Fundamentals of Investment Management 10th Edition Hirt Solutions Manual

Fundamentals of Investment
Management 10th Edition Hirt Solutions

Manual
Visit to Download in Full: https://testbankdeal.com/download/fundamentals-of-investm
ent-management-10th-edition-hirt-solutions-manual/
Chapter 11 - Bond and Fixed -Income Fundamentals
SOLUTIONS MANUAL
CHAPTER 11
BOND AND FIXED-INCOME FUNDAMENTALS
Answers to Text Discussion Questions
1. What are some of the major provisions found in the bond indenture?
11-1. The indenture spells out the contractual arrangements and features of each bond.
For example, such important points as the interest rate to be paid in periodic
amounts, the maturity date, the method of repayment, protective covenants for the
bondholders, and special features such as call provisions would be detailed in the
indenture.
2. Does a serial bond normally have only one maturity date? What types of bonds are
normally issued on this basis?
11-2. No. The bonds are paid off in installments over the life of the issue. Each serial
bond has its own predetermined date of maturity and receives interest only to that
point. Municipal bonds are often issued as serial bonds.
3. Explain how a sinking fund works.
11-3. A sinking fund calls for the issuer to set aside funds on a periodic basis. These
funds are usually passed on to a bond trustee to administer. The funds are used to
buy bonds from sellers in the market (or are invested to grow until the bonds can
be purchased). If sellers are not available, a lottery system may be used to select
bonds to be sold to the fund.
4. Why do you think the right to call a bond is often deferred for a time?
11-4. If deferral were not guaranteed, many investors would not purchase the bonds for
fear that the interest promised would be paid only a short period of time and then
the bonds would be called.
5. What is the nature of a mortgage agreement?
11-5. Under the mortgage agreement, real property (plant and equipment) is pledged as
security for a loan. A mortgage may be senior or junior in nature, with the former
requiring satisfaction of claims before payment is given to the latter.
11-1
© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or
distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.
6. What is a senior security?
11-6. A senior security must have its claim satisfied before claims of more junior
securities can be paid off.
7. Discuss the statement, “A debenture may not be more risky than a secured bond.”
11-7. A debenture is an unsecured corporate bond. Debenture issuers may have such
strong financial statements that security pledges may be unnecessary.
8. How do zero-coupon securities, such as Treasury strips, provide returns to investors?

How are the returns taxed?
11-8. Returns on zero-coupon bonds come in the form of increases in value of the
investment. For example, 25 year Treasury strips might initially sell for 19
percent of par value or $1,900. The Internal Revenue Service taxes zero-coupon
bonds as if interest were paid semi-annually even though no cash flow is received
until maturity. The tax is based on amortizing the built-in gain over the life of the
instrument.
9. What are the two forms of returns associated with inflation-indexed Treasury
securities?
11-9. The first is the interest that is paid out semiannually and the second is an
automatic increase in the initial value of principal to compensate for inflation.
10. What is an agency issue? Are they direct obligations of the U.S. Treasury?
11-10. An agency issue is a security sold by a federal agency such as the Federal Home
Loan Bank or Federal Intermediate Credit Bank. Although these issues are
authorized by an act of Congress and used to finance federal projects, they are not
direct obligations of the Treasury but rather of the agency.
11. What tax advantages are associated with municipal bonds?
11-11. Municipal bond interest payments are exempt from federal income taxes.
Furthermore, the income is also exempt from state and local taxes if bought
within the locality in which one resides.
12. Distinguish between general obligation and revenue bonds.
11-12. A general-obligation issue is backed by the full faith, credit, and taxing power of
the governmental unit. For a revenue bond, the repayment of the issue is fully
dependent on the review generating capability of the specific project or venture,
such as a toll road, bridge, or municipal coliseum.
11-2
whole or part.
13. How might an investor reduce the credit risk in buying a municipal
bond issue?
11-13. An investor could seek to purchase issues that have been guaranteed by a third
party such as MBIA or AMBAC.
14. What is an industrial bond?

11-14. It is a broad, catchall bond category that includes everything from high
technology companies to discount chain stores. Basically, it includes all types of firms
except public utilities, rails and transportation, and financial firms.
15. What is shelf registration?
11-15. Shelf registration permits large companies to file one comprehensive registration
statement, which outlines the firm's plans for future long-term financing. Then,
when market conditions seem appropriate, the firm can issue the securities
without further SEC approval. Future issues are said to be sitting on the shelf,
waiting for the most advantageous time to appear. Shelf registration has been
more frequently used with debt issues and other fixed income securities.
16. What is meant by the private placement of a bond issue?
11-16. A private placement means that the bond issue is sold privately to investors rather
than through the public markets.
17. What is a split bond rating?
11-17. A "split bond rating" means different ratings by different bond rating agencies.
18. What is meant by the term junk bond? What quality rating does it fail to meet?
11-18. A lower quality bond is sometimes referred to as a junk bond. It fails to meet the
investment grade qualities established by Moody's (Baa) or Standard & Poor's
(BBB). There may be great variation in bonds that are classified as junk bonds.
19. What does a bond quote of 72 1⁄4 represent in dollar terms?
11-19. 72 1/4 represents 72.25 percent of par. With a $1,000 par value bond, the value is
$722.50.
11-3
whole or part.
20. Why might the bond market be considered less efficient than the
stock market?
11-20. The reason the bond market may be less efficient is that the stock market is
heavily weighted toward being a secondary market in which existing issues are
constantly trading back and forth between investors. The bond market is more of a
primary market, with the emphasis on new issues. The market is not as liquid and
many financial institutions tend to hold bonds until maturity. This means that
there might not be an active liquid market.
21. What is the advantage of a money market fund? How does it differ from a money
market account?
11-21. It allows individuals with a small amount to invest to pool their funds to buy high
yielding large CDs and other similar instruments indirectly through the funds. (Funds can
be withdrawn through check writing privileges.)
Money market funds are offered by mutual funds (or brokerage houses) while
money market accounts are offered by financial institutions. Though money
market accounts are normally federally insured up to $100,000, this is not a
particularly important advantage because of the high quality of assets held by
money market funds.
22. Why would a corporate investor consider preferred stock over a bond? What is meant
by the cumulative feature of preferred stock issues?
11-22. The main reason is the tax advantage to corporate investors wherein only 30
percent of the preferred stock dividends are taxed as income. The cumulative
feature means that if preferred stock dividends are not paid in any one year they
accumulate and must be paid before common stockholders can receive any cash
dividends.
11-4
whole or part.
PROBLEMS
Municipal bond
1. If an investor is in a 34 percent marginal tax bracket and can purchase a municipal
bond paying 7.25 percent, what would the equivalent before-tax return from a
nonmunicipal bond have to be to equate the two?
i 7.25% 7.25%
11-1. Y= = = = 10.98%
(1 − t) (1 − .34) (.66)
Municipal bond
2. If an investor is in a 30 percent marginal tax bracket and can purchase a straight
(nonmunicipal bond) at 8.37 percent and a municipal bond at 6.12 percent, which should
he or she choose?
11-2. Yield on straight bond is 8.37%
Equivalent before-tax yield on municipal bond
i 6.12% 6.12%
Y=  = = 8.74%
(1 − t) (1 − .30) .70
Choose the municipal bond.
Alternative calculation
After-tax yield on straight bond
8.37%  (1 − .30) = 8.37% (.70) 5.86%

Yield on municipal bond 6.12%
Choose the municipal bond.
Bond quotes
3. Using the data in Table 11–6 on page 300, indicate the closing dollar value of the
National City Corp. bonds that pay 4.9 percent interest and mature January 15, 2015.
State your answer in terms of dollars based on a $1,000 par value bond.
11-3. Closing price National City Corp. January 15, 2015 bonds is 94.90.
$ 1, 000.00 par value

94.90 percent of par value
$949.00 bond value in dollars
11-5
whole or part.
Interest payments
4. Using the data in Table 11–6 on page 300, indicate the semiannual interest payment
dates for the Motorola bonds that mature in 2031. (For the item in question, look under
“Interest Dates.”) The two dates are six months apart. How much will the semiannual
payments be?
11-4. Interest payment dates – February 1 and August 1
8.4% × $1,000 = $84 annually
$84/2 = $42 semiannually
Bond quotes ( There is a misprint in the text on this problem)

5. Using the data in Table 11–7 on page 301, indicate the asking price for the 6.000
percent government note maturing in February 2026 (26). The asking price is the
purchase price for the note. State your answer based on a $1,000 par value.
11-5. Closing asked price 132.07
Restated as: 132 7/32
7/32 = .2188
Bond value as % of par 132.2188%
Par Value $1,000
Bond Value in dollars $1322.188
Treasury bill
6. Assume a $1,000 Treasury bill is quoted to pay 5 percent interest over a six-month
period.
a. How much interest would the investor receive?
b. What will be the price of the Treasury bill?
c. What will be the effective yield?
11-6. a) 5% annual interest  2 = 2.5% interest for 6 months
$1, 000
 2.5%
interest
$ 25
b) Price = $1,000 − $25 = $975
Interest $25
c) Effective yield = 2=  2 = 2.56%  2 = 5.12%
Price $975
11-6
whole or part.
Treasury bill
7. In problem 6, if the Treasury bill had only three months to maturity,

a. How much interest would the investor receive?
b. What would be the price of the Treasury bill?
c. What would be the effective yield?
11-7. a) 5% annual interest  4 = 1.25% interest for 3 months
$ 1, 000
1.25%
interest
$ 12.50
b) Price = $1,000 − $12.50 = $987.50
Interest $12.50
c) Effective yield = 4=  4 =1.27 %  4 = 5.08%
Price $987.50
If no rounding is used in part c, the answer is 5.06%. Either answer is correct.
Treasury strip
8. The price of a Treasury strip note or bond can be found using Appendix C toward the
back of the text. It is simply the present value factor from the table times the maturity
(par) value of the Treasury strip. Assume you are considering a $10,000 par value
Treasury strip that matures in 25 years. The discount rate is 7 percent. What is the price
(present value) of the investment?
$10, 000 par value

11-8. .184 Appendix C (n = 25,i = 7 %) present value factor of single payment
$ 1,840 Price of the investment
11-7
whole or part.
Treasury strip
9. Review the instructions in problem 8. Now assume as alternative A you are

considering a $10,000 par value Treasury strip that matures in 20 years. The discount rate
is 6 percent. You also are considering alternative B, which represents a $10,000 par value
Treasury strip that matures in 16 years. The discount rate is 8 percent. Which has the
lower price (present value)?
11-9. Alternative A
$ 10, 000 par value
.312 Appendix C (n = 20,i = 6%)
$3,120 Price
Alternative B
$ 10, 000 par value
.292 Appendix C (n =16,i = 8%)
$2,920 Price
Alternative B has the lower price (in spite of its shorter life).
Treasury Inflation Protection Securities (TIPS)

10. You buy a $1,000 inflation-indexed Treasury security that pays 4 percent annual
interest. Assume inflation is 5 percent in the first two years you own the security.
a. What is the inflation-adjusted value of the security after two years?
b. How much interest will be paid in the third year? The basis for computing interest is
the inflation-adjusted value after year two.
11-8
whole or part.
11-10. a) Par value $1,000
Inflation adjustment = 1.05
Inflation adjustment value (year 1) = $1,000 x 1.05 = $1,050
Inflation adjustment (year 1) $ 1,050
Inflation adjustment 1.05
Inflation adjusted value (year 2) = $1,050 x 1.05 = $1,102.50
or
Par value $1,000 x 1.103 from Appendix A (n = 2, i = 5%) = $1,103
Inflation adjusted value (year 2) $1,103
b) Interest in third year: 4% × $1,102.50 = $44.10
Treasury Inflation Protection Securities (TIPS)
11. You buy a 10-year, $1,000 inflation-indexed Treasury security that pays 3 percent
annual interest. Assume inflation is 3 percent for the first five years and 6 percent for the
last five years. What will be the value of the bond after 10 years? (Use Appendix A to
help you in your calculations.) Disregard the 3 percent annual interest.
11-11. 1st 5 years
Par value $1,000
Inflation adjustment:
Appendix A (n = 5, i = 3%) 1.159
Inflation adjusted value (year 5) = $1000 x 1.159 = $1,159
Next 5 years
Current value $1,159
Inflation adjustment:
Appendix A (n = 5, i = 6%) 1.338
Inflation adjusted value (year 10) = $1,159 x 1.338 = $1,550.74
11-9
whole or part.
Comparative after-tax returns
12. A corporation buys $100 par value preferred stock of another corporation. The
dividend payment is 7.8 percent of par. The corporation is in a 35 percent tax bracket.
a. What will be the after-tax return on the dividend payment? Fill in the following table.
Par value
Dividend payment (%)
Actual dividend
Taxable income (30% of dividend)
Taxes (35% of taxable income)
After-tax return (Actual dividend – Taxes)
After-tax return
Percent return =
Par value
b. Assume a second investment in a $1,000 par value corporate bond pays 8.6 percent
interest. What will be the after-tax return on the interest payment? Fill in the table below.
Par value
Interest payment (percent)
Actual interest
Taxes (35 percent of interest)
After-tax return (Actual interest – Taxes)
After-tax return
Percent return =
Par value
c. Should the corporation choose the corporate bond over the preferred stock because it
has a higher quoted yield (8.6 percent versus 7.8 percent)?
11-12. a) Par value $100
Dividend payment (%) 7.8%
Actual dividend = $7.80
Taxable income (30% of dividend) = $2.34
Taxes (35% of taxable income) = .35 x $2.34 = $.82
After-tax return (actual dividend−taxes) $7.80−0.82 = $6.98
After-tax return $6.98

Percent return = = = 6.98%
Par value $100
11-10
whole or part.
b) Par value $1000
Interest payment (%) 8.6%
Actual interest $86.00
Taxes (35% of taxable income) - 30.10
After-tax return (actual interest-taxes) $55.90
After-tax return $55.90

Percent return = = = 5.59%
Par value $1, 000
c) No. On an after-tax basis, the preferred stock investment is more attractive

(6.98% vs. 5.59%).
Comparative after-tax returns

13. Milton Simon owns 200 shares of preferred stock of the Global Travel Corp. The
shares were intended to pay $4.75 annually, but have not paid a dividend in five years.
Because the dividends are cumulative, the company cannot pay dividends to common
stockholders until it eliminates its obligation to preferred stockholders.
a. Can the preferred stockholders force Global Travel Corp. to pay dividends for the last
five years with a threat of forcing the firm into bankruptcy?
b. Assume Global Travel Corp. does not have the cash to pay the five years of past
preferred stock dividends, but will offer new common stock shares to make up for the
deficiency. The firm will offer a common stock payout that equals the five-year
deficiency, plus provide an additional 20 percent premium in common stock shares to
keep the preferred stockholders satisfied. What is the value of the common stock payout
for each preferred stock share? Note that the preferred stockholders will still retain
ownership of their original shares; only the deficiency in past dividends will be
eliminated.
c. Assume Milton Simon receives the proceeds from his 200 shares and reinvests them in
either a U.S. government security paying 5.6 percent or a municipal bond paying 4.5
percent. Milton is in a 35 percent tax bracket. How much will he have in cash on an after-
tax return basis from each investment? (Disregard a tax on the common stock payout,
only consider a potential tax on the returns from his investment.)
11-11
whole or part.
11-13. a) Since preferred stock dividends are not a fixed, contractual obligation, the
preferred stockholders cannot force the corporation into bankruptcy. However, because
the preferred stock is cumulative, the preferred stock dividend obligation must be
eliminated before dividends can be paid to common stockholders
b) $4.75 Annual dividend

×5 Years
$23.75 Total obligation
1.20 20% premium
$28.50 Value of common shares
c) $28.50 Value of Common stock shares

200 Number of shares
$5, 700 Total proceeds
U.S. government securities
$5,700 Total proceeds
× 5.6% % return
$319.20 $ return
35% Tax rate
$111.72 Taxes
$207.48 After-tax return ($319.20 - $111.72)
Municipal bond
$5,700 Total proceeds
4.5% % return
$256.50 $ return
0 Tax obligation (none on a municipal bond)
$256.50 After-tax return
11-12
whole or part.
Critical Thought Case – Focus on Ethics
Gail Rosenberg still had her head in the clouds when she joined Salomon
Brothers, Inc., in June 1990. While she was proud of her newly awarded MBA
from the Wharton School of Business at the University of Pennsylvania, she
was even prouder of joining the most prestigious investment banking house on
Wall Street, famous Salomon Brothers. She had a received five job offers, but
this was the one she wanted. Not only would she train with the best and
brightest on Wall Street, but she also would be working for a firm in which 90
employees made more than $1 million a year. How many Fortune 500
companies, law firms, or other employers could claim such a record? She was
pleased with her own starting salary of $110,000 a year and could see matters
only getting better in the future.
After some general training and apprenticeship-type work, she was assigned
to the government bond-trading unit in February 1991. Here she would help in
the bidding and distributing of U.S. Treasury bills and notes. Salomon Brothers
was the largest participant among investment banking houses in this field, so
she knew she would quickly learn the ropes.
Her first major participation would be in the Treasury bill auction for May
1991. Salomon Brothers would bid on behalf of many of its clients and probably
have some influence on the ultimate price and yield at which the Treasury bills
were sold. As Gail got on her PC to help process orders, she noticed Salomon
Brothers submitted bids for clients that did not exist. It was no surprise to Gail
that Salomon Brothers captured 85 percent of the bidding and virtually
controlled the pricing of the securities.
In a state of shock, Gail went to her immediate supervisor and reported what
she had observed on her computer screen. She was told to calm down, that she
was no longer in school, and she was witnessing a common practice on “The
Street.” She was further informed that John Gutfreund, chairman of the board of
Salomon Brothers, and President Thomas Strauss implicitly approved of such
practices. She felt a little like Oliver North in the Iran-Contra affair cover-up.
She had worked very hard to get to this tender point in her career and was now
disillusioned.
11-13
whole or part.
Question
1. What strategy or advice can you offer to Gail Rosenberg?
Although it is not the intent of this text to teach ethics as such, it would appear in
Gail Rosenberg’s best interest to come forward with the knowledge she had. Up
to this point she had been more of an observer than a participant. However by
continuing to remain quiet, she would become a party to a coverup of violations
of federal security law. She might not only be barred from Wall Street dealings in
the future, but could face possible criminal actions. If the people at Salomon
Brothers were unwilling to listen to her, she could report the illegal activity to the
Federal Reserve, which was in charge of conducting the auctions, or the Securities
and Exchange Commission, which had regulatory power over Salomon Brothers
and other investment bankers.
When the scandal did eventually break in the summer of 1991, all those involved
were fired. Warren Buffet took over as interim chairman of the board at Salomon
Brothers. One of his first statements was, “If you lose money for the firm by bad
decisions, I will be very understanding. If you lose reputation for the firm, I will
be ruthless.” (The Wall Street Journal, August 27, 1991, page C1.)
11-14
whole or part.

Fundamentals of Investment Management 10th Edition Hirt Solutions Manual

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Fundamentals of Investment Management 10th Edition Hirt Solutions Manual

Uploaded by

Copyright:

Available Formats

Fundamentals of Investment

Management 10th Edition Hirt Solutions

3. Explain how a sinking fund works.

5. What is the nature of a mortgage agreement?

6. What is a senior security?

8. How do zero-coupon securities, such as Treasury strips, provide returns to investors?

11. What tax advantages are associated with municipal bonds?

12. Distinguish between general obligation and revenue bonds.

14. What is an industrial bond?

15. What is shelf registration?

16. What is meant by the private placement of a bond issue?

17. What is a split bond rating?

19. What does a bond quote of 72 1⁄4 represent in dollar terms?

11-2. Yield on straight bond is 8.37%

Equivalent before-tax yield on municipal bond

Choose the municipal bond.

After-tax yield on straight bond

8.37%  (1 − .30) = 8.37% (.70) 5.86%

$ 1, 000.00 par value

11-4. Interest payment dates – February 1 and August 1

8.4% × $1,000 = $84 annually

$84/2 = $42 semiannually

Bond quotes ( There is a misprint in the text on this problem)

11-5. Closing asked price 132.07

Restated as: 132 7/32

Bond value as % of par 132.2188%

Par Value $1,000

Bond Value in dollars $1322.188

11-6. a) 5% annual interest  2 = 2.5% interest for 6 months

b) Price = $1,000 − $25 = $975

7. In problem 6, if the Treasury bill had only three months to maturity,

11-7. a) 5% annual interest  4 = 1.25% interest for 3 months

b) Price = $1,000 − $12.50 = $987.50

If no rounding is used in part c, the answer is 5.06%. Either answer is correct.

$10, 000 par value

9. Review the instructions in problem 8. Now assume as alternative A you are

Treasury Inflation Protection Securities (TIPS)

11-10. a) Par value $1,000

Inflation adjustment = 1.05

Inflation adjustment value (year 1) = $1,000 x 1.05 = $1,050

Inflation adjustment (year 1) $ 1,050

Inflation adjustment 1.05

Inflation adjusted value (year 2) = $1,050 x 1.05 = $1,102.50

Par value $1,000 x 1.103 from Appendix A (n = 2, i = 5%) = $1,103

Inflation adjusted value (year 2) $1,103

b) Interest in third year: 4% × $1,102.50 = $44.10

Treasury Inflation Protection Securities (TIPS)

11-11. 1st 5 years

Par value $1,000

Appendix A (n = 5, i = 3%) 1.159

Inflation adjusted value (year 5) = $1000 x 1.159 = $1,159

Current value $1,159

Appendix A (n = 5, i = 6%) 1.338

Inflation adjusted value (year 10) = $1,159 x 1.338 = $1,550.74

Comparative after-tax returns

11-12. a) Par value $100

Dividend payment (%) 7.8%

Actual dividend = $7.80

Taxable income (30% of dividend) = $2.34

Taxes (35% of taxable income) = .35 x $2.34 = $.82

After-tax return (actual dividend−taxes) $7.80−0.82 = $6.98

After-tax return $6.98

b) Par value $1000

Interest payment (%) 8.6%