the bond's coupon rate.Page 15 . and the same level of risk. Which of the following statements is most correct? Answer: b Diff: T a. Chapter 6 . Price sensitivity. b. the same yield to maturity. For any given maturity. a given percentage point increase in the interest rate causes a smaller dollar capital loss than the capital gain stemming from an identical decrease in the interest rate. that is. the change in price due to a given change in the required rate of return. the bond's price must be less than its maturity value. b. None of the answers above is correct. For a given bond of any maturity. A bond sinking fund would be good for investors if interest rates have declined after issuance and the investor’s bonds get called. Which of the following statements is correct? Answer: d Diff: M a. Mortgage bonds have less default risk than debentures. If a bond's yield to maturity exceeds its coupon rate. d. e. c. e.Sinking funds and default risk 61 . interest paid on bonds is taxdeductible. e. a given percentage point increase in the interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from an identical decrease in the interest rate. If a bond's yield to maturity exceeds its coupon rate. increases as a bond's maturity increases. Diff: T of the a. c. From a borrower's point of view. Which of the following is not true about bonds? In all statements.

4. 3. but all 10-year bonds have the same interest rate risk. 4. e. 2. an increase in interest rates will have a greater effect on higher-coupon bonds than it will have on lower-coupon bonds. 3.Page 16 . Answers a and c are correct. c. each viewed alone. c. 3. 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. a 5 percent coupon bond would have more interest rate risk than a 10 percent coupon bond. 6 4. Zero coupon bonds have more interest rate risk than any other type bond. have a sinking fund. 6 6 Chapter 6 . Listed below indentures: 1. All of the statements above are correct. 5. be subordinated to other classes of debt. 1. c. b.Bond concepts 64 . d. even perpetuities. Which of the following statements is most correct? Answer: c Diff: T a. If their maturities were the same. e. 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. 1. Which of the following statements is most correct? Answer: e Diff: T a. A 10-year bond would have more reinvestment rate risk than a 5-year bond. 1. e. have a call provision. 5. All else equal. 3. would tend to reduce the yield to maturity investors would otherwise require on a newly issued bond? a. are some provisions that are often Answer: d Diff: T contained in bond Fixed assets The bond may The bond may The bond may The bond may The bond may may be used as security. 6 4. If their maturities were the same. b. Bond indenture 66 . 3. Interest vs. 6 5. 1. but all 10-year bonds have the same reinvestment rate risk. a 5 percent coupon bond would have less interest rate risk than a 10 percent coupon bond. reinvestment rate risk 65 . be made convertible. d. 4. 2. b. have restrictive covenants in its indenture. 4. A 10-year bond would have more interest rate risk than a 5-year bond. Which of the above provisions. 1. All else equal. d. 2. 6.

a face value of $1. the debentures.103. 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.Page 17 .000. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds. an annual coupon rate of 10 percent.76 $1.Weighted average cost of debt Answer: e Diff: T 67 . If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds. Multiple Choice: Problems Easy: Bond value . c. e. Interest rates on the two types of bonds would vary as their percentages were changed. b. consequently. d. c.74 $1. Assume that you wish to purchase a bond with a 30-year maturity. and hence the interest rate on. and semiannual interest payments. what is the maximum price you should be willing to pay for the bond? a.63 Chapter 6 .106. In this situation. If you require a 9 percent nominal yield to maturity on this investment. d.semiannual payment Answer: c Diff: E 68 . The higher the percentage of total debt represented by debentures. e. the company can never borrow any more money.19 $1. we could be absolutely certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds. the higher the firm’s total dollar interest charges will be. we could be absolutely certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of debentures. we cannot tell for sure how.149. the riskier both types of bonds will be.35 $1. Which of the following statements is most correct? a. the firm's total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. and. 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 greater the risk of.102. The higher the percentage of total debt represented by mortgage bonds. $905. or whether. b. By an iron-clad provision in its charter.

$ 826. d. a face value of $1. 8.431. what is the annual nominal yield to maturity on the bond? a.31 $1.Yield to maturity Answer: b Diff: E 69 . 9% c.000. A bond has an annual 8 percent coupon rate. a maturity of 20 years. Assume that you wish to purchase a 20-year bond that has a maturity value of $1.000 face value bond that pays interest of $60 every 6 months. b. a face value of $1. $619 $674 $761 $828 $902 Chapter 6 . It has a yield to maturity of 8. e. None of the above Bond value .124.62 Bond value . what rate of return will an investor expect to receive during the next year? a. and makes annual payments. what is the maximum price you should be willing to pay for the bond? a. $1. If the price is $1. 11.Page 18 . If you require a 10 percent nominal yield to maturity on this investment. c.semiannual payment Answer: e Diff: E 71 . 9.49 $1. b. If your nominal annual required rate of return is 10 percent with semiannual compounding.000 and makes semiannual interest payments of $40.17% d.semiannual payment Answer: d Diff: E 72 .50 $1. a maturity of 10 years. how much should you be willing to pay for this bond? a.33% b. 11% e. A bond has an annual 11 percent coupon rate.15 $ 957.83% c.000.96.200. You intend to purchase a 10-year. e.83 percent. an annual interest payment of $110. 10% d. c. If the price is $934. 8% b. and makes semiannual payments. d. 12% Return on a bond Answer: b Diff: E 70 .086.00% e. -0.

8.52% e.00% d. 7.00% b. then at what rate should Rollincoast expect to issue new bonds? a.5 percent.391.Page 19 .Bond value . 8.46% c.8% b.36 $1. 9. If your nominal annual required rate of return is 12 percent with quarterly compounding. The current risk premium on BBB bonds versus government bonds is half what it was two years ago. 7. 10. e. b.8 percent. If the risk-free long-term governments are currently yielding 7. how much should you be willing to pay for this bond? a. maturity.000 par value bond pays interest of $35 each quarter and will mature in 10 years.57 $1.00 $ 825.quarterly payment Answer: c Diff: E 73 . 8.9% Chapter 6 . What is the current required return on the bond is 10 a. 10. 12. Rollincoast Incorporated issued BBB bonds two years ago that provided a yield to maturity of 11.000 par value bond bond pays interest annually.7% c. Consider a $1. The There are 9 years remaining until yield on the bond assuming that the percent? Current yield 74 . d.2% e.37% Risk premium on bonds Answer: c Diff: E 75 . $ 941.051.115. 8.7 percent at that time. c.25 $1.2% d. Long-term risk-free government bonds were yielding 8.49 Answer: b Diff: E with a 7 percent annual coupon. A $1.

and a par value of $1.580 Chapter 6 . The postponed payments will accrue interest at an annual rate of 6 percent. for Years 5 through 8.84 $266. Euler is on the brink of bankruptcy. Unfortunately. Marie Snell recently inherited some bonds (face value $100. $538. b. e. 2024. If Marie sells her bonds now and puts the proceeds into an account which pays 10 percent compounded annually. a University of Florida marketing graduate. Ltd. d.000) from her father.88 $249. what would be the largest equal annual amounts she could withdraw for two years. These bonds have 8 years remaining to maturity. and new annual coupon bonds with similar risk and maturity are currently yielding 12 percent.Page 20 . including yourself. have agreed to a postponement of the next 4 interest payments (otherwise. Interest on these bonds is paid annually on December 31 of each year. an annual coupon payment of $80.annual payment Answer: a Diff: M 77 .255 $29.000.98 Bond value . is now 28 percent. considering their substantial risk. and they will then be paid as a lump sum at maturity 8 years hence.305 $14. What is the present value of each bond? a.654 $25. and it is now January 1. d. 2004. The creditors. c. c. will be made as scheduled.e.708 $12. You are the owner of 100 bonds issued by Euler.Medium: Bond value .73 $384. 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 remaining interest payments.annual payment Answer: d Diff: M 76 . $13. The required rate of return on these bonds.21 $426. the first payment today and the second payment one year from today)? a. beginning today (i. two payments. the next interest payment would have been due in 1 year). The 2 percent annual coupon bonds mature on January 1.. b. and soon thereafter she became engaged to Sam Spade. e.

$1. Due to additional financing needs. You (and other investors) currently require a nominal annual rate of 16 percent. a par value of $1. These bonds pay $60 in interest each six months. how many new bonds must JRJ issue to raise $2.81 $1. Assume that you are considering the purchase of a $1. Their price has remained stable since they were issued.00 $1.000 cash? a. $ 842.783 $ 550 $ 450 Bond value . e. e.596 3. you expect to hold it for 5 years and then to sell it in the market.000 4.275 Bond value .000.semiannual payment Answer: d Diff: M 78 .26 $ 966. e. d. 2.400 2. a major chemical manufacturer has recently experienced a market reevaluation.000.000. i.000 $7. d.85 Chapter 6 ..000.Bond value . they still sell for $1.semiannual payment Answer: d Diff: M 80 . with interest paid semiannually. c. c.000 par value bond that pays interest of $70 each six months and has 10 years to go before it matures.e. b. JRJ Corporation recently issued 10-year bonds at a price of $1. c. The required nominal rate on this debt has now risen to 16 percent. the firm wishes to issue new bonds that would have a maturity of 10 years. and pay $40 in interest every six months. If both bonds have the same yield. d.000 5.Page 21 . If you buy this bond. but you expect the market to require a nominal rate of only 12 percent when you sell the bond due to a general decline in interest rates.115.273 $1. b. b.359.99 $ 731. Due to a number of lawsuits related to toxic wastes. How much should you be willing to pay for this bond? a. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent. What is the current value of this bond? a.semiannual payment Answer: b Diff: M 79 .

000. 2014.000 face value bond pays interest of $37. $5.000.207. so the bonds now sell below par.120. d.000 $2. and a par value of $1. If your client is to earn a nominal rate of return of 12 percent. how much should she pay for the bond? a. They mature on January 1.) a.216 $ 981 Market value of bonds Answer: a Diff: M 83 .000. c. What is the current market value of the firm's debt? a.50 every 3 months.71 $1.000 The bonds have a 4 percent coupon rate. c. $1.056.000 par value bond with a 10 percent coupon. Interest on this bond is paid quarterly.000. KJM Corporation's balance sheet as of today.412.531. it is necessary to convert its balance sheet figures to a market value basis.000 2.000.24 Bond value . $1.000. $ 800 $ 926 $1.000 $7.Page 22 .480. 2004. payable semiannually. is as follows: Long-term debt (bonds.1697.706.6748 and 0. e.000 10. with quarterly compounding. at par) Preferred stock Common stock ($10 par) Retained earnings Total debt and equity $10.000 4. how much should you be willing to pay for this bond? (Hint: The PVIFA and PVIF for 3 percent. respectively.025 $1. January 1.358.43 $1. d. b. Your client has been offered a 5-year. d.quarterly payment Answer: b Diff: M 82 . b.000 Chapter 6 .92 $1.000 $26.000 $5. b.quarterly payment Answer: b Diff: M 81 . If you require a nominal annual rate of return of 12 percent. c. e. Assume that a 15-year.57 $ 986.000 $7. 60 periods are 27.Bond value . e. The yield to maturity is 12 percent. $ 821. compounded quarterly. In order to accurately assess the capital structure of a firm.

b. Interest on this bond is paid every six months.150 Answer: c Diff: M with an 11 percent annual coupon. You just purchased a 15-year bond The bond has a face value of $1. d.000 Assuming that the yield to maturity what will be the price of the bond 1 a. has 100 bonds outstanding (maturity value = $1. what is the annual coupon rate on this bond? a. b. and a current yield of 10 percent. d. The bonds mature in 5 years. e.158.100 $1. and their current market value is $768 per bond.000). 8% 6% 4% 2% 0% Bond coupon rate Answer: d Diff: M 86 . Cold Boxes Ltd. e. and interest is paid semiannually. $1. b.000 $1. e. The current price of a 10-year. d. 10% 12% 14% 17% 21% Chapter 6 . c.000 par value bond is $1. The nominal required rate of return on these bonds is currently 10 percent.Future value of bond 84 .91.7072 percent remains constant. What is the annual coupon interest rate? a. c. c.Page 23 . Given these facts. year from now? Bond coupon rate Answer: c Diff: M 85 . of 9. $1. and the nominal annual yield is 14 percent.064 $1.097 $1.

000 of 12 percent. However. e.856 $50. d.31 $362. b.000. 30-year. $43. at maturity (Year 10). paid annually.000 $37. If the nominal yield to maturity (15 years remaining) on the bonds is currently 14 percent.000). If the required annual return is 20 percent.422 Chapter 6 . The bonds are not callable. Recently. c. b. c. no interest will be paid on the deferred interest. and the court permitted a new indenture on an outstanding bond issue to be put into effect. Then.69 Bond sinking fund payment Answer: d Diff: T 88 .. The new agreement allows the firm to pay no interest for 5 years. the principal plus the interest that was not paid during the first 5 years will be paid. what should the bonds sell for in the market today? a. The company can either call bonds at par for sinking fund purposes or purchase bonds on the open market. interest payments will be resumed for the next 5 years.69 $578. $242. d.Tough: Bond value Answer: d Diff: T 87 . what is the least amount of money GP&L must put up to satisfy the sinking fund provision? a. Finally.26 $281. GP&L sold $1.500 $43. e.796 $39. 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. spending sufficient money to redeem 5 percent of the original face value each year. 25 percent of the issue has been retired. The issue has 10 years to maturity and a coupon rate of 10 percent. Ohio Hospitals Inc. filed for bankruptcy. To date. semiannual payment bonds 15 years ago. beginning in Year 11. The firm was reorganized as American Hospitals Inc.Page 24 .44 $813.

d.05% Chapter 6 .52% = 7. b. Palmer Products has outstanding bonds with an annual 8 percent coupon. d. YTC = 3. b.Financial Calculator Section Multiple Choice: Problems Easy: Bond value .13% c. 10. YTC = 4.09% b. A corporate bond with a $1.89% YTM and YTC Answer: e Diff: E 92 . YTM YTM YTM YTM YTM = 14.38 $1.19 Yield to maturity Answer: a Diff: E 91 . 11. e. A corporate bond matures in 14 years. e. c. What is the yield to maturity on the bonds? a.064.29%. e. The bond is callable in five years at a call price of $1.050. What are the bond’s yield to maturity and yield to call? a.078.25% d.99 $1.259.semiannual payment Answer: c Diff: E 89 . The bond has an 8 percent semiannual coupon and a par value of $1.000 and a price of $865.075. YTC = 14.34% = 6. b. c.065.000.094. 9. 8.00 $ 739.000 face value pays a $50 coupon every six months. What is the price of the bond? a.14%.18 $1. The bond will mature in ten years.04 $1. The bonds have a par value of $1. $ 634. The nominal yield to maturity is 11 percent. The bonds will mature in 11 years. c. $ 784.78% = 7.000 face value and an 8 percent annual coupon pays interest semiannually.27 $ 781. and has a nominal yield to maturity of 9 percent. The price of the bond today is $1. d. YTC = 7.56 Bond value .64%.86 $1.semiannual payment Answer: b Diff: E 90 .23 $1.00% e.09% = 3. What is the price of the bond today? a. The bond will mature in 15 years. 9.000. A bond with a $1. YTC = 7.14%.Page 25 .57%.

10.5 percent and a par value of $1. and pays an 8 percent annual coupon. 7. 9.37%.000 has a 9 percent annual coupon.12%. The bond matures in 12 years and sells at a price of $1. 8. b.65% c. d. $ 966.000. the bond has a 10 percent semiannual coupon). 10.00 Chapter 6 . and currently sells for $985. The bond currently sells for $925.12%. The bond has a yield to maturity of 9.79 $ 831. 8. and pays a $50 coupon every six months (i.35 $1.15% c. d. 8.000.5 percent.14% e.78% Yield to maturity and bond value--annual Answer: d Diff: E 96 . 6.28% b. c. The bond has a face value of $1. 8. yield yield yield yield yield to to to to to maturity maturity maturity maturity maturity = = = = = 7.92%. 8.00 $ 933..37%. What is the bond’s current yield? a. Yield on semiannual bond Answer: c Diff: E 95 . Current Current Current Current Current yield yield yield yield yield = = = = = 8.31% e. c. A bond matures in 12 years.20%.00%. 8.080.21% Current yield and yield to maturity Answer: b Diff: E 94 .36% b.90% d.090.12%. 8. What is the bond’s current yield and yield to maturity? a. e. 8. If the bond’s yield to maturity remains at its current rate.09 $ 925. 9.92%.e.Current yield Answer: d Diff: E 93 . What is the bond’s nominal yield to maturity? a.Page 26 . 8. e. what will be the price of the bond 5 years from now? a. A 20-year bond with a par value of $1. A 12-year bond pays an annual coupon of 8. A corporate bond has a face value of $1.20%.000. 8.95% d. b. 2. 8.

036.89% d.Medium: Bond value .77 $1.00% Yield to call Answer: d Diff: M Chapter 6 . a.23 Call price Answer: c Diff: M 98 ..27 $1.86 854. What should be the price of a 10-year noncallable bond of equal risk which pays an 8 percent semiannual coupon? Assume both bonds have a par value of $1. e. The bonds have a nominal yield to maturity of 8 percent and a yield to call of 7.34 $1.000. $ $ $ $ $ 898.00% e. The bonds may be called in five years. Also. d. Hood Corporation recently issued 20-year bonds. 10. what is the yield to call? a.000. b.025. c.5 percent. 9. Kennedy Gas Works has bonds which mature in 10 years. An 8 percent annual coupon.048.1 percent. and have a face value of $1.75% c. the nominal coupon rate is 10 percent). 7.Page 27 . c.e. If the yield to maturity is 7 percent. $ 379. b. The par value of the bonds is $1. d.33% b. What is the call price on the bonds? a. 7.64 736. noncallable bond has ten years until it matures and a yield to maturity of 9.09 964.27 941. The bonds have a coupon rate of 8 percent and pay interest semiannually. 8. The bonds have a 10 percent quarterly coupon (i.136. the bonds are callable in 6 years at a call price equal to 115 percent of par value.semiannual payment Answer: d Diff: M 97 .00 $1.000.78 Yield to call Answer: b Diff: M 99 . e.

000.82% 8. A corporate bond which matures in 12 years.65% 9. 13. The bond can be called 3 years from now at a price of $1. The maturity value is $1. c. d.41% 8. The call price is $1. e.50% 8.100 . b.000 par value has a nominal yield to maturity of 9 percent. What is the bond’s nominal yield to call? a.000.45% Yield to call Answer: b Diff: M 103 .25% 8. A bond that matures in 11 years has an annual coupon rate of 8 percent with interest paid annually.5 percent. 9.50% d.58% 8.88% 8. A corporate bond with an 11 percent semiannual coupon has a yield to maturity of 9 percent. The bond matures in 20 years but is callable in ten years. 8. 7. 6. 7. c.00% Yield to call Answer: c Diff: M 101 . The bond’s face value is $1.43% 8.10% c.060. d. A 12-year bond with a 10 percent semiannual coupon and a $1.98% 9. and a yield to maturity of 7. b.055.54% 8.00% Yield to call Answer: a Diff: M 102 .050. b. The bond can first be called four years from now. What is the bond's nominal yield to call? a.000 and its yield to maturity is 7.5 percent.050. e.Page 28 . 4.38% 7. What is the bond's yield to call? a. The bond can be called in five years at a call price of $1. What is the bond’s yield to call? a.50% 8. 11.73% b. The call price is $1. d. has a face value of $1. e. c. pays a 9 percent annual coupon.86% e.86% Chapter 6 .

McGriff Motors has bonds outstanding which will mature in 12 years.88. The coupon rate (and yield to maturity) on the bonds is 8 percent (with annual payments) and the bonds will mature in 10 years. c. 5. c.10% Interest payments remaining Answer: b Diff: M 107 . d.Yield to call Answer: b Diff: M 104 . You have just been offered a $1. A 15-year bond with a 10 percent semiannual coupon has a par value of $1. e. d.07% 9. 12. The bonds are callable in 8 years and have a call price of $1.89% c. 14 15 12 20 10 Chapter 6 . 9.000 (i.050. b.000.00% After-tax yield to call Answer: c Diff: M 105 . e. or annual basis? a.75% 6. b. The bonds currently have a yield to maturity of 10 percent. The bond has a nominal yield to call of 6.89% b. but the party selling the bond cannot remember.000 par value bond for $847. What are the bonds' yield to call? a. What is the after-tax yield to call for an investor with a 31 percent tax rate? a.97% 6. the bonds pay a $60 coupon every six months).90% 6. The bonds pay a 12 percent semiannual coupon and have a face value of $1. c. A company is issuing $1. Can you determine how many interest payments remain? a.5 percent. 9. 10. d. and annual interest rates on new issues of the same degree of risk are 10 percent.e. payable annually. The bond may be called after 10 years at a call price of $1. 8. stated on a nominal. e.000 bonds at par value.60% 7.050. b.. The coupon rate is 8 percent.Page 29 .94% d.00% e. You want to know how many more interest payments you will receive. 5.52% Yield to maturity Answer: d Diff: M 106 .30% 6. The bonds can be called at a call premium of 5 percent above face value after 3 years. What is the bond's yield to maturity.95% 7.52% 5.

05 $980. The Burger King bond has an annual coupon rate of 8 percent and matures 20 years from today. The McDonald's bond has a coupon rate of 8 percent.00% Bond value Answer: e Diff: M 109 .00%. is 12 percent. Current Current Current Current None of yield = 8. b.28 Chapter 6 .53 $ 6. d. Meade Corporation bonds mature in 6 years and have a yield to maturity of 8. for both bonds.85% 0.77 $17.000. What are the current yield and capital gains yield on the bonds for this year? (Assume that interest rates do not change over the course of the year). The bonds are equally risky. capital gains yield = 10.50%. semiannual basis. A 6-year bond which pays 8 percent interest semiannually sells at par ($1. what is the difference in current market prices of the two bonds? a. d. Both bonds are non-callable and have a face value of $1. c. capital gains yield = 9.43 $986.64 Tough: Bond value Answer: d Diff: T 110 .35%. e. The par value of the bonds is $1. The bonds have a 10 percent coupon rate and pay interest on a semiannual basis. a. If the nominal required rate of return. b. capital gains yield = 9. rd. with interest paid semiannually. What is the price of the bond which pays annual interest? a.35%. No difference. b. c. d.65% -0.000. Another 6-year bond of equal risk pays 8 percent interest annually.000).50% 0. yield yield yield yield = = = = 1.Current yield and capital gains yield Answer: c Diff: M 108 . Assume that McDonald's and Burger King have similar $1. $ 2. e. e. c.08 $712. capital gains the answers above is correct. $689.000 par value bond issues outstanding.20 $ 3.5 percent. and it also matures in 20 years.Page 30 .72 $992.

25 $27.037. and both sell for $701. what should be price of the security you are considering purchasing? a.16 Bonds with differential payments Answer: c Diff: T 113 . e. The second has an identical yield to maturity as the first bond. e. the security has an 8 percent coupon with quarterly payments (i. you receive $25 a quarter for the second 20 quarters). Semiannual payment bonds with the same risk (Aaa) and maturity (20 years) as your company's bonds have a nominal (not EAR) yield of 9 percent.. You are considering investing in a security that matures in 10 years with a par value of $1. What is the annual interest payment on the second issue? a. What would the quarterly interest payment be. has two bond issues outstanding.22.00 Chapter 6 .22 $1. The first issue has an annual coupon rate of 8 percent and 20 years to maturity.e. During the remaining five years the security has a 10 percent coupon with quarterly payments (i. d. b.00 $22.060. Fish & Chips Inc. quarterly payment bonds. $120. This bond has the same risk as the security you thinking of purchasing... Your company's treasurer is thinking of issuing at par some $1.68 $ 11.65 $1.e. $1.61 $ 943. semiannual payment bonds. 20-year.Bond value and effective annual rate Answer: b Diff: T 111 .000 par value.42 $ 29.145. c. Given this information. Another 10-year bond has an 8 percent semiannual coupon (i.89 the its are the Bond coupon payment Answer: b Diff: T 112 .00 $ 37. $45.000. d.000.50 $23.12 $ 56. During the first five years. c.72 $1. $ 898. c. in dollars. She has asked you to determine what quarterly interest payment. This bond is selling at par value. Both issues pay interest annually. d. After 10 years (40 quarters) you receive the par value. in dollars? a. but only 5 years until maturity. coupon payment is $40 every six months). b.00 $25. you receive $20 a quarter for the first 20 quarters).e. b. e. the company would have to set in order to provide the same effective annual rate (EAR) as those on the 20-year.Page 31 .

Page 32 .CHAPTER 6 ANSWERS AND SOLUTIONS Chapter 6 .

20. 12. 3. 4. 7. 11. I = 12.000 Numerical solution: VB = $100(PVIFA12%.1. 17. 13. . 2. 21. 9. Prices and interest rates Bond premiums and discounts Callable bond Indexed bond Income bond Restrictive covenants Output: PV = -$887. PMT = 100.000(0.annual payment Time Line: 0 Answer: b Answer: b Answer: b Answer: b Answer: a Answer: a Answer: a Answer: b Answer: a Answer: b Answer: a Answer: a Answer: a Answer: a Answer: a Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: E Diff: M Diff: M 1 2 3 9 10 Years 12% ├────────┼─────────┼─────────┼──────···─────┼──────────┤ PMT = 100 100 100 100 100 PV = ? FV = 1.6502) + $1.02. Financial calculator solution: Inputs: N = 10.12) + $1.000(1/1. 19.1210) = $100(5. 14. Discounted cash flows Issuing bonds Interest rate risk Interest rate risk Bond prices and interest rates Mortgage bond Debt coupon rate Call provision Sinking fund Zero coupon bond Floating rate debt Junk bond Bond ratings and required returns Bond value Bond value . FV = 1.1210)/0. 8. Answer: a Answer: a Answer: b Answer: b Answer: b Answer: a Diff: M Diff: M Diff: M Diff: M Diff: M Diff: M 1 16 .000(PVIF12%.00.10) + $1. 6. the value is significantly higher than the market price and the bond should be purchased.1/1. 18. 10.000.3220) = $887.10) = $100((1. 15. 5. Thus.

Sinking fund provision Answer: d Diff: E Statements a and c are correct. if interest rates have risen (causing bond prices to fall) the company will buy bonds back in the open market. therefore. Call provision Bond coupon rate Bond concepts Answer: b Answer: c Answer: a Diff: E Diff: E Diff: E Statement a is correct. Callable bond 2 28 . Statements b and c are true. and d are all correct. the other statements are false. then it will trade at a discount. Sinking fund Floating rate debt Bond ratings Interest rates Interest rate and reinvestment risk Statements a. If a bond’s YTM > annual coupon. the other statements are false. the callable bonds would not be called.000 = 9%. 33. statement d is the correct choice. 24. the bond will sell at par. So. The current yield is calculated as $90/$1. A bond's price and YTM are negatively related. companies will call the bonds and investors will have to reinvest at lower rates. c. b. If the call premium (the cost paid in excess of par) increases. Bond concepts Answer: c Diff: E Statement c is correct. the 10-year zero coupon bond’s price change is greater than the 10-year coupon bond’s. Answer: a Diff: E 27. therefore. 26. 30. if interest rates have declined. A bond downgrade generally raises the cost of issuing new debt. the cost of calling debt increases. Since the bond is selling at par.22. callable bonds would not be called. 32 . the correct statement is e. statement e is the correct choice. the answer is e. 31. If a bond's YTM is greater than its coupon rate. if the bond’s YTM remains constant the bond’s price will remain at par. the other statements are false. its YTM = coupon rate. 23. Statement a is correct. 29. it will sell at a discount. Therefore. Statement b is true. therefore. Answer: b Answer: b Answer: a Answer: e Answer: e Diff: M Diff: M Diff: M Diff: E Diff: E Therefore. If interest rates increase. Bond concepts Answer: e Diff: E All the statements are true. Statement c is true. 25. 34. Bonds will be purchased on the open market when they are selling at a . sinking funds require companies to retire a certain portion of their debt annually. therefore. Sinking fund Answer: e Diff: E Statement a is false. If YTM = coupon rate.

A debenture is an unsecured bond. 35. If we let Bond A be a 5-year. 41. which they always are. Price risk Answer: a Diff: M Statement a is correct. the others are false. 12% coupon bond that sells at par. but its yield to maturity equals 12%. Types of debt Answer: e Diff: E Statement e is correct. Zero coupon bonds have greater price risk than either of the coupon bonds or the annuity. A zero coupon bond will always sell at a discount below par. All other things equal. while subordinated debt has greater default risk than senior debt. The YTC is a better measure of return than the YTM if the bond is selling at a premium. of the bonds listed the 10-year zero coupon bond will have the largest percentage increase in price. bonds with long remaining lives experience greater percentage changes in value than do bonds with short remaining lives. 43 . Its current yield equals 10. the other statements are incorrect. Further. a zero coupon bond will experience a larger percentage change in value for a given change in interest rates than will a coupon-bearing bond. lowcoupon bonds are most affected by changes in interest rates. Long-term. the 10-year zero coupon bond has the largest percentage increase in value.78% ($100/$927. bonds with long remaining lives experience greater percentage changes in value than do bonds with short remaining lives. if a coupon bond is selling at par its current yield will equal its yield to maturity. Further. Price risk Answer: c Diff: M The correct answer is c. its current yield equals its YTM which equals 12%. 42. 10% coupon bond (in a 12% interest rate environment) the bond will sell for $927.90. 36. Bond yield Bond yield Answer: b Answer: c Diff: M Diff: M Statement c is correct. the other statements are false. Bond concepts Answer: e Diff: M The correct answer is e. a zero coupon bond will experience a larger percentage change in value for a given change in interest rates than will a coupon-bearing bond. 37. therefore. the other statements are false. 40. Junk bonds have a higher yield to maturity relative to investment grade bonds. If we let Bond B be a 5year. 38. provided interest rates are above zero. Price risk Answer: c Diff: M The correct answer is c. 39. By definition. All other things equal.90). the 10-year zero coupon bond has the largest percentage increase in value. the other statements are false. Thus. the other statements are false. Thus. Price risk Answer: c Diff: M Statement c is correct.discount and will be called for redemption when the price of the bonds exceeds the redemption price.

The bonds' prices would differ substantially only if investors think a call is likely. Firms prefer the less expensive option of calling the bonds--which in this case is the sinking fund call price. Bond concepts Answer: b Diff: M Statement b is correct.05%. Statement c is correct.. If a bond is selling at a premium. Calls are most likely if the current market rate is well below the coupon rate. 45. 49. thus bond prices would fall. therefore. 53. since the coupon rate < YTM we know the bond is selling at a discount. 50. In addition. the bond will sell at a premium. Interest expense accrues for tax purposes on zero coupon bonds. Statement b is correct. Callable bonds will sell for a higher yield than noncallable bonds. Current yield = $100/$887 = 11. Bond concepts Answer: d Diff: M Statements a and c are correct. Statement a is correct. the other statements are false. 48. If inflation were to increase. V B = $887. Statement b is incorrect. 52. statement d is the correct choice. The YTC = 14. therefore. 4 46 Bond concepts Answer: e Diff: M Bond concepts Answer: d Diff: M Statements a and c are correct. If a bond’s coupon rate > than the required rate. if all other things are held constant. we can solve for the price of the bond = $887. the bond won't be called. the other statements are false.00. Bond concepts Answer: b Diff: M . so firms can realize the tax savings from issuing debt. 51. 44. Callable bond Callable bond Answer: d Answer: b Diff: M Diff: M Statement b is correct. interest rates would rise. the other statements are false. since the bond is selling at a discount its YTC > YTM. 47. From the information given. A bond’s total return also includes a capital gains component that represents the change in the price of the bond over a given year. Types of debt Miscellaneous concepts Answer: c Answer: b Diff: M Diff: M Statement b is correct. the YTM would be less than the coupon rate. in which case investors would have to give up a high coupon bond. Low coupon bonds have less reinvestment rate risk than high coupon . therefore statement e is the correct choice. Note that if the current rate is above the coupon rate. Miscellaneous concepts Miscellaneous concepts Answer: b Answer: e Diff: M Diff: M Statements a and b are both correct.274%. zeros should never trade above par. as long as interest rates are greater than zero. statement d is the appropriate choice. the other statements are false. From the information given.

e. Corporate bonds and default risk Answer: c Diff: M Statement c is the correct choice. 5 57 . yield to maturity. 54. 60. If interest rates have declined after the issuance of a bond. Therefore. 5 56 . The bond with the smallest coupon and longest maturity will be most sensitive to changes in interest rates. Current yield and yield to maturity Answer: a Diff: M Statement a is correct. When the coupon rate is below the market rate. If the bond is trading at a premium. The longer the maturity and the lower the coupon of a bond. the default risk premium on its existing bonds will increase. 59. its price will move toward the par value. less than. then the bond has a coupon rate higher than the going market interest rate. Sinking funds and default risk Answer: d Diff: M Statements a and c are correct. a capital loss) while the bond selling at par will have no capital gain. this implies that the YTM must be less than the coupon rate. The bond in answer a has a maturity greater than or equal to and a coupon less than or equal to all the other bonds. However. The issuer would be likely to call the bond and issue new bonds at the lower current interest rate. therefore. then its current yield.. Interest rate risk Answer: a Diff: M The correct answer is a. The expected return may be greater than. An indenture is not a bond. Current yield and yield to maturity Answer: e Diff: M Statement e is the correct choice. or equal to the yield to maturity. the bond selling for more than par will have a negative capital gain (i. therefore. the other statements are false. If a company increases its debt ratio. If a bond sells for less than par. investors are being paid a higher rate than current interest rates and they would prefer to keep the bonds to receive a higher return. then its coupon rate is high in relation to current interest rates. it is a legal contract spelling out the rights of investors and issuers. the more sensitive it is to interest rate price risk. As a bond approaches maturity. If the bond sells for a premium. so the firm will buy back its bonds on the open market. If a bond sells at par. the other statements are false. 55. statement d is the correct choice. and coupon rate are all the same. 58.bonds. statement d is the correct choice. Thus. . 61. we would expect to earn the yield to call. The bond selling for more than par will have a lower current yield than a bond selling at par. Interest rate risk Answer: a Diff: M Statement a is correct. Default risk Default risk Answer: b Answer: d Diff: M Diff: M Statements a and b are correct. then its yield to maturity will exceed its coupon rate. then the price is below par.

Consider zero coupon bonds. 10 percent annual coupon bond at 2 different interest rates.16 percent. however. while the 12 percent coupon bond's price decreases by only 16. The longer the maturity of a bond. Statement e is false because perpetuities have no maturity date. To see this. Bond yields and prices Answer: b Diff: T Statement b is correct. 65. The 5 percent coupon bond's price decreases by 19. A zero coupon bond's YTM exceeds its coupon rate (which is equal to zero).62. while the 9-year. 6 67 . Statement b is false. a bond's value is determined by its cash flows: coupon payments plus principal. The zero coupon bond's price decreases by 24. evaluate a 10-year.9 percent. then. the greater the impact an increase in interest rates will have on the bond's price. assume interest rates increase from 7 percent to 10 percent. therefore. hence. the lower-coupon bond has more interest rate risk than the higher-coupon bond. Statement a is false. the greater its interest rate risk.4 percent. Thus. 66. therefore. Evaluate the change in the prices of a 10-year. 12 percent coupon bond. its current yield is equal to zero which is equal to its coupon rate. Statement a is false--as we demonstrated above.33 percent. If the 2 bonds have different coupon payments. zero coupon bond and a 9-year. Bond concepts Answer: e Diff: T Statements a and c are correct. For example. To see this. Interest vs. 63. the bond sells at a discount. 10 percent coupon bond's price decreases by only 16.00. The lower the coupon. while the 10 percent coupon bond's value is $887. Statement c is false. their prices would have to be different in order for them to have the same YTM. The longer a security's maturity. by definition. the greater the percentage of the cash flow that will come in the later years (from the maturity value). Statement d is false--as we demonstrated earlier. say 7 percent and 10 percent. The 5 percent coupon bond's value is $604.48. reinvestment rate risk Answer: c Diff: T Statement c is correct. Statement e is the correct choice. If a bond's YTM exceeds its coupon rate. Bond concepts Answer: b Diff: T 64. 5 percent coupon bond and a 10-year. Thus. the bond's price is less than its maturity value. Statement c is correct. they have more interest rate risk than zero coupon bonds. Weighted average cost of debt Answer: e Diff: T Bond indenture Answer: d Diff: T . assume these coupon bonds have 10 years until maturity and the current interest rate is 12 percent. Statement b is false--shorter-term bonds have more reinvestment rate risk than longer-term bonds because the principal payment must be reinvested sooner on the shorter-term bond. the greater the impact of interest rate changes.

103. Financial calculator solution: Inputs: N = 60.04560)/0. Answer: b Diff: E .103.045) + $1.04560) = $50(20. 69. 3. the annual rate is 9%. .000(0. Bond value .5. Debentures' risk rises as mortgage debt rises. 4.5% Answer: c 4 | 50 .103.071289) = $1. PMT = 50. Mortgage bonds' risk rises as more mortgage bonds are issued. Yield to maturity Enter N = 20 PV = -934. the "WACD" will likely remain fairly stable.r d% e.semiannual payment Time Line: 0 | 4. Diff: E 1 2 | 50 3 | 50 60 | 50 FV = 1.103.g. Company can't lower its total cost of the $100 million of debt very much if any by the mix of debentures and mortgage bonds. Output: PV = -$1.96. Part A represents 50% debentures and 50% mortgage bonds Debentures WACD Mortgage A 0 50% 100% Percentage of total issue as mortgage bonds 1.000.5%.19. VB ≈ $1. and FV = 1000. PMT = 40.19≈ $1. So. 2. 68.6380) + $1.000 PV = ? | 50 6-month Periods Numerical solution: VB = $50((1. Return on a bond Answer: b Diff: E So Solve for I = 4.000(1/1. I = 4.1/1. FV = 1. 70.

000.20) = $60((1. . Output: PV = -$828.000(1/1.0.17% = $110/$1200.1/1. PMT=110.000.The bond has a current yield of 9. Financial calculator solution: Inputs: N = 40. FV=1000). which is the yield to maturity. PMT = 40.57. Output: PV = -$1. 20 | 60 FV = 1.115.62.000 6-month Periods PV = ? Numerical solution: VB = $40((1. Output: PV = -$1.05) + $1.1420) = $828.83.03) + $1.1591) + $1.0520) = $60(12. Bond value .000(0. VB = $1.33%.1/1.4622) + $1. VB ≈ $828.57.semiannual payment Answer: e Diff: E Time Line: 0 | PV = ? 5% 1 | PMT = 60 2 | 60 .83%.000 Quarters Numerical solution: VB = $35((1. I = 5.000. FV = 1. FV = 1. PMT = 60.000 6-month periods Numerical solution: VB = $60(PVIFA5%. PMT = 35.0540) = $40(17.0340) = $35(23.000(0.3066) = $1.0340)/0.124.0520)/0.000(1/1. 71.02 (N=19.000(1/1.196.semiannual payment Answer: d Diff: E Time Line: 0 | 5% 1 | 40 2 | 40 3 | 40 4 | 40 . VB = $1.84% ≈ 8. I=8.0540)/0.115.1148) + $1. . Financial calculator solution: Inputs: N = 40.quarterly payment Answer: c Diff: E Time Line: 1 2 | | PMT = 35 35 PV = ? 3% 0 | 3 | 35 4 | 35 40 | · · 35 FV = 1.36 ≈ $828.115.63. The total return is 9.124. 72.000(PVIF5%.62.3769) = $1. Bond value .000(0. 73.20) + $1. I = 3. FV = 1. 40 | 40 FV = 1.1/1.05) + $1. for a capital gains return of –0. Next year’s projected price is $1. .33% = 8. Financial calculator solution: Inputs: N = 20.62.17% .124. Bond value . I = 5.41.

Nj = 4. which is the PV of scheduled interest.86.annual payment Answer: d Diff: M Time Line: 0 28% 1 2 3 4 | 80 5 | 80 6 | 80 6% 6% 6% 6% PMTs 7 | 80 8 Years | | | | Deferred PMTs earn 6% 80 80 80 VB = ? FVDeferred Numerical solution: Find the compounded value at Year 8 of the postponed interest payments FVDeferred interest = $80(1.2%.83.8%. Nj = 3.28)5 + $80(1/1. Nj = 4.06)7 + $80(1.109) = $70(5.88.7590) + $1. Output: NPV = $266. I = 28. Answer: b Diff: E Financial calculator solution: N = 9.23.109)/0. Bond value .83 payable at t = 8.88.8.4%. Financial calculator solution: Calculate FV of deferred interest Inputs: CF0 = 0. I = 10.000.28)6 + $80(1/1. 76.10 = $827.06)6 + $80(1.06)4 = $441.46%. New RPBBB = 2.28)8 = $266.23 = 8.4241) = $403. and maturity value Inputs: CF0 = 0. CF1 = 0.23.06 113.521. RPBBB. Risk premium on bonds Answer: c Diff: E Calculate the previous risk premium.13 + $424.1/1. CF1 = 80. and new RPBBB: RPBBB = 11.000(0.10) + $1. Calculate VB. I = 6.5% .29 + Interest = 441.8%/2 = 1. and solve for PV = ? = -$827.00 . deferred accrued interest. CF2 = 80.74.48 120.06)5 + $80(1. Current yield Numerical solution: VB = $70((1.828.28)8 + $1.8% + 1. Output: NFV = $441.7% = 2. Calculate new YTM on BBB bonds: YTMBBB = 7. | 80 101. Now find the value of the bond considering all cash flows VB = $80(1/1. Nj = 4. Differences in numerical and financial calculator solutions are due to rounding of interest rate table figures.000(1/1.000. CF2 = 0. CF3 = 1. 75.00 107. Current yield = $70/$827. PMT = 70.83(1/1.4% = 9. VB = $266.28)8 + $441.83 FVPar = 1.28)7 + $80(1/1.000(1/1. FV = 1.

4694) + $100.000((1.1220)/0.2 )(1. I = 10.1220) = $2.27. Output: PV = -$25.257.80 PMT = = 2 ( PVIFA10%.29 ≈ $13.000.000 Numerical solution: .10) (1.308.10) ((1 .10) Financial calculator solution: Calculate the PV of the bonds Inputs: N = 20.80 = $13. Calculate equal annuity due payments BEGIN mode Inputs: N = 2.1037) = $25. PV = -25.56.20) + $100.semiannual payment Answer: d Diff: M Time Line: 0 | 1 | PMT = 40 VB = ? 8% 2 | 40 30 6-month ·· · | Periods 40 FV = 1.000 2.000(1/1.1/1.12) + $100.80 $25. 78. $25.000(PVIF12%. Bond value .000 FV = 100.000.308.10) = $25.255.308. FV = 100.255. I = 12.000(PVIFA12%. FV = 0. Step 2 Calculate the equal payments of the annuity due. Output: PMT = $13. Bond value .80.7355)(1.000(0.000 | | 2.56.7 77 . .308. 1/1/2022 20 Years | 2. .000 Numerical solution: Step 1 Calculate PV of the bonds VB = $2.305.305.20) = $2.10 )/0.000(7.annual payment Answer: a Diff: M Time Line: 1/1/02 0 12% 1 | VB = ? 2 . PMT = 2.1/1. (1.

4699) + $1.60 = 2. .10) .1/1.000/$770.20) = $40((1.000 Diff: M TL2 rd/2 = .000/$770. VB = $770.000. Output: PV = -$549.VB = $40(PVIFA8%.000(0.000 Numerical solution: Since the old bond issue sold at its maturity (or par) value.60. VB = $549. 80.60.3601) + $1.0610)/0.69.3118) = $770. . VB = $70(PVIFA8%.38 ≈ 2.073. Output: PV = -$770. FV = 1. I = 6. Number of bonds: $2.000(1.30) = $40((1.0620)/0.71 ≈ $550. PMT = 40.semiannual payment Answer: d Time Line: 0 rd/2 = 8% 1 2 10 6-month .1/1.073.61 10 | 11 6% | PMT = 70 12 | 70 Maturity 20 6-month | Periods 70 FV = 1. Number of bonds = $2. its yield (and the yield on the new issue) must be 6 percent semiannually. .06) + $1. Financial calculator solution: Inputs: N = 30. I = 8.semiannual payment Answer: b Diff: M Time Line: 0 6% 1 | | PMT = 60 VB-Old = 1.61.0994) = $549. 20 6-month | Periods 60 FV = 1.596.02) + $1. .000(0.0620) = $40(11.06) + $1.000(1/1.000(PVIF6%.000(0. .10) + $1.000(1/1.30) + $1.000. Financial calculator solution: Inputs: N = 20.000. Bond value . TL1 | | | | Periods PMT = 70 70 70 VB = ? FV = VB5 = 1.000 PMT = 40 VB-New = ? 2 | 60 40 . and still sells at par.595. Bond value .0610) = $70(7.60 ≈ 2.60.61(PVIF8%.000(PVIF6%.0230)/0.073. 79. FV = 1.000 40 FV = 1.1/1.69 ≈ $550.10) + $1.000(PVIF8%. PMT = 40.2578) + $1.596 bonds.10) = $70((1.000. VB5 = ? Numerical solution: VB5 = $70(PVIFA6%.* *Rounded up to next whole bond.20) + $1. .5584) = $1. The new bonds will be offered at a discount: VB = $40(PVIFA6%.0230) = $40(11.

0810)/0. VB ≈ $926.207.20) + $1.000. I = 6. Solve for VB at Time = 0.08) + $1.61(0.60) + $1.4632) = $967.5 60 Quarters | 37.60) = $37. 82. PMT = 70.207.6748) + $1.5 FV = 1.000(0. PMT = 37.50(PVIFA3%. . Inputs: N = 10. 83. PMT = 25.000. I = 8.8775) + $1.073. Output: PV = -$925. Output: PV = -$1.1697) = $1.= $70((1.207.51.000 Numerical solution: (PVIFA and PVIF are given in the problem. VB = $966. . Note: Numerical solution differs from calculator solution due to interest factor rounding. FV = 1. VB = $1.60.5 4 | · · · 37. Numerical solution: .000 Numerical solution: VB = $25(PVIFA3%.073.57.00.073. FV = 1. Financial calculator solution: Solve for VB at Time = 5 (V5) with 5 years to maturity Inputs: N = 10.0320)/0. assuming sale at V B5 = $1.57.99.20) = $25((1.60.50(27.1/1. 20 Quarters | 25 FV = 1.60.000(PVIF3%.64 ≈ $926. .7101) + $1. .5 VB = ? 2 3 | | 37.03) + $1.61(1. FV = 1.61. Market value of bonds Time Line: 1/1/04 0 6% | VB = ? Answer: a 1/1/2014 20 6-month | Periods 20 FV = 1. PMT = 70. Bond value .50.000 Diff: M 1 | PMT = 20 2 | 20 . I = 3. Financial calculator solution: Inputs: N = 20.quarterly payment Answer: b Diff: M Time Line: 0 3% 1 | | PMT = 25 VB = ? 2 | 25 3 | 25 4 | 25 .quarterly payment Answer: b Diff: M Time Line: 0 3% 1 | | PMT = 37.000. 81. Output: PV = -$1. Output: PV = -$966. FV = 1.073.000(PVIF3%.000(0. Bond value . I = 3.073.) VB = $37.0810) = $70(6.99.0320) = $25(14.5537) = $925.5 37. Financial calculator solution: Inputs: N = 60.1/1.000(1/1.

0620) = $20(11.000(0. Output: PV = -$541.1/1.10% = -0. Annual coupon rate = (2)($85)/$1.20.06) + $1.10 = $1. I = 6.000(1/1. Bond coupon rate Answer: c Diff: M Time Line: 0 rd/2 = 5% 1 | | PMT = ? VB = 768 2 | PMT 3 | PMT 4 | PMT 10 6-month | Periods PMT FV = 1.000 .000(0.99% ≈ 4%.096. VB = $541.000(0. Future value of bond Answer: c Diff: M The YTM = Current yield + Capital Gain Thus: Capital gain = YTM .100.0510)/0. FV = 1. PMT = 20.10) + $1. 20 6-month | Periods PMT = ? PMT FV = 1.05) + $1. capital gain as a decimal. Financial calculator solution: Inputs: N = 20. the total value of debt is Since there are 10.6139) 154. .000 = 3.100 × (1 .7217) + $1.7072% . I = 5.002928) (Remember to express the = $1.. PV = -768. Price in one year = $1.955 (semiannual PMT).000.000(1/1. .000 = 17%. . Annual coupon rate = PMT × 2/M = $19.) 85.10 = PMT/2(7.91 1 | 2 | PMT .20) = $20((1.20) + $1. 84.412 million.20) = PMT((1. Financial calculator solution: Inputs: N = 10.955 × 2/1.07) + $1.3118) = $541.5940) + $1. Numerical solution: $768 = PMT/2(PVIFA5%.000(1/1.0620)/0.2584) PMT = $900.000(PVIF7%.10) = PMT/2((1. Price now: Current yield = Annual coupon/Price Thus: Price = Annual coupon/Current yield = $110/0.4699) + $1. Output: PMT = $19.158.7217) PMT/2 = $19. Bond coupon rate Answer: d Diff: M Time Line: 0 rd/2 = 7% | VB = 1.000(PVIF5%. 86.91 = PMT(PVIFA7%. .VB = $20(PVIFA6%.0.0510) = PMT/2(7. The price in 1 year = Price now × (1 + CG%).5940 = $85.100 × (1 + CG%) = $1.000.20(10.Current yield = 9.000) = $5.0720) = PMT(10.000(PVIF6%.158.2928%.000 Numerical solution: $1..78 ≈ $1.96 ≈ $20 PMT ≈ $40 and coupon rate ≈ 4%.0720)/0.20 per bond.51/10.20) + $1.1/1. FV = 1.1/1.000 bonds outstanding $541.20.097.

2.PVIFA20%.158.0730) = $60(12. Bond value Answer: d Diff: T Time Line: 0 1 rd = 20% | | 100 | | VB = ? 2 | 100 | | 3 | 100 | | 4 | 100 | | 5 | 100 | | 6 | 100 i = 0% .44. Nj = 5. Output: PMT = $85. Financial calculator solution: Method 1.5) + $1.40 = $875.2]– [(1.1/1.10 .000 face value each year.44. Bond sinking fund payment Answer: d Diff: T The company must call 5 percent or $50.44. 87.000 Yrs Deferred payments accruing no interest Numerical solution: PVbond = VB = = = = ∑ (1 + r ) t =6 10 $100 t + $1. 88..30) = $60((1. FV = 1. .91.000(PVIF7%.00 (semiannual PMT).1/1. I = 7. Since the interest rate is higher than the coupon rate (14% vs.600. PMT = 100.500(PVIF20%.878. so open market purchases should be used. The company would have to buy $50.25 = $362.000 = 17. CF5 = 1.1925 . Output: PV5 = -$901. Annual coupon rate = $85(2)/$1. 10 | 100 500 FV = 1. Method 2.210)/0. V5) Inputs: N = 5. Output: PV = -$362.2]) + $1. FV = 1. Cash flows: Inputs: CF0 = 0.000 or buy on the open market. . Time Line: 0 1 7% | | PV = ? PMT = 60 2 | 60 .000 = 50 bonds at $875. CF2 = 100.94 each = $43.1615) $120. It could call at par and spend $50.1/1.25)/0.9906) + $1. I = 20.796. VB = $362.0730)/0. I = 20.. Numerical solution: VB = $60(PVIFA7%.Financial calculator solution: Inputs: N = 20.44. Nj = 4.1314) = $744. Time value discounting: (Calculate VB as of Year 5. 30 6-month | Periods 60 FV = 1. PV = -1.210) $100(4.0%.54 + $131.44. VB = $362.07) + $1.19 + $242.500 (1 + r ) t $100(PVIFA20%. FV = 901. the bonds will sell at a discount.000 .10) $100([(1. I = 20.500.000/1. Output: NPV = $362.500(1/1. CF1 = 0.000(0. Calculate VB or PV of V5 Inputs: N = 5.797 ≈ $43.878.500(0.94.30) + $1.000(1/1. 12%).4090) + $1.000.

Solve for PV = $930. PV = -865. I/YR = 3. I = 7.08/2 = 40 FV = 1.065. PMT = 40.000. PV = -1075. Yield to maturity Enter N = 11. PMT = 80. and FV = 1050.5.91. and FV = 1000. Current yield is calculated as: $80/$985 = 8. Output: PV = -$875. Current yield Current yield = Annual coupon payment/Current price.796.14%.20%.12%. 93.50 $43. Bond value .14%.05%.semiannual payment N = 15 × 2 = 30 I/YR = 11/2 = 5.000 × 0.09%. Answer: c Diff: E .99.5 PMT = 1. PMT = 60. FV = 1. Solve for I/YR = 10.04.52% × 2 = 7.000 Solve for PV = -$781. PMT = 85.795. Step 1 Step 2 Find the price of the bond: 1000. 89.5 PMT = 50 FV = 1.000 Solve for PV = -$1. Current yield and yield to maturity N = 12 PV = -985 PMT = 80 FV = 1. and FV = 1000. To calculate YTC: N = 10. Yield on semiannual bond N = 12 × 2 = 24 9 95 . ≈ 10. The company would have to buy 50 bonds at $875. PMT = 40. Bond value . Calculate the current yield: Answer: d Diff: E N = 12.semiannual payment N = 10 × 2 = 20 I = 9/2 = 4.000 Solve for I/YR (YTM) = 8.57% × 2 = 7. Answer: b Diff: E 94.Financial calculator solution: Inputs: N = 30.91 each = $43. and FV = CY = $85/$930 = 9. I/YR = 3. 91. PV = -1075. YTM and YTC Answer: a Diff: E Answer: b Diff: E Answer: c Diff: E ≈ 9 90 . I/YR = 9. 92.0868% Answer: e Diff: E Solve for Solve for To calculate YTM: N = 28.

and solve for I = 3.semiannual payment The 8% annual coupon bond’s YTM is 9. Now. Solve for the YTC: N = 5 × 2 = 10 Answer: d Diff: M . 9 99 . Yield to call Find the current price of the bond using the YTM: N = 12 × 2 = 24 I = 9/2 = 4.000. there will be 15 years left until maturity.136. In 5 years.5/4 = 1.1 P/YR = 2 Solve for NOM% = 8. Yield to maturity and bond value--annual Step 1 Step 2 Answer: d Diff: E Find the YTM. PMT = 8%/2 × 1. I = 9.4508% × 2 = 8.78. PMT = 25.1% because the bond is an annual bond. PMT = 100/4 = 25. PMT = 90. we need to find the nominal rate for the semiannual bond which has the same EAR. FV = 1000. solve for FV = $1.1%. and solve for I = YTM. FV = 1. An equally risky 8% semiannual coupon bond has the same EAR. FV = 1000. 1 100 . and solve for PV = ? $1. FV = 1.5 PMT = 100/2 = 50 FV = 1. and FV = 1. N = 2 × 10 = 20.8733.000 Solve for PV = -1.000. Now.048. Answer: d Diff: M 9 97 .080 PMT = 50 FV = 1.48.78. I/YR = 9.9016%. Now. FV = 1. The effective annual rate (EAR) is 9.136.78.072.150: 6 × 2 = 12. Yield to call Answer: b Diff: M 7/2 = the N = ? = First. Bond value . solve for the semiannual bond’s price. the call price can be solved for as follows: N = 5 × 4 = 20. PV = -1. thus.34. Solve for P5.78. I = 8/4 = 2. PMT = 80/2 = 40. Call price Answer: c Diff: M First.9019/2 = 4. PV = $933. PMT = 40. recognizing that bond can be called in 6 years at a call price of 115% × 1. PMT = 90. and solve for PV. PV = -925. I = = 3.5.000 = 40.09.8733%.000 = 1.000 Solve for I = 4.09. thus.4510. N = 20.106. so we can calculate its price.9019%.000.875. solve for PV = -$1. and solve for PV = $941. PV = -1. Now.8758% × 2 = 7.96. I = 7.150. I/YR = 8. 98 . EAR% = 9. so the price at t = 5 is: N = 15. solve for the price of the bond today as follows: N = 10 × 4 = 40. PV = -1.106. we can calculate the YTC as follows.75%. calculate the price of the bond as follows: N = 20 × 2 = 40.

02. Now use the price of the bond to figure the YTC: N = 8 × 2 = 16 PV = -1. 1 102 = . Now.116.137. Yield to call First get the price based on the YTM: N = 12 I = 7. Yield to call Answer: b Diff: M The price of the bond today is found as N = 11.184.58%. PMT = 55.73%.050 I = 4. PMT = 80. Solve for the yield to call as follows: N = 3. I = 7.7263% ≈ 6. FV = 1. PMT = 110/2 = 55. and solve for I/YR 4.000 Solve for PV = -$1.137.98%.58. 104.03 PMT = 90 FV = 1.29% × 2 = 8.000 Solve for PV = -$1. PMT = 80.5 PMT = 90 FV = 1.050 I = 6.000 and PV = ? = -$1. solve for the YTC: N = 2 × 10 = 20.99.072. Yield to call Answer: c Diff: M First calculate the price of the bond. Now solve for the YTC: N = 4 PV = -1.02. Yield to call First we need to find the price of the bond: N = 12 × 2 = 24 I = 10/2 = 5 PMT = 60 FV = 1. PV = -1.4915% × 2 = 8.060.99 PMT = 60 FV = 1.050 Answer: b Diff: M . FV = 1.055.184.41%.58. Answer: a Diff: M 1 103 . FV = 1.9829% ≈ 8. and solve for PV = -$1.036. and solve for I = ? = 8. PV = -1. N = 2 × 20 = 40.036.000. I/YR = 9/2 = 4.5. PV = -1.5.116.48 PMT = 50 FV = 1. FV = 1.03.1 101 .

0.Solve for I = 4.25.08 × $1.000 = $1.000. annual YTM: YTM = 3. FV = 1. and solve for I/YR = 9. Thus the nominal YTM for the semiannual bond is 8%. . I = 8. 109.25. Then.280. Bond value Answer: e Diff: M The semiannual bond selling at par has a nominal yield to maturity equal to its annual coupon rate (you can check this). . FV = 1.3780 = 9. b. Now.000 Years 1 108 .5%.88. PMT = 100/2 = 50.069.05 × $1. calculate the price of the bond as follows: N = 6 × 2 = 12. The current yield (CY) is then $100/$1. Financial calculator solution: Inputs: I = 10. FV = 1. Call price = 1. First find what the bond is selling for today based on the information given about its call feature: N = 10(2) = 20. PV = -1.5/2 = 3. Interest payments remaining Answer: b Diff: M Time Line: 0 1 10% | | PMT = 80 VB = 847.955% ≈ 6. we know the bonds will pay 0. PMT = 100/2 = 50. if called. c.81 = Current price.88 2 | 80 . 1 106 . find the after-tax YTC = YTC × (1 . Yield to maturity Answer: d Diff: M a. Finally. Since this is a semiannual rate. I = 6.9441% × 2 = 9.31) = 6. PMT = 10%/2 × 1.050. FV = 1. PV = -$847. PMT = 80.95%. Solve for I = 3. Output: N = 15 years. CG = -0. PV = -1.Tax rate) = 9.000.35%. To convert this to an effective annual rate for the annual bond: . Recognizing that the CY and capital gains yield (CG) constitute the total return (YTM) on the bond or CY + CG = YTM.81.5/2 = 4. 1 107 .60%.85%.050.280. solve for CG in the following equation 9.000.050.069. n = ? | 80 FV = 1. solve for yield to call: N = 3.3780. Current yield and capital gains yield Answer: c Diff: M First. find the call price on the bonds.4775%(2) = 6. Solve for PV = -$1. After-tax yield to call Answer: c Diff: M First. Use this current price solution to solve for the YTM: N = 15(2) = 30.000.8883% ≈ 9. will last for 3 years.5176%. and PV = ? = $1. FV = 1.4775%. multiply it by 2 to solve for the nominal.000 = $80 per year and.000 = 50.89%.5176% × (1 . PMT = 80.5672% ≈ 6. 1 105 .35% + CG = 8.

36%. NOM% = 12.000 4 38 | . .681. as the nominal rate is the same as the effective rate when compounding is done annually. . I = 6.000. its nominal yield is 8 percent. Calculate the difference between the two bonds' PVs Difference: VB(McD) .72. Bond value Answer: d Diff: T 1 110 .16 PMT = 80 FV = 1. We can now value the annual bond using this rate. CF3 = 1025. Thus. Output: PV = $699. | 40 40 Financial calculator solution: Burger King VB Calculate EAR to apply to Burger King bonds using interest rate conversion feature.54. Nj = 19. and calculate the value. CF1 = 20.16 percent. Nj = 20.64. N = 6 I = 8.000. Since the comparable 10-year bond is selling at par. (Don't forget to change back to P/YR = 1. the same as its coupon rate.060. . Bond coupon payment Answer: b Diff: T . 111. NPV = $1. I = 12.36% 1 TLBK | | PMT = 80 VBK = ? 0 6% 1 2 TLMcD | | | PMT = 40 40 VMcD = ? 3 | 40 2 | 80 3 | 80 . . FV = 1. 1 112 . Inputs: N = 20. McDonalds VB Inputs: N = 40. To determine the bond's price you must use the cash flow register because the payment amount changes. VBK.9804.36. Time Line: 0 12.000 39 40 6-month | | Periods 40 40 FV = 1.NOM% = 8 P/YR = 2 Solve for EFF% = 8. CF2 = 25. and solve for NOM%. CF 0 = 0. its effective rate is 8.9216%. P/YR = 4. and solve for EFF%.16.07 . I = 7. Bond value and effective annual rate Answer: b Diff: T Since the securities are of equal risk.) So. since the bond you are considering purchasing has quarterly payments. 20 Years | 80 FV = 1. PMT = 40. FV = 1.9216/4 = 1. P/YR = 2. Output: EFF% = EAR = 12. its nominal rate is calculated as follows: EFF% = 8. Because it is a semiannual coupon bond. solve for NPV.VB(BK) = 699. Using your calculator. they must have the same effective rate.000 Solve for PV = -$992.53. enter NOM% = 8. NOM% = 7.07. PMT = 80. Output: PV = -$681.54 = $17. of Burger King bonds: Inputs: P/YR = 2.16%.

1 113 . | PMT PMT FV = 1.22. | Periods PMT PMT FV = 1. Output: PMT = $37. EARS = (1 + 0. rNom = 0.25 = quarterly payment.22.09203.000 Quarterly 0 rd/4 | CFs -1.225% 1 2 | | PMT = ? PMT Numerical solution: Step 1 Solve for the EAR of 9% nominal compounded semiannually. PV = -701. Step 2 Solve for rNom of 9. 1 + EAR = (1 + rNOM/4)4 = 1.Time Line: 0 1 rd = ? TL1 | | VB1 = 701...09/2)2 .000 = 4.116 ≈ $37.09203.000 3 | PMT Years 4 5 Years | | PMT PMT FV = 1. .000 = 2. Calculate PMT on second issue using 12% = rd = YTM Inputs: N = 5.5% 1 | PMT = ? 2 | PMT 3 | PMT 3 | PMT 4 | PMT 4 40 6-month | ..02225. Calculate the quarterly payment using the periodic rate.22 PMT = 80 0 rd = 12% 1 TL2 | | VB2 = 701.. rNom/4 = periodic rate = 0.000 Financial calculator solution: Calculate YTM or rd for first issue Inputs: N = 20. FV = 1.08901. | .000 = $22. PV = -701. . FV = 1. Step 3 . I = 12.02225 × 4 = 0.02225 × $1.000 5 | PMT 6 80 Qtrs. Multiply 0. Bonds with differential payments Answer: c Diff: T Time Line: Semiannual 0 rd/2 | CFs -1. PMT = 80.1 = 0.000. Output: I = 12%.12.203% EAR but with quarterly compounding. | 80 FV = 1.22 PMT = ? 2 | PMT 2 | 80 20 .000.

PV = -1.000.000. Calculate the quarterly periodic rate from rNom of 8. Output: EFF% = 9.90%/4 = 2.2025. Inputs: P/YR = 2.90%. Output: PMT = $22. I = 2. NOM% = 9. Inputs: P/YR = 4. rNom. Step 2 semi- Calculate the nominal rate. Step 3 .25.2025% EAR but with quarterly compounding.2025%. rPER = rNom/4 = 8. Use interest rate conversion feature.225. EFF% = 9. Output: NOM% = 8. FV = 1.225%.Financial calculator solution: Step 1 Calculate the EAR of 9% nominal yield bond compounded annually. of a 9.9% and calculate the quarterly payment. Inputs: N = 80.

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