Bonds and Valuation

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

Interest rates
1
Answer: e
Diff: E
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. Statements c and d are correct. Answer: c Diff: E
Interest rates and bond prices

2
Assume that a 10 year !reasury bond has a 12 percent annual coupon, "hile a 1# year !reasury bond has an $ percent annual coupon. !he yield curve is flat; all !reasury securities have a 10 percent yield to maturity. %hich of the follo"ing statements is most correct& a. !he 10 year bond is selling at a discount, "hile the 1# year bond is selling at a premium. b. !he 10 year bond is selling at a premium, "hile the 1# year bond is selling at par. c. 'f interest rates decline, the price of both bonds "ill increase, but the 1# year bond "ill have a larger percentage increase in price. d. 'f the yield to maturity on both bonds remains at 10 percent over the ne(t year, the price of the 10 year bond "ill increase, but the price of the 1# year bond "ill fall. e. Statements c and d are correct.

)
Answer: c
Diff: E
A 12 year bond has an annual coupon rate of * percent. !he coupon rate "ill remain fi(ed until the bond matures. !he bond has a yield to maturity of + percent. %hich of the follo"ing statements is most correct& a. !he bond is currently selling at a price belo" its par value. b. 'f mar,et interest rates decline today, the price of the bond "ill also decline today. c. 'f mar,et interest rates remain unchanged, the bond-s price one year from no" "ill be lo"er than it is today. Chapter 7 - Page 1
d. All of the statements above are correct. e. .one of the statements above is correct. Interest rates and bond prices
/
Answer: d
Diff: E
A 10 year !reasury bond has an $ percent coupon. An $ year !reasury bond has a 10 percent coupon. 0oth bonds have the same yield to maturity. 'f the yields to maturity of both bonds increase by the same amount, "hich of the follo"ing statements is most correct& a. b. c. d. !he prices of both bonds "ill increase by the same amount. !he prices of both bonds "ill decrease by the same amount. !he prices of the t"o bonds "ill remain the same. 0oth bonds "ill decline in price, but the 10 year bond "ill have a greater percentage decline in price than the $ year bond. e. 0oth bonds "ill decline in price, but the $ year bond "ill have a greater percentage decline in price than the 10 year bond.
Interest vs. reinvestment rate risk

#
Answer: e
Diff: E
%hich of the follo"ing statements is most correct& a. All else equal, long term bonds have more interest rate ris, than short term bonds. b. All else equal, high coupon bonds have more reinvestment rate ris, than lo" coupon bonds. c. All else equal, short term bonds have more reinvestment rate ris, than do long term bonds. d. Statements a and c are correct. e. All of the statements above are correct.

1
Answer: c
Diff: E
%hich of the follo"ing statements is most correct& a. 2elative to short term bonds, long term bonds have less interest rate ris, but more reinvestment rate ris,. b. 2elative to short term bonds, long term bonds have more interest rate ris, and more reinvestment ris,. c. 2elative to coupon bearing bonds, 3ero coupon bonds have more interest rate ris, but less reinvestment rate ris,. d. 'f interest rates increase, all bond prices "ill increase, but the increase "ill be greatest for bonds that have less interest rate ris,. e. One advantage of 3ero coupon bonds is that you don-t have to pay any ta(es until you sell the bond or it matures.
Price risk
+
Answer: a
Diff: E
%hich of the follo"ing bonds "ill have the greatest percentage increase in value if all interest rates decrease by 1 percent& a. 20 year, 3ero coupon bond. b. 10 year, 3ero coupon bond.
Chapter 7 - Page 2
c. 20 year, 10 percent coupon bond. d. 20 year, # percent coupon bond. e. 1 year, 10 percent coupon bond. Callable bond
$
Answer: a
Diff: E
%hich of the follo"ing events "ould ma,e it more li,ely that a company "ould choose to call its outstanding callable bonds& a. b. c. d. e. A reduction in mar,et interest rates. !he company-s bonds are do"ngraded. An increase in the call premium. Statements a and b are correct. Statements a, b, and c are correct. Answer: b Diff: E
Call provision
*
Other things held constant, if a bond indenture contains a call provision, the yield to maturity that "ould e(ist "ithout such a call provision "ill generally be the 4!5 "ith a call provision. a. b. c. d. 6igher than. 7o"er than. !he same as. 8ither higher or lo"er 9depending on the level of the call premium: than. e. ;nrelated to.
Bond coupon rate

10
Answer: c
Diff: E
All of the follo"ing may serve to reduce the coupon rate that "ould other"ise be required on a bond issued at par, e(cept a a. b. c. d. e. Sin,ing fund. 2estrictive covenant. <all provision. <hange in rating from Aa to Aaa. .one of the statements above. 9All may reduce the required coupon rate.: Answer: a Diff: E
Bond concepts
11
%hich of the follo"ing statements is most correct& a. All else equal, if a bond-s yield to maturity increases, its price "ill fall. b. All else equal, if a bond-s yield to maturity increases, its current yield "ill fall. c. 'f a bond-s yield to maturity e(ceeds the coupon rate, the bond "ill sell at a premium over par. d. All of the statements above are correct. e. .one of the statements above is correct.
Chapter 7 - Page 3
Bond concepts
12
Answer: c
Diff: E
%hich of the follo"ing statements is most correct& a. 'f a bond-s yield to maturity e(ceeds its annual coupon, then the bond "ill be trading at a premium. b. 'f interest rates increase, the relative price change of a 10 year coupon bond "ill be greater than the relative price change of a 10 year 3ero coupon bond. c. 'f a coupon bond is selling at par, its current yield equals its yield to maturity. d. Statements a and c are correct. e. .one of the statements above is correct.
Bond concepts
1)
Answer: e
Diff: E
A 10 year corporate bond has an annual coupon payment of * percent. !he bond is currently selling at par 9=1,000:. %hich of the follo"ing statements is most correct& a. !he bond-s yield to maturity is * percent. b. !he bond-s current yield is * percent. c. 'f the bond-s yield to maturity remains constant, the bond-s price "ill remain at par. d. Statements a and c are correct. e. All of the statements above are correct.
Bond concepts
1/
Answer: a
Diff: E
A 1# year bond "ith a face value of =1,000 currently sells for =$#0. %hich of the follo"ing statements is most correct& a. !he bond-s yield to maturity is greater than its coupon rate. b. 'f the yield to maturity stays constant until the bond matures, the bond-s price "ill remain at =$#0. c. !he bond-s current yield is equal to the bond-s coupon rate. d. Statements b and c are correct. e. All of the statements above are correct.
Bond concepts
1#
Answer: d
Diff: E
A !reasury bond has an $ percent annual coupon and a yield to maturity equal to +.# percent. %hich of the follo"ing statements is most correct& a. !he bond has a current yield greater than $ percent. b. !he bond sells at a price above par. c. 'f the yield to maturity remains constant, the price of the bond is e(pected to fall over time. d. Statements b and c are correct. e. All of the statements above are correct.
Chapter 7 - Page 4
Bond concepts
11
Answer: a
Diff: E
4ou are considering investing in three different bonds. 8ach bond matures in 10 years and has a face value of =1,000. !he bonds have the same level of ris,, so the yield to maturity is the same for each. 0ond A has an $ percent annual coupon, 0ond 0 has a 10 percent annual coupon, and 0ond < has a 12 percent annual coupon. 0ond 0 sells at par. Assuming that interest rates are e(pected to remain at their current level for the ne(t 10 years, "hich of the follo"ing statements is most correct& a. 0ond A sells at a discount 9its price is less than par:, and its price is e(pected to increase over the ne(t year. b. 0ond A-s price is e(pected to decrease over the ne(t year, 0ond 0-s price is e(pected to stay the same, and 0ond <-s price is e(pected to increase over the ne(t year. c. Since the bonds have the same yields to maturity, they should all have the same price, and since interest rates are not e(pected to change, their prices should all remain at their current levels until the bonds mature. d. 0ond < sells at a premium 9its price is greater than par:, and its price is e(pected to increase over the ne(t year. e. Statements b and d are correct.
Bond concepts
1+
Answer: d
Diff: E
An investor is considering buying one of t"o bonds issued by <arson <ity Airlines. 0ond A has a + percent annual coupon, "hereas 0ond 0 has a * percent annual coupon. 0oth bonds have 10 years to maturity, face values of =1,000, and yields to maturity of $ percent. Assume that the yield to maturity for both of the bonds "ill remain constant over the ne(t 10 years. %hich of the follo"ing statements is most correct& a. 0ond A has a higher price than 0ond 0 today, but one year from no" the bonds "ill have the same price as each other. b. 0ond 0 has a higher price than 0ond A today, but one year from no" the bonds "ill have the same price as each other. c. 0oth bonds have the same price today, and the price of each bond is e(pected to remain constant until the bonds mature. d. One year from no", 0ond A-s price "ill be higher than it is today. e. 0ond A-s current yield 9not to be confused "ith its yield to maturity: is greater than $ percent.
Bond concepts
1$
Answer: c
Diff: E
A 10 year bond "ith a * percent annual coupon has a yield to maturity of $ percent. %hich of the follo"ing statements is most correct& a. !he bond is selling at a discount. b. !he bond-s current yield is greater than * percent. c. 'f the yield to maturity remains constant, the bond-s price one year from no" "ill be lo"er than its current price. d. Statements a and b are correct. Chapter 7 - Page 5
e. .one of the statements above is correct. Bond concepts

1*
Answer: a
Diff: E
%hich of the follo"ing statements is most correct& a. 7ong term bonds have more interest rate price ris,, but less reinvestment rate ris, than short term bonds. b. 0onds "ith higher coupons have more interest rate price ris,, but less reinvestment rate ris, than bonds "ith lo"er coupons. c. 'f interest rates remain constant for the ne(t five years, the price of a discount bond "ill remain the same for the ne(t five years. d. Statements b and c are correct. e. All of the statements above are correct.
Bond concepts
20
Answer: d
Diff: E
%hich of the follo"ing statements is most correct& a. 'f a bond is selling at par value, its current yield equals its yield to maturity. b. 'f a bond is selling at a discount to par, its current yield "ill be less than its yield to maturity. c. All else equal, bonds "ith longer maturities have more interest rate 9price: ris, than do bonds "ith shorter maturities. d. All of the statements above are correct. e. .one of the statements above is correct.
Bond yield
21
Answer: a
Diff: E
A 10 year bond pays an annual coupon. !he bond has a yield to maturity of $ percent. !he bond currently trades at a premium its price is above the par value of =1,000. %hich of the follo"ing statements is most correct& a. 'f the yield to maturity remains at $ percent, then the bond-s price "ill decline over the ne(t year. b. !he bond-s current yield is less than $ percent. c. 'f the yield to maturity remains at $ percent, then the bond-s price "ill remain the same over the ne(t year. d. !he bond-s coupon rate is less than $ percent. e. 'f the yield to maturity increases, then the bond-s price "ill increase.
Chapter 7 - Page 6
Bond yields and prices

22
Answer: d
Diff: E
4ou are considering t"o !reasury bonds. 0ond A has a * percent annual coupon, and 0ond 0 has a 1 percent annual coupon. 0oth bonds have a yield to maturity of + percent. Assume that the yield to maturity is e(pected to remain at + percent. %hich of the follo"ing statements is most correct& a. 'f the yield to maturity remains at + percent, the price of both bonds "ill increase by + percent per year. b. 'f the yield to maturity remains at + percent, the price of both bonds "ill increase over time, but the price of 0ond A "ill increase by more. c. 'f the yield to maturity remains at + percent, the price of both bonds "ill remain unchanged. d. 'f the yield to maturity remains at + percent, the price of 0ond A "ill decrease over time, but the price of 0ond 0 "ill increase over time. e. 'f the yield to maturity remains at + percent, the price of 0ond 0 "ill decrease over time, but the price of 0ond A "ill increase over time.
inkin! fund provision

2)
Answer: e
Diff: E
%hich of the follo"ing statements is most correct& a. Sin,ing fund provisions do not require companies to retire their debt; they only establish >targets? for the company to reduce its debt over time. b. Sin,ing fund provisions sometimes "or, to the detriment of bondholders particularly if interest rates have declined over time. c. 'f interest rates have increased since the time a company issues bonds "ith a sin,ing fund provision, the company is more li,ely to retire the bonds by buying them bac, in the open mar,et, as opposed to calling them in at the sin,ing fund call price. d. Statements a and b are correct. e. Statements b and c are correct.
inkin! fund provision

2/
Answer: d
Diff: E
%hich of the follo"ing statements is most correct& a. 2etiring bonds under a sin,ing fund provision is similar to calling bonds under a call provision in the sense that bonds are repurchased by the issuer prior to maturity. b. ;nder a sin,ing fund, bonds "ill be purchased on the open mar,et by the issuer "hen the bonds are selling at a premium and bonds "ill be called in for redemption "hen the bonds are selling at a discount. c. !he sin,ing fund provision ma,es a debt issue less ris,y to the investor. d. Statements a and c are correct. e. All of the statements above are correct.
Chapter 7 - Page 7
"ypes of debt
2#
Answer: e
Diff: E
%hich of the follo"ing statements is most correct& a. @un, bonds typically have a lo"er yield to maturity relative to investment grade bonds. b. A debenture is a secured bond that is bac,ed by some or all of the firm-s fi(ed assets. c. Subordinated debt has less default ris, than senior debt. d. All of the statements above are correct. e. .one of the statements above is correct.
Medium:
Bond yield
21
Answer: b
Diff: #
%hich of the follo"ing statements is most correct& a. 2ising inflation ma,es the actual yield to maturity on a bond greater than the quoted yield to maturity, "hich is based on mar,et prices. b. !he yield to maturity for a coupon bond that sells at its par value consists entirely of an interest yield; it has a 3ero e(pected capital gains yield. c. On an e(pected yield basis, the e(pected capital gains yield "ill al"ays be positive because an investor "ould not purchase a bond "ith an e(pected capital loss. d. !he mar,et value of a bond "ill al"ays approach its par value as its maturity date approaches. !his holds true even if the firm enters ban,ruptcy. e. .one of the statements above is correct.
Bond yield
2+
Answer: c
Diff: #
%hich of the follo"ing statements is most correct& a. !he current yield on 0ond A e(ceeds the current yield on 0ond 0; therefore, 0ond A must have a higher yield to maturity than 0ond 0. b. 'f a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity. c. 'f a coupon bond is selling at par, its current yield equals its yield to maturity. d. Statements a and b are correct. e. Statements b and c are correct.
Price risk
2$
Answer: c
Diff: #
Assume that all interest rates in the economy decline from 10 percent to * percent. %hich of the follo"ing bonds "ill have the largest percentage increase in price& a. b. c. d. A 10 year bond "ith a 10 percent coupon. An $ year bond "ith a * percent coupon. A 10 year 3ero coupon bond. A 1 year bond "ith a 1# percent coupon.
Chapter 7 - Page 8
e. A ) year bond "ith a 10 percent coupon. Price risk

2*
Answer: c
Diff: #
%hich of the follo"ing has the greatest interest rate 9price: ris,& a. A 10 year, =1,000 face value, 10 percent coupon bond "ith semiannual interest payments. b. A 10 year, =1,000 face value, 10 percent coupon bond "ith annual interest payments. c. A 10 year, =1,000 face value, 3ero coupon bond. d. A 10 year =100 annuity. e. All of the above have the same price ris, since they all mature in 10 years.
Price risk
)0
Answer: c
Diff: #
'f the yield to maturity decreased 1 percentage point, "hich of the follo"ing bonds "ould have the largest percentage increase in value& a. b. c. d. e. A A A A A 1 year bond "ith an $ percent coupon. 1 year 3ero coupon bond. 10 year 3ero coupon bond. 10 year bond "ith an $ percent coupon. 10 year bond "ith a 12 percent coupon. Answer: a Diff: #
Price risk
)1
'f interest rates fall from $ percent to + percent, "hich of the follo"ing bonds "ill have the largest percentage increase in its value& a. b. c. d. e. A A A A A 10 year 3ero coupon bond. 10 year bond "ith a 10 percent semiannual coupon. 10 year bond "ith a 10 percent annual coupon. # year 3ero coupon bond. # year bond "ith a 12 percent annual coupon. Answer: a Diff: #
Price risk
)2
%hich of the follo"ing !reasury bonds "ill have the largest amount of interest rate ris, 9price ris,:& a. b. c. d. e. A A A A A + percent coupon bond that matures in 12 years. * percent coupon bond that matures in 10 years. 12 percent coupon bond that matures in + years. + percent coupon bond that matures in * years. 10 percent coupon bond that matures in 10 years.
Chapter 7 - Page 9
Price risk
))
Answer: a
Diff: #
All treasury securities have a yield to maturity of + percent so the yield curve is flat. 'f the yield to maturity on all !reasuries "ere to decline to 1 percent, "hich of the follo"ing bonds "ould have the largest percentage increase in price& a. b. c. d. e. 1# year 3ero coupon !reasury bond. 12 year !reasury bond "ith a 10 percent annual coupon. 1# year !reasury bond "ith a 12 percent annual coupon. 2 year 3ero coupon !reasury bond. 2 year !reasury bond "ith a 1# percent annual coupon. Answer: e Diff: #
Bond concepts
)/
%hich of the follo"ing statements is most correct& a. Other things held constant, a callable bond "ould have a lo"er required rate of return than a noncallable bond. b. Other things held constant, a corporation "ould rather issue noncallable bonds than callable bonds. c. 2einvestment rate ris, is "orse from a typical investor-s standpoint than interest rate ris,. d. 'f a 10 year, =1,000 par, 3ero coupon bond "ere issued at a price that gave investors a 10 percent rate of return, and if interest rates then dropped to the point "here , d A 4!5 A #B, "e could be sure that the bond "ould sell at a premium over its =1,000 par value. e. 'f a 10 year, =1,000 par, 3ero coupon bond "ere issued at a price that gave investors a 10 percent rate of return, and if interest rates then dropped to the point "here , d A 4!5 A #B, "e could be sure that the bond "ould sell at a discount belo" its =1,000 par value.
Bond concepts
)#
Answer: d
Diff: #
%hich of the follo"ing statements is most correct& a. !he mar,et value of a bond "ill al"ays approach its par value as its maturity date approaches, provided the issuer of the bond does not go ban,rupt. b. 'f the Cederal 2eserve une(pectedly announces that it e(pects inflation to increase, then "e "ould probably observe an immediate increase in bond prices. c. !he total yield on a bond is derived from interest payments and changes in the price of the bond. d. Statements a and c are correct. e. All of the statements above are correct.
Chapter 7 - Page 10
Bond concepts
)1
Answer: b
Diff: #
%hich of the follo"ing statements is most correct& a. 'f a bond is selling for a premium, this implies that the bond-s yield to maturity e(ceeds its coupon rate. b. 'f a coupon bond is selling at par, its current yield equals its yield to maturity. c. 'f rates fall after its issue, a 3ero coupon bond could trade for an amount above its par value. d. Statements b and c are correct. e. .one of the statements above is correct.
Bond concepts
)+
Answer: b
Diff: #
%hich of the follo"ing statements is most correct& a. All else equal, a bond that has a coupon rate of 10 percent "ill sell at a discount if the required return for a bond of similar ris, is $ percent. b. !he price of a discount bond "ill increase over time, assuming that the bond-s yield to maturity remains constant over time. c. !he total return on a bond for a given year consists only of the coupon interest payments received. d. Statements b and c are correct. e. All of the statements above are correct.
Bond concepts
)$
Answer: e
Diff: #
%hich of the follo"ing statements is most correct& a. %hen large firms are in financial distress, they are almost al"ays liquidated. b. Debentures generally have a higher yield to maturity relative to mortgage bonds. c. 'f there are t"o bonds "ith equal maturity and credit ris,, the bond that is callable "ill have a higher yield to maturity than the bond that is noncallable. d. Statements a and c are correct. e. Statements b and c are correct.
Bond concepts
)*
Answer: d
Diff: #
A 10 year bond has a 10 percent annual coupon and a yield to maturity of 12 percent. !he bond can be called in # years at a call price of =1,0#0 and the bond-s face value is =1,000. %hich of the follo"ing statements is most correct& a. b. c. d. e. !he bond-s current yield is greater than 10 percent. !he bond-s yield to call is less than 12 percent. !he bond is selling at a price belo" par. Statements a and c are correct. .one of the statements above is correct. Chapter 7 - Page 11
Bond concepts
/0
Answer: d
Diff: #
0ond E has an $ percent annual coupon, 0ond 4 has a 10 percent annual coupon, and 0ond F has a 12 percent annual coupon. 8ach of the bonds has a maturity of 10 years and a yield to maturity of 10 percent. %hich of the follo"ing statements is most correct& a. 0ond E has the greatest reinvestment rate ris,. b. 'f mar,et interest rates remain at 10 percent, 0ond F-s price "ill be 10 percent higher one year from today. c. 'f mar,et interest rates increase, 0ond E-s price "ill increase, 0ond F-s price "ill decline, and 0ond 4-s price "ill remain the same. d. 'f mar,et interest rates remain at 10 percent, 0ond F-s price "ill be lo"er one year from no" than it is today. e. 'f mar,et interest rates decline, all of the bonds "ill have an increase in price, and 0ond F "ill have the largest percentage increase in price.
Bond concepts
/1
Answer: b
Diff: #
0onds A, 0, and < all have a maturity of 10 years and a yield to maturity equal to + percent. 0ond A-s price e(ceeds its par value, 0ond 0-s price equals its par value, and 0ond <-s price is less than its par value. %hich of the follo"ing statements is most correct& a. 'f the yield to maturity on the three bonds remains constant, the price of the three bonds "ill remain the same over the course of the ne(t year. b. 'f the yield to maturity on each bond increases to $ percent, the price of all three bonds "ill decline. c. 'f the yield to maturity on each bond decreases to 1 percent, 0ond A "ill have the largest percentage increase in its price. d. Statements a and c are correct. e. All of the above statements are correct.

/2
Answer: e
Diff: #
0ond A has a * percent annual coupon, "hile 0ond 0 has a + percent annual coupon. 0oth bonds have the same maturity, a face value of =1,000, and an $ percent yield to maturity. %hich of the follo"ing statements is most correct& a. 0ond A trades at a discount, "hereas 0ond 0 trades at a premium. b. 'f the yield to maturity for both bonds remains at $ percent, 0ond A-s price one year from no" "ill be higher than it is today, but 0ond 0-s price one year from no" "ill be lo"er than it is today. c. 'f the yield to maturity for both bonds immediately decreases to 1 percent, 0ond A-s bond "ill have a larger percentage increase in value. d. All of the statements above are correct. e. .one of the statements above is correct.
Chapter 7 - Page 12
Callable bond
/)
Answer: d
Diff: #
%hich of the follo"ing statements is most correct& a. Distant cash flo"s are generally ris,ier than near term cash flo"s. Curther, a 20 year bond that is callable after # years "ill have an e(pected life that is probably shorter, and certainly no longer, than an other"ise similar noncallable 20 year bond. !herefore, investors should require a lo"er rate of return on the callable bond than on the noncallable bond, assuming other characteristics are similar. b. A noncallable 20 year bond "ill generally have an e(pected life that is equal to or greater than that of an other"ise identical callable 20 year bond. 5oreover, the interest rate ris, faced by investors is greater the longer the maturity of a bond. !herefore, callable bonds e(pose investors to less interest rate ris, than noncallable bonds, other things held constant. c. Statements a and b are correct. d. .one of the statements above is correct.
Callable bond
//
Answer: b
Diff: #
%hich of the follo"ing statements is most correct& a. A callable 10 year, 10 percent bond should sell at a higher price than an other"ise similar noncallable bond. b. !"o bonds have the same maturity and the same coupon rate. 6o"ever, one is callable and the other is not. !he difference in prices bet"een the bonds "ill be greater if the current mar,et interest rate is belo" the coupon rate than if it is above the coupon rate. c. !"o bonds have the same maturity and the same coupon rate. 6o"ever, one is callable and the other is not. !he difference in prices bet"een the bonds "ill be greater if the current mar,et interest rate is above the coupon rate than if it is belo" the coupon rate. d. !he actual life of a callable bond "ill be equal to or less than the actual life of a noncallable bond "ith the same maturity date. !herefore, if the yield curve is up"ard sloping, the required rate of return "ill be lo"er on the callable bond. e. <orporate treasurers disli,e issuing callable bonds because these bonds may require the company to raise additional funds earlier than "ould be true if noncallable bonds "ith the same maturity "ere used.
Chapter 7 - Page 13
"ypes of debt and t$eir relative costs

/#
Answer: c
Diff: #
A company is planning to raise =1,000,000 to finance a ne" plant. %hich of the follo"ing statements is most correct& a. 'f debt is used to raise the million dollars, the cost of the debt "ould be lo"er if the debt is in the form of a fi(ed rate bond rather than a floating rate bond. b. 'f debt is used to raise the million dollars, the cost of the debt "ould be lo"er if the debt is in the form of a bond rather than a term loan. c. 'f debt is used to raise the million dollars, but =#00,000 is raised as a first mortgage bond on the ne" plant and =#00,000 as debentures, the interest rate on the first mortgage bonds "ould be lo"er than it "ould be if the entire =1 million "ere raised by selling first mortgage bonds. d. !he company "ould be especially an(ious to have a call provision included in the indenture if its management thin,s that interest rates are almost certain to rise in the foreseeable future. e. .one of the statements above is correct.
#iscellaneous concepts
/1
Answer: c
Diff: #
%hich of the follo"ing statements is most correct& a. Once a firm declares ban,ruptcy, it is liquidated by the trustee, "ho uses the proceeds to pay bondholders, unpaid "ages, ta(es, and la"yer fees. b. A firm "ith a sin,ing fund payment coming due "ould generally choose to buy bac, bonds in the open mar,et, if the price of the bond e(ceeds the sin,ing fund call price. c. 'ncome bonds pay interest only "hen the amount of the interest is actually earned by the company. !hus, these securities cannot ban,rupt a company and this ma,es them safer to investors than regular bonds. d. One disadvantage of 3ero coupon bonds is that issuing firms cannot reali3e the ta( savings from issuing debt until the bonds mature. e. Other things held constant, callable bonds should have a lo"er yield to maturity than noncallable bonds.
Chapter 7 - Page 14
/+
Answer: b
Diff: #
%hich of the follo"ing statements is most correct& a. A 10 year 10 percent coupon bond has less reinvestment rate ris, than a 10 year # percent coupon bond 9assuming all else equal:. b. !he 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. c. !he price of a 20 year 10 percent bond is less sensitive to changes in interest rates 9that is, has lo"er interest rate ris,: than the price of a # year 10 percent bond. d. A =1,000 bond "ith =100 annual interest payments "ith five years to maturity 9not e(pected to default: "ould sell for a discount if interest rates "ere belo" * percent and "ould sell for a premium if interest rates "ere greater than 11 percent. e. Statements a, b, and c are correct.
/$
Answer: e
Diff: #
%hich of the follo"ing statements is most correct& a. All else equal, a 1 year bond "ill have a higher 9that is, better: bond rating than a 20 year bond. b. A 20 year bond "ith semiannual interest payments has higher price ris, 9that is, interest rate ris,: than a # year bond "ith semiannual interest payments. c. 10 year 3ero coupon bonds have higher reinvestment rate ris, than 10 year, 10 percent coupon bonds. d. 'f a callable bond "ere trading at a premium, then you "ould e(pect to earn the yield to maturity. e. Statements a and b are correct.
Current yield and yield to maturity

/*
Answer: e
Diff: #
%hich of the follo"ing statements is most correct& a. 'f a bond sells for less than par, then its yield to maturity is less than its coupon rate. b. 'f a bond sells at par, then its current yield "ill be less than its yield to maturity. c. Assuming that both bonds are held to maturity and are of equal ris,, a bond selling for more than par "ith 10 years to maturity "ill have a lo"er current yield and higher capital gain relative to a bond that sells at par. d. Statements a and c are correct. e. .one of the statements above is correct.
Chapter 7 - Page 15

#0
Answer: a
Diff: #
4ou Gust purchased a 10 year corporate bond that has an annual coupon of 10 percent. !he bond sells at a premium above par. %hich of the follo"ing statements is most correct& a. !he bond-s yield to maturity is less than 10 percent. b. !he bond-s current yield is greater than 10 percent. c. 'f the bond-s yield to maturity stays constant, the bond-s price "ill be the same one year from no". d. Statements a and c are correct. e. .one of the statements above is correct.
Corporate bonds and default risk

#1
Answer: c
Diff: #
%hich of the follo"ing statements is most correct& a. !he e(pected return on corporate bonds "ill generally e(ceed the yield to maturity. b. Cirms that are in financial distress are forced to declare ban,ruptcy. c. All else equal, senior debt "ill generally have a lo"er yield to maturity than subordinated debt. d. Statements a and c are correct. e. .one of the statements above is correct.
Default risk and bankruptcy

#2
Answer: b
Diff: #
%hich of the follo"ing statements is incorrect& a. Cirms "ill often voluntarily enter ban,ruptcy before they are forced into ban,ruptcy by their creditors. b. An indenture is a bond that is less ris,y than a subordinated debenture. c. %hen a firm files for <hapter 11 ban,ruptcy, it may attempt to restructure its e(isting debt by changing 9subGect to creditor approval: the interest payments, maturity, andHor principal amount. d. All else equal, mortgage bonds are less ris,y than debentures because mortgage bonds provide investors "ith a lien 9that is, a claim: against specific property. e. A company-s bond rating is affected by financial performance and provisions in the bond contract.

#)
Answer: b
Diff: #
%hich of the follo"ing statements is most correct& a. 'f a company increases its debt ratio, this is li,ely to reduce the default premium on its e(isting bonds. b. All else equal, senior debt has less default ris, than subordinated debt. c. %hen companies enter <hapter 11, their assets are immediately liquidated and the firm no longer continues to operate. d. Statements a and c are correct. e. All of the statements above are correct.
Chapter 7 - Page 16

#/
Answer: d
Diff: #
%hich of the follo"ing statements is most correct& a. !he e(pected return on a corporate bond is al"ays less than its promised return "hen the probability of default is greater than 3ero. b. All else equal, secured debt is considered to be less ris,y than unsecured debt. c. ;nder <hapter 11 0an,ruptcy, the firm-s assets are sold and debts are paid off according to the seniority of the debt claim. d. Statements a and b are correct. e. All of the statements above are correct.
inkin! funds and bankruptcy

##
Answer: d
Diff: #
%hich of the follo"ing statements is correct& a. 'f a company is retiring bonds for sin,ing fund purposes it "ill buy bac, bonds on the open mar,et "hen the coupon rate is less than the mar,et interest rate. b. A bond sin,ing fund "ould be good for investors if interest rates have declined after issuance and the investor-s bonds get called. c. A company that files for <hapter 11 2eorgani3ation under the Cederal 0an,ruptcy Act can temporarily prevent foreclosure and sei3ing of the assets of the company. 7iquidation may still occur for this company. d. Statements a and c are correct. e. All of the statements above are correct.
Tough:
#1
Answer: b
Diff: "
%hich of the follo"ing statements is most correct& a. 'f a bond-s yield to maturity e(ceeds its coupon rate, the bond-s current yield must also e(ceed its coupon rate. b. 'f a bond-s yield to maturity e(ceeds its coupon rate, the bond-s price must be less than its maturity value. c. 'f t"o bonds have the same maturity, the same yield to maturity, and the same level of ris,, the bonds should sell for the same price regardless of the bond-s coupon rate. d. Statements b and c are correct. e. .one of the statements above is correct.
Chapter 7 - Page 17
Bond concepts
#+
Answer: b
Diff: "
%hich of the follo"ing statements is incorrect about bonds& the statements, assume other things are held constant.
'n all of
a. Irice sensitivity, that is, the change in price due to a given change in the required rate of return, increases as a bond-s maturity increases. b. Cor a given bond of any maturity, a given percentage point increase in the interest rate 9,d: causes a larger dollar capital loss than the capital gain stemming from an identical decrease in the interest rate. c. Cor 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. d. Crom a borro"er-s point of vie", interest paid on bonds is ta( deductible. e. A 20 year 3ero coupon bond has less reinvestment rate ris, than a 20 year coupon bond. Bond concepts
#$
Answer: e
Diff: "
%hich of the follo"ing statements is most correct& a. All else equal, an increase in interest rates "ill have a greater effect on the prices of long term bonds than it "ill on the prices of short term bonds. b. All else equal, an increase in interest rates "ill have a greater effect on higher coupon bonds than it "ill have on lo"er coupon bonds. c. An increase in interest rates "ill have a greater effect on a 3ero coupon bond "ith 10 years maturity than it "ill have on a * year bond "ith a 10 percent annual coupon. d. All of the statements above are correct. e. Statements a and c are correct.

#*
Answer: c
Diff: "
%hich of the follo"ing statements is most correct& a. A 10 year bond "ould have more interest rate ris, than a # year bond, but all 10 year bonds have the same interest rate ris,. b. A 10 year bond "ould have more reinvestment rate ris, than a # year bond, but all 10 year bonds have the same reinvestment rate ris,. c. 'f their maturities "ere the same, a # percent coupon bond "ould have more interest rate ris, than a 10 percent coupon bond. d. 'f their maturities "ere the same, a # percent coupon bond "ould have less interest rate ris, than a 10 percent coupon bond. e. Fero coupon bonds have more interest rate ris, than any other type bond, even perpetuities.
Chapter 7 - Page 18
Bond indenture
10
Answer: d are some provisions that are often contained
Diff: " in bond
7isted belo" indenturesJ 1. 2. ). /. #. 1.
Ci(ed assets !he bond may !he bond may !he bond may !he bond may !he bond may
may be used as security. be subordinated to other classes of debt. be made convertible. have a sin,ing fund. have a call provision. have restrictive covenants in its indenture.
%hich of the above provisions, each vie"ed alone, "ould tend to reduce the yield to maturity investors "ould other"ise require on a ne"ly issued bond& a. b. c. d. e. 1, 1, 1, 1, 1, 2, 2, ), ), /, ), ), /, /, 1 /, #, 1 /, 1 #, 1 1 Answer: e Diff: "
"ypes of debt and t$eir relative costs

11
Suppose a ne" company decides to raise its initial =200 million of capital as =100 million of common equity and =100 million of long term debt. 0y an iron clad provision in its charter, the company can never borro" any more money. %hich of the follo"ing statements is most correct& a. 'f the debt "ere raised by issuing =#0 million of debentures and =#0 million of first mortgage bonds, "e could be absolutely certain that the firm-s total interest e(pense "ould be lo"er than if the debt "ere raised by issuing =100 million of debentures. b. 'f the debt "ere raised by issuing =#0 million of debentures and =#0 million of first mortgage bonds, "e could be absolutely certain that the firm-s total interest e(pense "ould be lo"er than if the debt "ere raised by issuing =100 million of first mortgage bonds. c. !he higher the percentage of total debt represented by debentures, the greater the ris, of, and hence the interest rate on, the debentures. d. !he higher the percentage of total debt represented by mortgage bonds, the ris,ier both types of bonds "ill be, and, consequently, the higher the firm-s total dollar interest charges "ill be. e. 'n this situation, "e cannot tell for sure ho", or "hether, the firm-s total interest e(pense on the =100 million of debt "ould be affected by the mi( of debentures versus first mortgage bonds. 'nterest rates on the t"o types of bonds "ould vary as their percentages "ere changed, but the result might "ell be such that the firm-s total interest charges "ould not be affected materially by the mi( bet"een the t"o.
Chapter 7 - Page 19
Multiple Choice: P*o+lems Easy:

Annual coupon rate
12
Answer: d
Diff: E
An annual coupon bond "ith a =1,000 face value matures in 10 years. !he bond currently sells for =*0).+)#1 and has a * percent yield to maturity. %hat is the bond-s annual coupon rate& a. b. c. d. e. 1.+B +.0B +.2B +.#B +.+B Answer: d Diff: E
Bond value%%annual payment

1)
A 12 year bond has a * percent annual coupon, a yield to maturity of $ percent, and a face value of =1,000. %hat is the price of the bond& a. b. c. d. e. =1,/1* =1,000 = *2$ =1,0+# =1,*#+ Answer: e Diff: E
Bond value%%semiannual payment

1/
4ou intend to purchase a 10 year, =1,000 face value bond that pays interest of =10 every 1 months. 'f your nominal annual required rate of return is 10 percent "ith semiannual compounding, ho" much should you be "illing to pay for this bond& a. b. c. d. e. = $21.)1 =1,0$1.1# = *#+.#0 =1,/)1./* =1,12/.12 Answer: d Diff: E

1#
Assume that you "ish to purchase a 20 year bond that has a maturity value of =1,000 and ma,es semiannual interest payments of =/0. 'f you require a 10 percent nominal yield to maturity on this investment, "hat is the ma(imum price you should be "illing to pay for the bond& a. b. c. d. e. =11* =1+/ =+11 =$2$ =*02
Chapter 7 - Page 20

11
Answer: e
Diff: E
A bond that matures in 12 years has a * percent semiannual coupon 9i.e., the bond pays a =/# coupon every si( months: and a face value of =1,000. !he bond has a nominal yield to maturity of $ percent. %hat is the price of the bond today& a. b. c. d. e. = *2+.#2 = *2$.)* =1,0+).** =1,0+#.)1 =1,0+1.2) Answer: b Diff: E N

1+
A bond "ith 10 years to maturity has a face value of =1,000. !he bond pays an $ percent semiannual coupon, and the bond has a * percent nominal yield to maturity. %hat is the price of the bond today& a. b. c. d. e. =*0$.+1 =*)/.*1 =*)#.$2 =*#2.)+ =*10.// Answer: c Diff: E

1$
A corporate bond "ith a =1,000 face value pays a =#0 coupon every si( months. !he bond "ill mature in 10 years, and has a nominal yield to maturity of * percent. %hat is the price of the bond& a. b. c. d. e. = 1)/.$1 =1,01/.1$ =1,01#.0/ =1,0+$.2) =1,0*/.#1 Answer: b Diff: E

1*
A bond "ith a =1,000 face value and an $ percent annual coupon pays interest semiannually. !he bond "ill mature in 1# years. !he nominal yield to maturity is 11 percent. %hat is the price of the bond today& a. b. c. d. e. = +$/.2+ = +$1.** =1,2#*.)$ =1,000.00 = +)*.1*
Chapter 7 - Page 21

+0
Answer: c
Diff: E
A 12 year bond has an $ percent semiannual coupon and a face value of =1,000. !he bond pays a =/0 coupon every si( months. !he bond has a nominal yield to maturity of + percent. %hat is the price of the bond& a. b. c. d. e. =1,11/.1* = +11.+2 =1,0$0.2* = 1##.*2 =1,0+*./) Answer: c Diff: E
Bond value%%&uarterly payment

+1
A =1,000 par value bond pays interest of =)# each quarter and "ill mature in 10 years. 'f your nominal annual required rate of return is 12 percent "ith quarterly compounding, ho" much should you be "illing to pay for this bond& a. b. c. d. e. = */1.)1 =1,0#1.2# =1,11#.#+ =1,)*1.00 = $2#./* Answer: a Diff: E
'ield to maturity%%annual bond

+2
Ialmer Iroducts has outstanding bonds "ith an annual $ percent coupon. !he bonds have a par value of =1,000 and a price of =$1#. !he bonds "ill mature in 11 years. %hat is the yield to maturity on the bonds& a. 10.0*B b. 11.1)B c. *.2#B d. $.00B e. *.$*B
'ield to maturity%%semiannual bond

+)
Answer: c
Diff: E
A corporate bond has a face value of =1,000, and pays a =#0 coupon every si( months 9that is, the bond has a 10 percent semiannual coupon:. !he bond matures in 12 years and sells at a price of =1,0$0. %hat is the bond-s nominal yield to maturity& a. $.2$B b. $.1#B c. $.*0B d. *.)1B e. 10.+$B
Chapter 7 - Page 22

+/
Answer: b
Diff: E
4ou Gust purchased a =1,000 par value, * year, + percent annual coupon bond that pays interest on a semiannual basis. !he bond sells for =*20. %hat is the bond-s nominal yield to maturity& a. b. c. d. e. +.2$B $.2$B *.10B $.1+B /.1)B Answer: e Diff: E
'"# and '"C%%semiannual bond

+#
A corporate bond matures in 1/ years. !he bond has an $ percent semiannual coupon and a par value of =1,000. !he bond is callable in five years at a call price of =1,0#0. !he price of the bond today is =1,0+#. %hat are the bond-s yield to maturity and yield to call& a. b. c. d. e. 4!5 4!5 4!5 4!5 4!5 A 1/.2*B; 4!< A 1/.0*B A ).#+B; 4!< A ).#2B A +.1/B; 4!< A +.)/B A 1.1/B; 4!< A /.+$B A +.1/B; 4!< A +.0#B Answer: d Diff: E
'ield to maturity and bond value%%annual bond

+1
A 20 year bond "ith a par value of =1,000 has a * percent annual coupon. !he bond currently sells for =*2#. 'f the bond-s yield to maturity remains at its current rate, "hat "ill be the price of the bond # years from no"& a. b. c. d. e. = *11.+* = $)1.)# =1,0*0.00 = *)).0* = *2#.00 Answer: b Diff: E
Current yield
++
<onsider a =1,000 par value bond bond pays interest annually. maturity. %hat is the current required return on the bond is 10 a. 10.00B b. $./1B c. +.00B d. $.#2B e. $.)+B
"ith a + percent annual coupon. !he !here are * years remaining until yield on the bond assuming that the percent&
Chapter 7 - Page 23
Current yield
+$
Answer: d
Diff: E
A 12 year bond pays an annual coupon of $.# percent. !he bond has a yield to maturity of *.# percent and a par value of =1,000. %hat is the bond-s current yield& a. 1.)1B b. 2.1#B c. $.*#B d. *.1/B e. 10.21B
Current yield
+*
Answer: c
Diff: E
A 1# year bond "ith an $ percent annual coupon has a face value of =1,000. !he bond-s yield to maturity is + percent. %hat is the bond-s current yield& a. b. c. d. e. ).))B #.00B +.))B +.#0B $.00B Answer: b Diff: E

$0
A bond matures in 12 years and pays an $ percent annual coupon. !he bond has a face value of =1,000 and currently sells for =*$#. %hat is the bond-s current yield and yield to maturity& a. b. c. d. e. <urrent <urrent <urrent <urrent <urrent yield yield yield yield yield A A A A A $.00B; $.12B; $.20B; $.12B; $.12B; yield yield yield yield yield to to to to to maturity maturity maturity maturity maturity A A A A A +.*2B $.20B $.)+B $.)+B +.*2B Answer: b Diff: E N
(uture bond value%%annual payment

$1
A bond "ith a face value of =1,000 matures in 10 years. !he bond has an $ percent annual coupon and a yield to maturity of 10 percent. 'f mar,et interest rates remain at 10 percent, "hat "ill be the price of the bond t"o years from today& a. b. c. d. e. = $++.11 = $*).)0 =1,011.)0 = *12.## =1,02).01
Chapter 7 - Page 24
)isk premium on bonds

$2
Answer: c
Diff: E
2ollincoast 'ncorporated issued 000 bonds t"o years ago that provided a yield to maturity of 11.# percent. 7ong term ris, free government bonds "ere yielding $.+ percent at that time. !he current ris, premium on 000 bonds versus government bonds is half of "hat it "as t"o years ago. 'f the ris, free long term government bonds are currently yielding +.$ percent, then at "hat rate should 2ollincoast e(pect to issue ne" bonds& a. +.$B b. $.+B c. *.2B d. 10.2B e. 12.*B
Medium:
$)
Answer: e
Diff: #
A 1 year bond that pays $ percent interest semiannually sells at par 9=1,000:. Another 1 year bond of equal ris, pays $ percent interest annually. 0oth bonds are noncallable and have face values of =1,000. %hat is the price of the bond that pays annual interest& a. b. c. d. e. =1$*.0$ =+12.0# =*$0./) =*$1.+2 =**2.1/ Answer: a Diff: #

$/
A 10 year bond "ith a * percent semiannual coupon is currently selling at par. A 10 year bond "ith a * percent annual coupon has the same ris,, and therefore, the same effective annual return as the semiannual bond. 'f the annual coupon bond has a face value of =1,000, "hat "ill be its price& a. b. c. d. e. = *$+.12 =1,000.00 = /+1.$+ =1,0$*.$/ = *1+.)/
Chapter 7 - Page 25

$#
Answer: d
Diff: #
4ou are the o"ner of 100 bonds issued by 8uler, 7td. !hese bonds have $ years remaining to maturity, an annual coupon payment of =$0, and a par value of =1,000. ;nfortunately, 8uler is on the brin, of ban,ruptcy. !he creditors, including yourself, have agreed to a postponement of the ne(t / interest payments 9other"ise, the ne(t interest payment "ould have been due in 1 year:. !he remaining interest payments, for 4ears # through $, "ill be made as scheduled. !he postponed payments "ill accrue interest at an annual rate of 1 percent, and they "ill then be paid as a lump sum at maturity $ years hence. !he required rate of return on these bonds, considering their substantial ris,, is no" 2$ percent. %hat is the present value of each bond& a. b. c. d. e. =#)$.21 =/21.+) =)$/.$/ =211.$$ =2/*.*$ Answer: a Diff: #

$1
5arie Snell recently inherited some bonds 9face value =100,000: from her father, and soon thereafter she became engaged to Sam Spade, a ;niversity of Clorida mar,eting graduate. Sam "ants 5arie to cash in the bonds so the t"o of them can use the money to >live li,e royalty? for t"o years in 5onte <arlo. !he 2 percent annual coupon bonds mature on December )1, 2022, and it is no" @anuary 1, 200). 'nterest on these bonds is paid annually on December )1 of each year, and ne" annual coupon bonds "ith similar ris, and maturity are currently yielding 12 percent. 'f 5arie sells her bonds no" and puts the proceeds into an account that pays 10 percent compounded annually, "hat "ould be the largest equal annual amounts she could "ithdra" for t"o years, beginning today 9that is, t"o payments, the first payment today and the second payment one year from today:& a. b. c. d. e. =1),2## =2*,+0$ =12,1#/ =2#,)0# =1/,#$0
Chapter 7 - Page 26

$+
Answer: d
Diff: #
Due to a number of la"suits related to to(ic "astes, a maGor chemical manufacturer has recently e(perienced a mar,et reevaluation. !he firm has a bond issue outstanding "ith 1# years to maturity and a coupon rate of $ percent, "ith interest paid semiannually. !he required nominal rate on this debt has no" risen to 11 percent. %hat is the current value of this bond& a. b. c. d. e. =1,2+) =1,000 =+,+$) = ##0 = /#0 Answer: b Diff: #

$$
@2@ <orporation recently issued 10 year bonds at a price of =1,000. !hese bonds pay =10 in interest each si( months. !heir price has remained stable since they "ere issued, that is, they still sell for =1,000. Due to additional financing needs, the firm "ishes to issue ne" bonds that "ould have a maturity of 10 years, a par value of =1,000, and pay =/0 in interest every si( months. 'f both bonds have the same yield, ho" many ne" bonds must @2@ issue to raise =2,000,000& a. b. c. d. e. 2,/00 2,#*1 ),000 #,000 /,2+# Answer: d Diff: #

$*
Assume that you are considering the purchase of a =1,000 par value bond that pays interest of =+0 each si( months and has 10 years to go before it matures. 'f you buy this bond, you e(pect to hold it for # years and then to sell it in the mar,et. 4ou 9and other investors: currently require a nominal annual rate of 11 percent, but you e(pect the mar,et to require a nominal rate of only 12 percent "hen you sell the bond due to a general decline in interest rates. 6o" much should you be "illing to pay for this bond& a. b. c. d. e. = $/2.00 =1,11#.$1 =1,)#*.21 = *11.** = +)1.$#
Chapter 7 - Page 27

*0
Answer: d
Diff: #
An $ percent annual coupon, noncallable bond has 10 years until it matures and a yield to maturity of *.1 percent. %hat should be the price of a 10 year noncallable bond of equal ris, that pays an $ percent semiannual coupon& Assume both bonds have a par value of =1,000. a. b. c. d. e. = = = = = $*$.1/ +)1.$1 $#/.2+ */1.0* *1/.2) Answer: a Diff: # N

*1
A bond "ith 12 years to maturity has a + percent semiannual coupon and a face value of =1,000. 9!hat is, the bond pays a =)# coupon every si( months.: !he bond currently sells for =1,000. %hat should be the price of a bond "ith the same ris, and maturity that pays a + percent annual coupon and has a face value of =1,000& a. b. c. d. e. = **0.)) = **1.#0 =1,000.00 =1,002.2* =1,012.$2 Answer: b Diff: #

*2
Assume that a 1# year, =1,000 face value bond pays interest of =)+.#0 every ) months. 'f you require a nominal annual rate of return of 12 percent, "ith quarterly compounding, ho" much should you be "illing to pay for this bond& 96intJ !he IK'CA and IK'C for ) percent, 10 periods are 2+.1+#1 and 0.11*+, respectively.: a. b. c. d. e. = $21.*2 =1,20+.#+ = *$1./) =1,120.+1 =1,)#$.2/ Answer: b Diff: #

*)
4our client has been offered a # year, =1,000 par value bond "ith a 10 percent coupon. 'nterest on this bond is paid quarterly. 'f your client is to earn a nominal rate of return of 12 percent, compounded quarterly, ho" much should she pay for the bond& a. b. c. d. e. = $00 = *21 =1,02# =1,211 = *$1
Chapter 7 - Page 28
Chapter 7 - Page 29
Call price%%&uarterly payment

*/
Answer: c
Diff: #
Lennedy Mas %or,s has bonds that mature in 10 years, and have a face value of =1,000. !he bonds have a 10 percent quarterly coupon 9that is, the nominal coupon rate is 10 percent:. !he bonds may be called in five years. !he bonds have a nominal yield to maturity of $ percent and a yield to call of +.# percent. %hat is the bonds- call price& a. b. c. d. e. = )+*.2+ =1,02#.00 =1,0/$.)/ =1,0)1.++ =1,1)1.+$ Answer: e Diff: #
Call price%%semiannual payment

*#
A 1# year bond "ith a 10 percent semiannual coupon and a =1,000 face value has a nominal yield to maturity of +.# percent. !he bond, "hich may be called after five years, has a nominal yield to call of #.#/ percent. %hat is the bond-s call price& a. b. c. d. e. = #1/ =1,110 =1,100 =1,1+) =1,0/0 Answer: a Diff: # N
'ield to call
*1
A bond "ith a face value of =1,000 matures in 12 years and has a * percent semiannual coupon. 9!hat is, the bond pays a =/# coupon every si( months.: !he bond has a nominal yield to maturity of +.# percent, and it can be called in / years at a call price of =1,0/#. %hat is the bond-s nominal yield to call& a. 1.11B b. 11.)1B c. ).)1B d. *.*$B e. #.1$B
'ield to call%%annual bond

*+
Answer: a
Diff: #
A corporate bond that matures in 12 years coupon, has a face value of =1,000, and a percent. !he bond can first be called four price is =1,0#0. %hat is the bond-s yield to a. 1.+)B b. +.10B c. +.#0B d. 11.$1B e. 1)./#B
pays a * percent annual yield to maturity of +.# years from no". !he call call&
Chapter 7 - Page 30

*$
Answer: b
Diff: #
A bond that matures in 11 years has an annual coupon rate of $ percent "ith interest paid annually. !he bond-s face value is =1,000, and its yield to maturity is +.# percent. !he bond can be called ) years from no" at a price of =1,010. %hat is the bond-s nominal yield to call& a. b. c. d. e. *.$2B $./1B $.#/B $.)$B +.$1B Answer: a Diff: #
'ield to call%%semiannual bond

**
A corporate bond "ith 12 years to maturity has a * percent semiannual coupon and a face value of =1,000. 9!hat is, the semiannual coupon payments are =/#.: !he bond has a nominal yield to maturity of + percent. !he bond can be called in three years at a call price of =1,0/#. %hat is the bond-s nominal yield to call& a. /.12B b. 10.)2B c. 1+.22B d. #.11B e. 2.)1B
'ield to call%*semiannual bond

100
Answer: b
Diff: #
6ood <orporation recently issued 20 year bonds. !he bonds have a coupon rate of $ percent and pay interest semiannually. Also, the bonds are callable in 1 years at a call price equal to 11# percent of par value. !he par value of the bonds is =1,000. 'f the yield to maturity is + percent, "hat is the yield to call& a. $.))B b. +.+#B c. *.$*B d. 10.00B e. +.00B

101
Answer: d
Diff: #
A 12 year bond "ith a 10 percent semiannual coupon and a =1,000 par value has a nominal yield to maturity of * percent. !he bond can be called in five years at a call price of =1,0#0. %hat is the bond-s nominal yield to call& a. b. c. d. e. /.#0B $.2#B $.$$B $.*$B *.00B Chapter 7 - Page 31

102
Answer: c
Diff: #
A corporate maturity of 10 years. %hat is the a. b. c. d. e. $./)B $.#0B $.#$B $.1#B *.00B
bond "ith an 11 percent semiannual coupon has a yield to * percent. !he bond matures in 20 years but is callable in !he maturity value is =1,000. !he call price is =1,0##. bond-s yield to call&

10)
Answer: b
Diff: # !he of !he are the
5cMriff 5otors has bonds outstanding that "ill mature in bonds pay a 12 percent semiannual coupon and have a =1,000 9that is, the bonds pay a =10 coupon every si( bonds currently have a yield to maturity of 10 percent. callable in $ years and have a call price of =1,0#0. bonds- yield to call& a. $.$*B b. *.$*B c. *.*/B d. 10.00B e. 12.00B
12 years. face value months:. !he bonds %hat is

10/
Answer: c
Diff: #
A 12 year bond has a 10 percent semiannual coupon and a face value of =1,000. !he bond has a nominal yield to maturity of + percent. !he bond can be called in five years at a call price of =1,0#0. %hat is the bond-s nominal yield to call& a. b. c. d. e. #.2*B #./0B #.))B #.+1B /.#1B Answer: c Diff: #

10#
A 12 year, =1,000 face value bond has an $ percent semiannual coupon and a nominal yield to maturity of 1 percent. !he bond is callable in # years at a call price of =1,0/0. %hat is the bond-s nominal yield to call& a. b. c. d. e. 1.+1B $.2+B /.$1B ).#2B #.22B
Chapter 7 - Page 32

101
Answer: b
Diff: #
A 10 year bond sells for =1,0+#. !he bond has a * percent semiannual coupon and a face value of =1,000. 9!hat is, the bond pays a =/# coupon every si( months.: !he bond is callable in # years and the call price is =1,0)#. %hat is the bond-s nominal yield to call& a. b. c. d. e. +.1*B +.+#B +.*0B $.00B $.1)B Answer: c Diff: # N
'ield to maturity
10+
A bond "ith a face value of =1,000 has a 10 year maturity and an $.# percent annual coupon. !he bond has a current yield of $ percent. %hat is the bond-s yield to maturity& a. b. c. d. e. $.2#B $.$1B +.#*B $.#0B $.00B Answer: d Diff: #

10$
A 1# year bond "ith a 10 percent semiannual coupon has a par value of =1,000. !he bond may be called after 10 years at a call price of =1,0#0. !he bond has a nominal yield to call of 1.# percent. %hat is the bond-s yield to maturity, stated on a nominal, or annual basis& a. b. c. d. e. #.*+B 1.)0B 1.+#B 1.*#B +.10B Answer: d Diff: #

10*
A 10 year bond has a face value of =1,000. !he bond has a + percent semiannual coupon. !he bond is callable in + years at a call price of =1,0/0. !he bond has a nominal yield to call of 1.# percent. %hat is the bond-s nominal yield to maturity& a. b. c. d. e. ).1/B 1.0#B +.12B 1.2+B 1.##B
Chapter 7 - Page 33

110
Answer: d
Diff: #
A bond that matures in $ years has a *.# percent coupon rate, semiannual payments, a face value of =1,000, and an $.2 percent current yield. %hat is the bond-s nominal yield to maturity 94!5:& a. b. c. d. e. +.20B +./#B 1.##B 1.$*B $.20B Answer: b Diff: #
Annual interest payments remainin!

111
4ou have Gust been offered a =1,000 par value bond for =$/+.$$. !he coupon rate is $ percent, payable annually, and annual interest rates on ne" issues of the same degree of ris, are 10 percent. 4ou "ant to ,no" ho" many more interest payments you "ill receive, but the party selling the bond cannot remember. <an you determine ho" many interest payments remain& a. b. c. d. e. 1/ 1# 12 20 10 Answer: c Diff: #
Current yield and capital !ains yield

112
5eade <orporation bonds mature in 1 years and have a yield to maturity of $.# percent. !he par value of the bonds is =1,000. !he bonds have a 10 percent coupon rate and pay interest on a semiannual basis. %hat are the current yield and capital gains yield on the bonds for this year& 9Assume that interest rates do not change over the course of the year.: a. b. c. d. e. <urrent <urrent <urrent <urrent <urrent yield yield yield yield yield A $.#0B; capital A *.)#B; capital A *.)#B; capital A 10.00B; capital A 10.#0B; capital gains gains gains gains gains yield yield yield yield yield A A A A A 1.#0B 0.1#B 0.$#B 0.00B 1.#0B Answer: c Diff: #
Current yield and '"#

11)
A 11 year bond "ith a 10 percent annual coupon has a current yield of $ percent. %hat is the bond-s yield to maturity 94!5:& a. b. c. d. e. 1.*B +.1B +.)B +.#B +.+B
Chapter 7 - Page 34
+en!t$ of time until annual bonds called

11/
Answer: b
Diff: #
5atteo !oys has bonds outstanding that have a * percent annual coupon and a face value of =1,000. !he bonds "ill mature in 10 years, although they can be called before maturity at a call price of =1,0#0. !he bonds have a yield to call of 1.# percent and a yield to maturity of +./ percent. 6o" long until these bonds may first be called& a. b. c. d. e. 2.21 ).11 ).1$ #.)+ 1.)2 years years years years years Answer: a Diff: #
#arket value of semiannual bonds

11#
'n order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures to a mar,et value basis. L@5 <orporation-s balance sheet as of today, @anuary 1, 200), is as follo"sJ 7ong term debt 9bonds, at par: Ireferred stoc, <ommon stoc, 9=10 par: 2etained earnings !otal debt and equity =10,000,000 2,000,000 10,000,000 /,000,000 =21,000,000
!he bonds have a / percent coupon rate, payable semiannually, and a par value of =1,000. !hey mature on @anuary 1, 201). !he yield to maturity is 12 percent, so the bonds no" sell belo" par. %hat is the current mar,et value of the firm-s debt& a. b. c. d. e. =#,/12,000 =#,/$0,000 =2,#)1,000 =+,+01,000 =+,0#1,000 Answer: c Diff: #

111
4ou Gust purchased a 1# year bond "ith an 11 percent annual coupon. !he bond has a face value of =1,000 and a current yield of 10 percent. Assuming that the yield to maturity of *.+0+2 percent remains constant, "hat "ill be the price of the bond one year from no"& a. b. c. d. e. =1,000 =1,01/ =1,0*+ =1,100 =1,1#0
Chapter 7 - Page 35
Bond coupon rate

11+
Answer: c
Diff: #
<old 0o(es 7td. has 100 bonds outstanding 9maturity value A =1,000:. !he nominal required rate of return on these bonds is currently 10 percent, and interest is paid semiannually. !he bonds mature in # years, and their current mar,et value is =+1$ per bond. %hat is the annual coupon interest rate& a. b. c. d. e. $B 1B /B 2B 0B Answer: d Diff: #
Bond coupon rate

11$
!he current price of a 10 year, =1,000 par value bond is =1,1#$.*1. 'nterest on this bond is paid every si( months, and the nominal annual yield is 1/ percent. Miven these facts, "hat is the annual coupon rate on this bond& a. b. c. d. e. 10B 12B 1/B 1+B 21B
Tough:
Bond value
11*
Answer: d
Diff: "
Assume that 5cDonald-s and 0urger Ling have similar =1,000 par value bond issues outstanding. !he bonds are equally ris,y. !he 0urger Ling bond has an annual coupon rate of $ percent and matures 20 years from today. !he 5cDonald-s bond has a coupon rate of $ percent, "ith interest paid semiannually, and it also matures in 20 years. 'f the nominal required rate of return, ,d, is 12 percent, semiannual basis, for both bonds, "hat is the difference in current mar,et prices of the t"o bonds& a. b. c. d. e. = 0.#0 = 2.20 = ).++ =1+.#) = 1.2$
Chapter 7 - Page 36
Bond value and effective annual rate

120
Answer: b
Diff: "
4ou are considering investing in a security that matures in 10 years "ith a par value of =1,000. During the first five years, the security has an $ percent coupon "ith quarterly payments 9that is, you receive =20 a quarter for the first 20 quarters:. During the remaining five years the security has a 10 percent coupon "ith quarterly payments 9that is, you receive =2# a quarter for the second 20 quarters:. After 10 years 9/0 quarters: you receive the par value. Another 10 year bond has an $ percent semiannual coupon 9that is, coupon payment is =/0 every si( months:. !his bond is selling at par value, =1,000. !his bond has the same ris, as the security you thin,ing of purchasing. Miven this information, "hat should be price of the security you are considering purchasing& a. b. c. d. e. = $*$.1# =1,010.+2 =1,0)+.11 = */).22 =1,1/#.$* Answer: d Diff: " the its are the
Bond value after reor!ani,ation

121
2ecently, Ohio 6ospitals 'nc. filed for ban,ruptcy. !he firm "as reorgani3ed as American 6ospitals 'nc., and the court permitted a ne" indenture on an outstanding bond issue to be put into effect. !he issue has 10 years to maturity and a coupon rate of 10 percent, paid annually. !he ne" agreement allo"s the firm to pay no interest for # years. !hen, interest payments "ill be resumed for the ne(t # years. Cinally, at maturity 94ear 10:, the principal plus the interest that "as not paid during the first # years "ill be paid. 6o"ever, no interest "ill be paid on the deferred interest. 'f the required annual return is 20 percent, "hat should the bonds sell for in the mar,et today& a. b. c. d. e. =2/2.21 =2$1.1* =#+$.)1 =)12.// =$1).1*
Chapter 7 - Page 37
Bond sinkin! fund payment

122
Answer: d
Diff: "
MIN7 sold =1,000,000 of 12 percent, )0 year, semiannual payment bonds 1# years ago. !he bonds are not callable, but they do have a sin,ing fund that requires MIN7 to redeem # percent of the original face value of the issue each year 9=#0,000:, beginning in 4ear 11. !o date, 2# percent of the issue has been retired. !he company can either call bonds at par for sin,ing fund purposes or purchase bonds on the open mar,et, spending sufficient money to redeem # percent of the original face value each year. 'f the nominal yield to maturity 91# years remaining: on the bonds is currently 1/ percent, "hat is the least amount of money MIN7 must put up to satisfy the sin,ing fund provision& a. b. c. d. e. =/),$#1 =#0,000 =)+,#00 =/),+*1 =)*,/22 Answer: b Diff: "
Bond coupon payment

12)
Cish N <hips 'nc. has t"o bond issues outstanding, and both sell for =+01.22. !he first issue has an annual coupon rate of $ percent and 20 years to maturity. !he second has an identical yield to maturity as the first bond, but only # years remain until maturity. 0oth issues pay interest annually. %hat is the annual interest payment on the second issue& a. b. c. d. e. =120.00 = )+.12 = #1./2 = 2*.1$ = 11.11 Answer: c Diff: "
Bonds wit$ differential payments

12/
Semiannual payment bonds "ith the same ris, 9Aaa: and maturity 920 years: as your company-s bonds have a nominal 9not 8A2: yield to maturity of * percent. 4our company-s treasurer is thin,ing of issuing at par some =1,000 par value, 20 year, quarterly payment bonds. She has as,ed you to determine "hat quarterly interest payment, in dollars, the company "ould have to set in order to provide the same effective annual rate 98A2: as those on the 20 year, semiannual payment bonds. %hat "ould the quarterly, dollar interest payment be& a. b. c. d. e. =/#.00 =2#.00 =22.2# =2+.#0 =2).00
Chapter 7 - Page 38
Multiple Part:
(The following information applies to the next three problems.) A bond that matures in 10 years sells for =*2#. =1,000 and an $ percent annual coupon. Current yield%%annual bond
12#
!he bond has a face value of Answer: a Diff: E N
%hat is the bond-s current yield& a. b. c. d. e. $.1#B $.00B $.))B +.$$B $.*#B Answer: c Diff: # N
'ield to maturity%%annual bond

121
%hat is the bond-s yield to maturity& a. b. c. d. e. *.00B *.##B *.1$B $.+#B *.))B Answer: e Diff: # N

12+
Assume that the yield to maturity remains constant for the ne(t three years. %hat "ill be the price of the bond three years from today& a. b. c. d. e. = *2# = *#1 =1,000 = *++ = */1 (The following information applies to the next two problems.)
A 12 year bond has an $ percent annual coupon and a face value of =1,000. !he bond has a yield to maturity of + percent. Bond value%%annual payment
12$
Answer: d
Diff: E
%hat is the price of the annual coupon bond today& a. b. c. d. e. = *2/.1/ =1,000.00 =1,0+0.2/ =1,0+*./) =1,0**.21
Chapter 7 - Page 39

12*
Answer: e
Diff: E
'f the yield to maturity remains at + percent, "hat "ill be the price of the bond three years from today& a. b. c. d. e. = *)+.#) = *1).*/ =1,021.2/ =1,0#2.1$ =1,01#.1# (The following information applies to the next two problems.)
A 1# year bond has a par value of =1,000 and a 10 percent semiannual coupon. 9!hat is, the bond pays a coupon of =#0 every si( months.: !he bond has a price of =1,1*0 and it is callable in # years at a call price of =1,0#0. 'ield to maturity%%semiannual bond
1)0
Answer: d
Diff: E
%hat is the semiannual coupon bond-s nominal yield to maturity 94!5:& a. b. c. d. e. 1.)+B 1.+)B +.10B +.$)B $.2#B Answer: a Diff: E N

1)1
%hat is the semiannual coupon bond-s nominal yield to call 94!<:& a. b. c. d. e. 1.)+B 1.+)B +.10B +.$)B $.2#B (The following information applies to the next two problems.)
6astings 5otors has bonds outstanding "ith 12 years left until maturity. !he bonds have a =1,000 par value and an $ percent annual coupon. <urrently, the bonds sell at a price of =1,02#. 'ield to maturity%%annual bond
1)2
Answer: a
Diff: E
%hat is the annual coupon bond-s yield to maturity& a. b. c. d. e. +.1+B +.$0B $.00B $.1)B $.))B
Chapter 7 - Page 40
Price risk%%annual bond

1))
Answer: e
Diff: #
%hat "ill be the percentage increase in the annual coupon bond-s price if the yield to maturity "ere to immediately fall by one percentage point 9100 basis points:& a. b. c. d. e. #.+B 1.0B 1.*B +.+B $.0B
,e+ Appendi- !A
Multiple Choice: Conceptual Easy:
-ero coupon bond concepts +A
1)/
Answer: a
Diff: E
%hich of the follo"ing statements is most correct& a. 'f interest rates increase, a 10 year 3ero coupon bond "ill drop in price by a greater percentage than "ill a 10 year $ percent coupon bond. b. One nice thing about 3ero coupon bonds is that individual investors do not have to pay any ta(es on a 3ero coupon bond until it matures, even if they are not holding the bonds as part of a ta( deferred account. c. 'f a bond "ith a sin,ing fund provision has a yield to maturity greater than its coupon rate, the issuing company "ould prefer to comply "ith the sin,ing fund by calling the bonds in at par rather than buying the bonds bac, in the open mar,et. d. Statements a and c are correct. e. All of the statements above are correct.
Medium:
Coupon and ,ero coupon bond concepts +A
1)#
Answer: d
Diff: #
<onsider each of the follo"ing bondsJ 0ond AJ $ year maturity "ith a + percent annual coupon. 0ond 0J 10 year maturity "ith a * percent annual coupon. 0ond <J 12 year maturity "ith a 3ero coupon. 8ach bond has a face value of =1,000 and a yield to maturity of $ percent. %hich of the follo"ing statements is most correct& a. 0ond A sells at a discount, "hile 0ond 0 sells at a premium. b. 'f the yield to maturity on each bond falls to + percent, 0ond < "ill have the largest percentage increase in its price. c. 0ond < has the most reinvestment rate ris,. d. Statements a and b are correct. Chapter 7 - Page 41
Multiple Choice: P*o+lems Easy:
e. All of the statements above are correct.
tripped .. . "reasury bond +A

1)1
Answer: e
Diff: E
5cM"ire <ompany-s pension fund proGected that a significant number of its employees "ould ta,e advantage of an early retirement program the company plans to offer in five years. Anticipating the need to fund these pensions, the firm bought 3ero coupon ;.S. !reasury !rust <ertificates maturing in five years. %hen these instruments "ere originally issued, they "ere 12 percent coupon, )0 year ;.S. !reasury bonds. !he stripped !reasuries are currently priced to yield 10 percent. !heir total maturity value is =1,000,000. %hat is their total cost 9price: to 5cM"ire today& a. b. c. d. e. = ##),++1 =#,1/2,100 =),/0/,#11 =/,0/2,0/0 =),+2#,#2$ Answer: b Diff: E
-ero coupon bond +A

1)+
At the beginning of the year, you purchased a + year, 3ero coupon bond "ith a yield to maturity of 1.$ percent. !he bond has a face value of =1,000. 4our ta( rate is )0 percent. %hat is the total ta( that you "ill have to pay on the bond during the first year& a. b. c. d. e. =20./0 =12.$+ =)0.0) =1).+# =11./#
Medium:
-ero coupon bond +A
1)$
Answer: d
Diff: #
4ou Gust purchased a 3ero coupon bond "ith a yield to maturity of * percent. !he bond matures in 12 years, and has a face value of =1,000. Assume that your ta( rate is 2# percent. %hat is the dollar amount of ta(es you "ill pay at the end of the first year of holding the bond& a. b. c. d. e. =#.00 =1.00 =+.00 =$.00 =*.00
Chapter 7 - Page 42
-ero coupon bond +A

1)*
Answer: b
Diff: #
S. <laus N <ompany is planning a 3ero coupon bond issue. !he bond has a par value of =1,000, matures in 2 years, and "ill be sold at a price of =$21./#. !he firm-s marginal ta( rate is /0 percent. %hat is the annual after ta( cost of debt to the company on this issue& a. /.0B b. 1.0B c. $.0B d. 10.0B e. 12.0B
-ero coupon bond +A

1/0
Answer: a
Diff: #
A 1# year 3ero coupon bond has a yield to maturity of $ percent and a maturity value of =1,000. %hat is the amount of ta( an investor in the )0 percent ta( brac,et "ill pay the first year of the bond& a. b. c. d. e. = +.#+ =10./1 =1#.$* =20.// =2#.22 Answer: d Diff: #
-ero coupon bond +A

1/1
On @anuary 1st @ulie bought a + year, 3ero coupon bond "ith a face value of =1,000 and a yield to maturity of 1 percent. Assume that @ulie-s ta( rate is 2# percent. 6o" much ta( "ill @ulie have to pay on the bond the first year she o"ns it& a. b. c. d. e. =1#.00 =2#.00 =+).+1 = *.*$ =$).+/ Answer: d Diff: #
-ero coupon bond and EA) +A

1/2
;.S. Delay <orporation, a subsidiary of the Iostal Service, must decide "hether to issue 3ero coupon bonds or quarterly payment bonds to fund construction of ne" facilities. !he =1,000 par value quarterly payment bonds "ould sell at =+*#.#/, have a 10 percent annual coupon rate, and mature in 10 years. At "hat price "ould the 3ero coupon bonds "ith a maturity of 10 years have to sell to earn the same effective annual rate as the quarterly payment bonds& a. b. c. d. e. =2+/.#0 =2+1.** =1*$.$* =2#+.#2 =2#/.$/
Chapter 7 - Page 43
Callable ,ero coupon bond +A

1/)
Answer: c
Diff: #
2ecycler 0attery <orporation 920<: issued 3ero coupon bonds # years ago at a price of =21/.#0 per bond. 20<-s 3eros had a 20 year original maturity, "ith a =1,000 par value. !he bonds "ere callable 10 years after the issue date at a price + percent over their accrued value on the call date. 'f the bonds sell for =2)*.)* in the mar,et today, "hat annual rate of return should an investor "ho buys the bonds today e(pect to earn on them& a. 1#.+B b. 12./B c. 10.0B d. *.#B e. $.0B
"a/es on ,ero coupon bond +A

1//
Answer: a
Diff: #
!oday is @anuary 1, 200) and you Gust purchased a + year, 3ero coupon bond "ith a face value of =1,000 and a yield to maturity of 1 percent. 4our ta( rate is )0 percent. 6o" much in ta(es "ill you have to pay on the bond the first year that you hold it& a. b. c. d. e. = 11.*+ =211./* = 12.1* = )*.*0 =1**.#2 Answer: e Diff: # N

1/#
A 3ero coupon bond "ith a face value of =1,000 matures in 1# years. !he bond has a yield to maturity of + percent. 'f an investor buys the bond at the beginning of the year, ho" much money in ta(es "ill the investor have to pay on the 3ero coupon bond the first year. Assume that the investor has a 2# percent marginal ta( rate. a. b. c. d. e. =#.2# =#.// =#.** =1.2# =1.)/ Answer: a Diff: #
Accrued value and interest e/pense +A

1/1
Kogril <ompany issued 20 year, 3ero coupon bonds "ith an e(pected yield to maturity of * percent. !he bonds have a par value of =1,000 and "ere sold for =1+$./) each. %hat is the e(pected interest e(pense on these bonds for 4ear $& a. b. c. d. =2*.)# =)2.00 =*0.00 =21.12
Chapter 7 - Page 44
Tough:
+A
1/+
e. =2#.+* Answer: d Diff: "
-eros and e/pectations t$eory .
A 2 year, 3ero coupon !reasury bond "ith a maturity value of =1,000 has a price of =$+)./)$+. A 1 year, 3ero coupon !reasury bond "ith a maturity value of =1,000 has a price of =*)$.*1+1. 'f the pure e(pectations theory is correct, for "hat price should 1 year, 3ero coupon !reasury bonds sell one year from no"& a. b. c. d. e. =+*$.$* =$2/.11 =$#2.2$ =*)0.2) =*$*.11 Answer: a Diff: "
-eros and e/pectations t$eory +A

1/$
A / year, 3ero coupon !reasury bond sells at a price of =+12.$*#2. A ) year, 3ero coupon !reasury bond sells at a price of =$2+.$/*1. Assuming the e(pectations theory is correct, "hat does the mar,et believe the price of 1 year, 3ero coupon bonds "ill be in three years& a. b. c. d. e. =*21.11 =*)/.#$ =*)$.*+ =*/#.21 =*#0./+ Answer: d Diff: "
-ero coupon bond +A

1/*
Assume that the State of Clorida sold ta( e(empt, 3ero coupon bonds "ith a =1,000 maturity value # years ago. !he bonds had a 2# year maturity "hen they "ere issued, and the interest rate built into the issue "as a nominal $ percent, compounded semiannually. !he bonds are no" callable at a premium of / percent over the accrued value. %hat effective annual rate of return "ould an investor "ho bought the bonds "hen they "ere issued and "ho still o"ns them earn if they "ere called today& a. b. c. d. e. /./1B 1.+)B $.2#B *.01B *.#2B
Chapter 7 - Page 45
-ero coupon bond +A

1#0
Answer: e
Diff: "
Assume that the <ity of !ampa sold an issue of =1,000 maturity value, ta( e(empt 9muni:, 3ero coupon bonds # years ago. !he bonds had a 2# year maturity "hen they "ere issued, and the interest rate built into the issue "as a nominal 10 percent, but "ith semiannual compounding. !he bonds are no" callable at a premium of 10 percent over the accrued value. %hat effective annual rate of return "ould an investor "ho bought the bonds "hen they "ere issued and "ho still o"ns them earn if they "ere called today& a. b. c. d. e. 12.01B 10.2#B 10.00B 11.1)B 12.)+B Answer: a Diff: "

1#1
Schiffauer 8lectronics plans to issue 10 year, 3ero coupon bonds "ith a par value of =1,000 and a yield to maturity of *.# percent. !he company has a ta( rate of )0 percent. 6o" much e(tra in ta(es "ould the company pay 9or save: the second year 9at t A 2: if they go ahead and issue the bonds& a. b. c. d. e. Save =12.#* Save =1).+* Save =/1.*+ .o savings Iay =1).+*
Multiple Part:
(The information below applies to the next two problems.) Margoyle ;nlimited is planning to issue a 3ero coupon bond to fund a proGect that "ill yield its first positive cash flo" in three years. !hat cash flo" "ill be sufficient to pay off the entire debt issue. !he bond-s par value "ill be =1,000, it "ill mature in ) years, and it "ill sell in the mar,et for =+2+.2#. !he firm-s marginal ta( rate is /0 percent. -ero coupon interest ta/ s$ield +A
1#2
Answer: b
Diff: "
%hat is the nominal dollar value of the interest ta( savings to the firm in the third year of the issue& a. b. c. d. e. = )2.#$ = /0.2* =100.+2 = 10./) =10*.10
Chapter 7 - Page 46
After%ta/ cost of debt +A

1#)
Answer: c
Diff: #
%hat is the e(pected after ta( cost of this debt issue& a. 11.20B b. /./$B c. 1.+2B d. 1.10B e. /.00B
,e+ Appendi- !"

Multiple Choice: Conceptual Medium:
+i&uidation procedures +0
1#/
Answer: e the 0an,ruptcy Act is designed to do "hich
Diff: # of the
<hapter + of follo"ing&
a. Irovide safeguards against the "ithdra"al of assets by the o"ners of the ban,rupt firm. b. 8stablish the rules of reorgani3ation for firms "ith proGected cash flo"s that eventually "ill be sufficient to meet debt payments. c. Allo" insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt. d. Statements a and b are correct. e. Statements a and c are correct. Bankruptcy law +0
1##
Answer: d
Diff: #
%hich of the follo"ing statements is most correct& a. Our ban,ruptcy la"s "ere enacted in the 1$00s, revised in the 1*)0s, and have remained unaltered since that time. b. Cederal ban,ruptcy la" deals only "ith corporate ban,ruptcies. 5unicipal and personal ban,ruptcy are governed solely by state la"s. c. All ban,ruptcy petitions are filed by creditors see,ing to protect their claims on firms in financial distress. !hus, all ban,ruptcy petitions are involuntary as vie"ed from the perspective of the firm-s management. d. <hapters 11 and + are the most important ban,ruptcy chapters for financial management purposes. 'f a reorgani3ation plan cannot be "or,ed out under <hapter 11, then the company "ill be liquidated as prescribed in <hapter + of the Act. e. >2estructuring? a firm-s debt can involve forgiving a certain portion of the debt but does not involve changing the debt-s maturity or its contractual interest rate.
Chapter 7 - Page 47
Bankruptcy issues +0
1#1
Answer: e
Diff: #
%hich of the follo"ing statements is most correct& a. !he primary test of feasibility in a reorgani3ation is "hether every claimant agrees "ith the reorgani3ation plan. b. !he basic doctrine of fairness states that all debt holders must be treated equally. c. Since the primary issue in ban,ruptcy is to determine the sharing of losses bet"een o"ners and creditors, the >public interest? is not a relevant concern. d. %hile the firm is in ban,ruptcy, the e(isting management is al"ays allo"ed to remain in control of the firm, though the court monitors its actions closely. e. !o a large e(tent, the decision to dissolve a firm through liquidation or to ,eep it alive through reorgani3ation depends on a determination of the value of the firm if it is rehabilitated versus the value of its assets if they are sold off individually.
Tough:
Priority of claims +0
1#+
Answer: c
Diff: "
%hat "ould be the priority of the claims as to the distribution of assets in a liquidation under <hapter + of the 0an,ruptcy Act& 1. 2. ). /. !rustees- costs to administer and operate the firm. <ommon stoc,holders. Meneral, or unsecured, creditors. Secured creditors "ho have claim to the proceeds from the sale of a specific property pledged for a mortgage. #. !a(es due to federal and state governments. a. b. c. d. e. 1, #, /, #, 1, /, /, 1, 1, #, ), 1, #, /, /, #, ), ), 2, ), 2 2 2 ) 2
Chapter 7 - Page 48
A$%,E CHAPTE % A$D %#()T&#$% !
1. 2
Interest rates . Interest
Answer: e rates and
Diff: E bond prices
Answer: c
Diff: E
Statement a is false; Gust the reverse is true. Statement b is false; the 1# year bond is selling at a discount because its coupon payment is less than the 4!5. Statement c is true; longer maturity and lo"er coupon bonds have a larger percentage price change than short maturity, high coupon bonds. Statement d is false; Gust the reverse is true. ). Interest rates and bond prices Answer: c Diff: E
'f the going mar,et interest rate 94!5: is + percent, but the coupon rate is * percent, then investors are getting a better coupon payment from this bond than they could from a ne" bond issued in the mar,et today. !herefore, this bond is more valuable and must be selling at a premium. !herefore, statement a is false. %henever interest rates fall, the price of a bond increases. !herefore, statement b is false. 'f interest rates remain un changed, as the bond gets closer to its maturity, its price "ill approach par value. Since the bond is selling at a premium, its price must decline to its par value as it gets closer to maturity. !herefore, statement c is true. /. Interest rates and bond prices Answer: d Diff: E
Cirst, both bonds "ill decrease in price. 7onger maturity, lo"er coupon bonds have greater price changes "ith rate movements than shorter maturity, higher coupon bonds. So statement d must be correct. #. Interest vs. reinvestment rate risk Statements a, b, c, and d are all correct. statement e. Answer: e Diff: E
!herefore, the correct choice is
1.
Answer: c
Diff: E
'nterest rate ris, means the ris, that the price of the bond "ill change due to interest rate changes. !he longer the maturity, the greater the interest rate ris,. 2einvestment rate ris, is the ris, that once the bond matures, you "on-t be able to reinvest the principal at the same rate. !he shorter the maturity,
the greater the reinvestment rate ris,. Statement a is false. 7ong term bonds have more interest rate ris, and less reinvestment rate ris, than short term bonds. Statement b is false. 7ong term bonds have less reinvestment rate ris, than short term bonds. Statement c is true. Feros have more interest rate ris, because their one payment is subGect to the ma(imum number of discounting periods, so the 3ero-s price "ill fluctuate greatly "henever interest rates change. !here is less reinvestment rate ris, because there are no coupons that need to be reinvested, Gust the par value at maturity. Statement d is false. 'f interest rates increase, the prices of all bonds "ill decrease. Statement e is false. 4ou have to pay ta(es on the difference in the accreted value of the 3eros each year, as though you had actually reali3ed the capital gain for the year. 4ou don-t actually reali3e your capital gain until maturity, or until you sell the bond, but you still pay ta(es as though you had. +. Price risk Answer: a Diff: E
!he longer the maturity of a bond, the more of an effect a change in interest rates "ill have on it. !he reason for this is that the price change is compounded into the bond price for more periods. !herefore, you can rule out statements b and e. A bond that pays coupons "ill be less affected by interest rate changes than one that doesn-t pay coupons. !he bond price is the .IK of all the future cash flo"s, both the coupon payments and the par value paid at maturity. !he first coupon payment is only discounted one period. !he second coupon is discounted t"o periods, and so on. !he par value is discounted for the full life of the bond. !hus, statements c and d can be eliminated. Since a 3ero coupon bond-s price today is determined Gust by the .IK of its par value, all of its payment is discounted for the ma(imum amount of time, "hereas a coupon bond has many payments discounted for less than the ma(imum amount of time. !herefore, a 3ero coupon bond is most affected by interest rate changes. So, the longest 3ero coupon bond is the correct ans"er, "hich is statement a. $. Callable bond Answer: a Diff: E
* . 10. 11 .
Statement a is correct; the other statements are false. A bond do"n grade generally raises the cost of issuing ne" debt. !herefore, the callable bonds "ould not be called. 'f the call premium 9the cost paid in e(cess of par: increases, the cost of calling debt increases; therefore, callable bonds "ould not be called. Call provision Bond coupon rate Bond concepts Answer: b Answer: c Answer: a Diff: E Diff: E Diff: E
Statement a is correct; the other statements are false. A bond-s price and 4!5 are negatively related. 'f a bond-s 4!5 is greater than its coupon rate, it "ill sell at a discount. 12. Bond concepts Answer: c Diff: E
Statement c is correct; the other statements are false. 'f a bond-s 4!5 O annual coupon, then it "ill trade at a discount. 'f interest rates increase, the 10 year 3ero coupon bond-s price change is greater than the 10 year coupon bond-s.
1)
. Bond concepts
Answer: e
Diff: E e. is at at
All the statements are true; therefore, the correct choice is statement Since the bond is selling at par, its 4!5 A coupon rate. !he current yield calculated as =*0H=1,000 A *B. 'f 4!5 A coupon rate, the bond "ill sell par. So, if the bond-s 4!5 remains constant the bond-s price "ill remain par. 1/. Bond concepts Answer: a Diff: E
'f the bond is selling at a discount, the coupon rate must be less than the required yield on the bond. So statement a is correct. Statement b is false, because the price "ill increase to"ards =1,000. Statement c can only be correct if the bond is trading at par, and it isn-t. 1#. Bond concepts Answer: d Diff: E
!he bond has a coupon rate higher than the 4!5, so it must be trading at a price above its par value. Statement a is incorrect; its current yield A <ouponHIrice, "hich "ill be less than $ percent because the price is greater than par. Statement b is correct. Statement c is also correct; the price of the bond "ill decline over time because it is currently trading above par. !herefore, statement d is the best ans"er. 11. Bond concepts Answer: a Diff: E
Since 0ond 0 sells at par, then the coupon rate on 0ond 0 equals its 4!5. !herefore, its 4!5 is 10 percent. Since all the bonds have the same ris, and the yield curve is steady, the 4!5 for 0onds A and < "ill also be 10 percent. 0ecause 0ond A has an $ percent coupon, it must be trading at a discount and its price "ill increase over time to"ards the par value. 0ecause 0ond < has a coupon rate of 12 percent, it must be trading at a premium and its price "ill decline over time to"ards the par value. !he only correct ans"er is statement a.
1+.
Bond concepts
Answer: d
Diff: E
Statement a is false. 'f the 4!5 is $ percent, and A-s coupon payment is only + percent, investors "ill find A to be less valuable than a ne" par value bond "ith an $ percent coupon. !herefore, A "ill be selling for less than its par value 9at a discount:. 'f the 4!5 is $ percent and 0-s coupon payment is * percent, investors "ill find 0 to be more valuable than a ne" par value bond "ith an $ percent coupon. !herefore, 0 "ill be selling for more than its par value 9at a premium:. !here fore, 0-s price must be higher than A-s. Statement b is false. !he bonds "ill not have the same price until e(piration, "hen the price of each "ill be its par value of =1,000. Statement c is false. 0ond 0 is selling at a higher price than 0ond A from the statements given in the problem. Statement d is correct. 'f a bond is selling at a discount, over time its price "ill increase until it reaches its par value at e(piration. Since 0ond A is selling at a discount this statement is true. Statement e is false. !he total yield on the bond "ill be the sum of the capital gains yield and the current yield. 'f it has a
positive capital gains yield, and it "ill since A is selling at a discount, its current yield must be less than $ percent because the sum of the t"o yields must equal $ percent. 1$. Bond concepts Answer: c Diff: E
'f the 4!5 is lo"er than the coupon rate, then this bond gives higher coupon payments than the >going rate.? !herefore, it is more valuable, and "ill sell at a premium. So, statement a is false. !he current yield is the bond-s annual coupon payments divided by the bond-s price todayJ <urrent yield A Annual coupon paymentH<urrent price. Since "e ,no" that the bond is selling at a premium, it "ill be selling for a higher price than =1,000. 'f the bond "ere selling at par 9=1,000:, then the current yield "ould be the same as the coupon rate. Since it is selling at a premium, the denominator of the current yield equation is larger, ma,ing the current yield smaller. !herefore, statement b is false. Since the bond is selling at a premium, its price "ill decrease through time until its price equals the par value, Gust at maturity. 2emember the follo"ing diagramJ Selling at Iremium
=1,000
5aturity
Selling at Discount !herefore, statement c is the correct choice. .
1*
Bond concepts Answer: a Diff: E N
Statement a is correct. Statement b is incorrect; Gust the opposite is true. 0onds "ith higher coupons have less interest rate price ris, but more reinvestment rate ris,. Statement c is incorrect; the price of a discount bond "ill continue to change, based on years to maturity. As a discount bond approaches maturity, its price "ill increase to its par value. <learly, then, statements d and e are also incorrect. 20 . Bond concepts Answer: d Diff: E N
!he correct ans"er is statement d. All of the statements are correct. All of the statements directly follo" from the basics of bond pricing presented in the te(t. 21. Bond yield Answer: a Diff: E
'f the bond sells at a premium, its price "ill decline as it approaches maturity. 92emember that at maturity it has to be "orth its par value.: !herefore, statement a is true. !he current yield is defined as the coupon payment divided by the price. 'f the bond is selling at a premium, then its price "ill have to decline over time. 'f its price is declining, then there is a negative capital gains yield. 2emember that 4!5 "ill equal the capital
gains yield plus the current yield. !herefore, for 4!5 to be $ percent "ith a negative capital gains yield, the current yield must be higher than $ percent. !herefore, statement b is false. 'f the bond is trading at a premium and the 4!5 is constant, it "ill have to slo"ly decline in value until, Gust at maturity, it is "orth its par value. !herefore, statement c is false. 'f the bond-s coupon rate "ere less than the 4!5, it "ould be less valuable than ne" bonds issued at the 4!5 and "ould, therefore, trade at a discount, not a premium. !herefore, statement d is false. 'f the 4!5 increases, then this bond-s cash flo"s 9coupons: "ill be discounted at a higher rate and "ill be "orth less. !herefore, the price "ill decrease, not increase. !herefore, statement e is false.
22.
Answer: d
Diff: E
'f the 4!5 is + percent, this is the mar,et interest rate. !herefore, 0ond A-s coupon rate is higher than the mar,et rate, so it must be selling above par 9at a premium:. 0ond 0-s coupon rate is lo"er than the mar,et rate, so it must be selling belo" par 9at a discount:. 0ond Kalue =
A
=1,000
5aturity 0 4ears
Statement a is false. 'f the 4!5 remains the same, the price of 0ond A "ill fall, and the price of bond 0 "ill rise. !he total yield of + percent on both bonds "ill consist of a capital gains yield and a current yield. !he sum of these t"o yields "ill be + percent. Statements b, c, and e are false for the reason mentioned above. !herefore, the correct ans"er is statement d. 2). inkin! fund provision Answer: e Diff: E
Statement a is false; sin,ing funds require companies to retire a certain portion of their debt annually. Statement b is true; if interest rates have declined, companies "ill call the bonds and investors "ill have to reinvest at lo"er rates. Statement c is true; if interest rates have risen 9causing bond prices to fall: the company "ill buy bonds bac, in the open mar,et. Statements b and c are true; therefore, statement e is the correct choice. 2/. inkin! fund provision Answer: d Diff: E
Statements a and c are correct; therefore, statement d is the correct choice. 0onds "ill be purchased on the open mar,et "hen they are selling at a discount and "ill be called for redemption "hen the price of the bonds e(ceeds the redemption price. 2#. "ypes of debt Answer: e Diff: E
Statement e is correct; the others are false. @un, bonds have a higher yield to maturity relative to investment grade bonds. A debenture is an unsecured bond, "hile subordinated debt has greater default ris, than senior debt. 21. 2+. Bond yield Bond yield Answer: b Answer: c Diff: # Diff: #
Statement c is correct; the other statements are false. 0y definition, if a coupon bond is selling at par its current yield "ill equal its yield to maturity. 'f "e let 0ond A be a # year, 12B coupon bond that sells at par, its current yield equals its 4!5 "hich equals 12B. 'f "e let 0ond 0 be a # year, 10B coupon bond 9in a 12B interest rate environment: the bond "ill sell for =*2+.*0. 'ts current yield equals 10.+$B 9=100H=*2+.*0:, but its yield to maturity equals 12B. !he 4!< is a better measure of return than the 4!5 if the bond is selling at a premium. 2$. Price risk Answer: c Diff: #
Statement c is correct; the other statements are incorrect. 7ong term, lo" coupon bonds are most affected by changes in interest rates; therefore, of the bonds listed, the 10 year 3ero coupon bond "ill have the largest percentage increase in price. 2*. Price risk Answer: c Diff: #
Statement c is correct; the other statements are false. Fero coupon bonds have greater price ris, than either of the coupon bonds or the annuity. )0. Price risk Answer: c Diff: #
Statement c is correct; the other statements are false. All other things equal, a 3ero coupon bond "ill e(perience a larger percentage change in value for a given change in interest rates than "ill a coupon bearing bond. Curther, bonds "ith long remaining lives e(perience greater percentage changes in value than do bonds "ith short remaining lives. !hus, of the bonds listed, the 10 year 3ero coupon bond has the largest percentage increase in value. )1. Price risk Answer: a Diff: #
Statement a is correct. All other things equal, a 3ero coupon bond "ill e(perience a larger percentage change in value for a given change in interest rates than "ill a coupon bearing bond. Curther, bonds "ith long remaining lives e(perience greater percentage changes in value than do bonds "ith short remaining lives. !hus, of the bonds listed, the 10 year 3ero coupon bond has the largest percentage increase in value. )2. Price risk Answer: a Diff: #
Statement a is correct. !he longer the maturity and the lo"er the coupon of a bond, the more sensitive it is to interest rate 9price: ris,. !he bond in ans"er a has a maturity greater than or equal to and a coupon less than or equal to all the other bonds. )). Price risk Answer: a Diff: #
)/.
Statement a is correct. !he bond "ith the smallest coupon and longest maturity "ill be most sensitive to changes in interest rates. Bond concepts Answer: e Diff: # !he correct ans"er is e; the other statements are false. A 3ero coupon bond "ill al"ays sell at a discount belo" par, provided interest rates are above 3ero, "hich they al"ays are. Bond concepts Answer: d Diff: #
)# .
Statements a and c are correct; therefore, statement d is the correct choice. 'f inflation "ere to increase, interest rates "ould rise, thus bond prices "ould decline. )1. Bond concepts Answer: b Diff: #
Statement b is correct; the other statements are false. 'f a bond is selling at a premium, the 4!5 "ould be less than the coupon rate. 'n addition, as long as interest rates are greater than 3ero, 3eros should never trade above par. )+. Bond concepts Statement b is correct; rate O than the required return includes both an represents the change in )$ Bond concepts Bond concepts Answer: b Diff: #
the other statements are false. 'f a bond-s coupon rate, the bond "ill sell at a premium. A bond-s total interest yield and a capital gains component, "hich the price of the bond over a given year. Answer: e Answer: d Diff: # Diff: #
. )*.
Statements a and c are correct; therefore, statement d is the correct choice. Statement a is correct. Crom the information given, "e can solve for the price of the bond A =$$+. <urrent yield A =100H=$$+ A 11.2+/B. Statement b is incorrect; since the bond is selling at a discount its 4!< O 4!5. !he 4!< A 1/.0#B. Statement c is correct. Crom the information given, since the coupon rate P 4!5 "e ,no" the bond is selling at a discount. K0 A =$$+.00.
/0.
Bond concepts
Answer: d
Diff: #
!he correct ans"er is statement d. 0onds "ith a lo"er coupon have a lo"er reinvestment rate ris,. 0onds "ith longer maturities have a lo"er reinvestment rate ris,. Since all three bonds have the same maturity, the one "ith the highest coupon "ill have the highest reinvestment rate ris,. 0ond F has the highest coupon, so statement a is false. 'f mar,et interest rates remain unchanged, discount bonds 9<I. P 4!5: "ill go up in price, "hile premium bonds 9<I. O 4!5: "ill go do"n in price. 0ond F is selling at a premium, so its price "ill decline 9if interest rates are unchanged:. !herefore, statement b is false. 'f mar,et interest rates increase, the prices of all bonds "ill decrease, therefore, statement c is incorrect. Statement d is correct from the information given above in response to statement b. 'f mar,et interest rates decline, all bonds "ill have an increase in price. !he one "ith the largest percentage increase "ill be the one "ith the most price ris,. As maturity increases, price ris, increases. As coupon decreases, price ris, increases. Since all three bonds have the same maturity, the one "ith the lo"est coupon "ill have the greatest price ris,. !herefore, 0ond E "ill have the largest percentage increase in price, so statement e is false. /1 . Bond concepts Answer: b Diff: # N
!he correct ans"er is statement b. 'f the 4!5 remains constant, the price of 0ond A "ill still e(ceed par, the price of 0ond 0 "ill equal par, and the price of 0ond < "ill be belo" par. So, statement a is incorrect. As the 4!5 rises, the price of all bonds "ill decrease. So, statement b is correct. 'f the 4!5 decreases, 0ond < "ill have the largest percentage increase in price since its price is the lo"est of the three bonds. 0ond 0 "ill follo", and 0ond A "ill have the lo"est percentage increase in price. So, statement c is incorrect. /2. Interest rates and bond prices Answer: e Diff: # N
!he correct ans"er is statement e. Statement a is incorrect; 0ond A is a premium bond, "hile 0ond 0 is a discount bond. Statement b is incorrect; because 0ond A is at a premium its price "ill decline one year from no", "hile 0ond 0-s price "ill increase one year from no" because it is a discount bond. Statement c is also incorrect; the t"o bonds have the same maturity, but 0ond 0 has the lo"er coupon so it "ill e(perience the greatest increase in value. !herefore, statement e is the correct choice. /). Callable bond Answer: d Diff: #
//.
Callable bond
Answer: b
Diff: #
Statement b is correct; the other statements are false. !he bonds- prices "ould differ substantially only if investors thin, a call is li,ely, in "hich case investors "ould have to give up a high coupon bond. <alls are most li,ely if the current mar,et rate is "ell belo" the coupon rate. .ote that if the current rate is above the coupon rate, the bond "on-t be called. /#. /1. "ypes of debt and t$eir relative costs #iscellaneous concepts Answer: c Answer: c Diff: # Diff: #
Statement c is correct; the other statements are false. 0an,rupt firms often are reorgani3ed rather than liquidated. Cirms prefer the less e(pensive option of calling the bonds "hich in this case is the sin,ing fund call price. 'nterest e(pense accrues for ta( purposes on 3ero coupon bonds, so firms can reali3e the ta( savings from issuing debt. <allable bonds "ill sell for a higher yield than noncallable bonds, if all other things are held constant. /+. /$. #iscellaneous concepts #iscellaneous concepts Answer: b Answer: e Diff: # Diff: #
Statements a and b are both correct; therefore statement e is the correct choice. 7o" coupon bonds have less reinvestment rate ris, than high coupon bonds. 'f the bond is trading at a premium, then its coupon rate is high in relation to current interest rates. !he issuer "ould be li,ely to call the bond and issue ne" bonds at the lo"er current interest rate. !hus, "e "ould e(pect to earn the yield to call. /*. Current yield and yield to maturity Answer: e Diff: #
Statement e is the correct choice. 'f a bond sells for less than par, then its yield to maturity "ill e(ceed its coupon rate. 'f a bond sells at par, then its current yield, yield to maturity, and coupon rate are all the same. !he bond selling for more than par "ill have a lo"er current yield than a bond selling at par. 6o"ever, the bond selling for more than par "ill have a negative capital gain 9that is, a capital loss: "hile the bond selling at par "ill have no capital gain. #0. Current yield and yield to maturity Answer: a Diff: #
Statement a is correct; the other statements are false. 'f the bond sells for a premium, this implies that the 4!5 must be less than the coupon rate. As a bond approaches maturity, its price "ill move to"ards the par value. #1. Corporate bonds and default risk Statement c is the e(pected return may maturity. Cirms in ban,ruptcy; that is, #2. Answer: c Diff: #
correct choice; the other statements are false. !he be greater than, less than, or equal to the yield to financial distress may or may not eventually declare they may recover. Answer: b Diff: # 't is a
Statement b is the appropriate choice. An indenture is not a bond.
#). #/.
legal contract that spells out in detail the rights of both investors and the firm issuing debt. Default risk and bankruptcy Answer: b Diff: # Default risk and bankruptcy Answer: d Diff: #
Statements a and b are correct; therefore, statement d is the correct choice. <hapter + is liquidation. <hapter 11 is reorgani3ation. ##. inkin! funds and bankruptcy Answer: d Diff: #
Statements a and c are correct; therefore, statement d is the correct choice. %hen the coupon rate is belo" the mar,et rate, then the price is belo" par, so the firm "ill buy bac, its bonds on the open mar,et. 'f interest rates have declined after the issuance of a bond, then the bond has a coupon rate higher than the going mar,et interest rate. !herefore, investors are being paid a higher rate than current interest rates and they "ould prefer to ,eep the bonds to receive a higher return. #1. Bond yields and prices Answer: b Diff: "
Statement b is correct. 'f a bond-s 4!5 e(ceeds its coupon rate, then, by definition, the bond sells at a discount. !hus, the bond-s price is less than its maturity value. Statement a is false. <onsider 3ero coupon bonds. A 3ero coupon bondQs 4!5 e(ceeds its coupon rate 9"hich is equal to 3ero:; ho"ever, its current yield is equal to 3ero "hich is equal to its coupon rate. Statement c is false; a bond-s value is determined by its cash flo"sJ coupon payments plus principal. 'f the 2 bonds have different coupon payments, their prices "ould have to be different in order for them to have the same 4!5. #+. #$. Bond concepts Bond concepts Answer: b Answer: e Diff: " Diff: "
Statements a and c are correct; therefore, Statement e is the correct choice. !he longer the maturity of a bond, the greater the impact an increase in interest rates "ill have on the bond-s price. Statement b is false. !o see this, assume interest rates increase from + percent to 10 percent. 8valuate the change in the prices of a 10 year, # percent coupon bond and a 10 year, 12 percent coupon bond. !he # percent coupon bond-s price decreases by 1*./ percent, "hile the 12 percent coupon bond-s price decreases by only 11.* percent. Statement c is correct. !o see this, evaluate a 10 year, 3ero coupon bond and a * year, 10 percent annual coupon bond at 2 different interest rates, say + percent and 10 percent. !he 3ero coupon bond-s price decreases by 2/.11 percent, "hile the * year, 10 percent coupon bond-s price decreases by only 11.)# percent.
#*.
Answer: c
Diff: "
Statement c is correct. Cor e(ample, assume these coupon bonds have 10 years until maturity and the current interest rate is 12 percent. !he # percent coupon bond-s value is =10/./$, "hile the 10 percent coupon bond-s value is =$$+.00. !hus, the lo"er coupon bond has more interest rate ris, than the higher coupon bond. !he lo"er the coupon, the greater the percentage of the cash flo" that "ill come in the later years 9from the maturity value:, hence, the greater the impact of interest rate changes. Statement a is false as "e demonstrated above. Statement b is false shorter term bonds have more reinvestment rate ris, than longer term bonds because the principal payment must be reinvested sooner on the shorter term bond. Statement d is false as "e demonstrated earlier. Statement e is false because perpetuities have no maturity date; therefore, they have more interest rate ris, than 3ero coupon bonds. !he longer a security-s maturity, the greater its interest rate ris,. 10. 11. Bond indenture "ypes of debt and t$eir relative costs Answer: d Answer: e Diff: " Diff: "
,dB Debentures e.g. Ioint A represents #0B debentures and #0B mortgage bonds %A<D
5ortgage
#0B
100B Iercentage of total issue as mortgage bonds.
12.
1. <ompany can-t lo"er its total cost of the =100 million of debt very much, if any, by the mi( of debentures and mortgage bonds. 2. Debentures- ris, rises as mortgage debt rises. ). 5ortgage bonds- ris, rises as more mortgage bonds are issued. /. So, the >%A<D? "ill li,ely remain fairly stable. Annual coupon rate Answer: d Diff: E N %e must solve for the payment and infer the coupon rate from that value. 8nter the follo"ing data into your financial calculatorJ . A 10; ' A *; IK A R*0).+)#1; CK A 1000; and then solve for I5! A =+#. 6ence, the coupon rate is =+#H=1,000 A +.#B.
1).
Bond value%%annual payment 8nter the follo"ing input data in the calculatorJ
Answer: d
Diff: E
. A 12; ' A $; I5! A *0; CK A 1000; and then solve for IK A =1,0+#. 1/. Bond value%%semiannual payment !ime 7ineJ 0 S IK A &
#B
=1,0+#.)1. K 0 Diff: E
Answer: e 2 S 10

1 S I5! A 10
20 S 10 CK A 1,000
1 month Ieriods
Cinancial calculator solutionJ 'nputsJ . A 20; ' A #; I5! A 10; CK A 1000. OutputJ IK A =1,12/.12; K0 A =1,12/.12. 1#. Bond value%%semiannual payment
!ime 7ineJ 0 S
#B
Answer: d
/ S /0

Diff: E
1 S /0
2 S /0
) S /0
/0 S /0 CK A 1,000
1 month Ieriods
IK A &
Cinancial calculator solutionJ 'nputsJ . A /0; ' A #; I5! A /0; CK A 1000. OutputJ IK A =$2$./1; K0 =$2$. 11. Bond value%%semiannual payment Answer: e Diff: E N
!his is a straight for"ard bond valuation, Gust remember that the bond has semiannual coupons. 8nter the follo"ing data into your financial calculatorJ . A 12 2 A 2/; ' A $ 2 A /; I5! A *0 2 A /#; CK A 1000; and then solve for IK A =1,0+1.2). K0 A =1,0+1.2). 1+ . Bond value%%semiannual payment Answer: b Diff: E N
;sing your financial calculator, enter the follo"ing data as inputsJ . A 2 10 A 20; ' A *H2 A /.#; I5! A 0.0$H2 1,000 A /0; CK A 1000; and then solve for IK A =*)/.*1. K0 A =*)/.*1. 1$. Bond value%%semiannual payment Answer: c Diff: E
1* .
. A 10 2 A 20; ' A *H2 A /.#; I5! A #0; CK A 1000; and then solve for IK A =1,01#.0/. K0 A =1,01#.0/. Bond value%%semiannual payment Answer: b Diff: E
. A 1# 2 A )0; 'H42 A 11H2 A #.#; I5! A 1,000 0.0$H2 A /0; CK A 1000; and then solve for IK A =+$1.**. K0 A =+$1.**. +0. Bond value%%semiannual payment Answer: c Diff: E N
8nter the follo"ing data inputs into the calculatorJ . A 2/; 'H4r A +H2 A ).#; I5! A /0; CK A 1000; and then solve for IK A
=1,0$0.2*. +1.
K0 A =1,0$0.2*. Answer: c
) S )# / S )#


!ime 7ineJ 0 S S S I5! A )# )# IK A &
)B
Diff: E
/0 S )# CK A 1,000
Tuarters
Cinancial calculator solutionJ 'nputsJ . A /0; ' A ); I5! A )#; CK A 1000. OutputJ IK A =1,11#.#+; K0 A =1,11#.#+. +2. 'ield to maturity%%annual bond 8nter . A 11; IK A 10.0$1$B 10.0*B. +). Answer: a Diff: E
$1#; I5! A $0; CK A 1000; and then solve for 'H42 A Answer: c Diff: E
'ield to maturity%%semiannual bond . A 12 2 A 2/; IK A /./#0$B 2 A $.*011B.
10$0; I5! A #0; CK A 1000; and then solve for ' A Answer: b Diff: E
+/ .
8nter the follo"ing input data in the calculatorJ . A 1$; IK A *20; I5! A )#; CK A 1000; and then solve for 'H42 A /.1)*1B. <onvert this semiannual periodic rate to a nominal annual rate, /.1)*1B 2 A $.2+$2B $.2$B.
+#.
'"# and '"C%%semiannual bond
Answer: e
Diff: E
!o calculate 4!5J . A 2$; IK A 10+#; I5! A /0; CK A 1000; and then solve for 'H42 A ).#+B 2 A +.1/B. !o calculate 4!<J . A 10; IK A 10+#; I5! A /0; CK A 10#0; and then solve for 'H42 A ).#2B 2 A +.0#B. +1. 'ield to maturity and bond value0annual bond Step 1J Step 2J Cind the 4!5. . A 20; IK A for ' A 4!5 A *.$+))B. Answer: d Diff: E
*2#; I5! A *0; CK A 1000; and then solve
Solve for I#. 'n # years, there "ill be 1# years left until maturity, so the price at t A # isJ . A 1#; 'H42 A *.$+)); I5! A *0; CK A 1000; and then solve for IK A =*)).0*. K0 A =*)).0*.
++.
Current yield <urrent yield A Annual coupon paymentH<urrent price. Step 1J
Answer: b
Diff: E
Cind the price of the bondJ . A *; 'H42 A 10; I5! A +0; CK A 1000; and then solve for IK A =$2+.2). K0 A =$2+.2). <alculate the current yieldJ <4 A =+0H=$2+.2) A $./1B. Answer: d Diff: E
Step 2J +$.
Current yield <urrent yield A Annual coupon paymentH<urrent price. Step 1J
Cind the price of the bondJ . A 12; 'H42 A *.#; I5! A $#; CK A 1000; and then solve for IK A =*)0. K0 A =*)0. <alculate the current yieldJ <4 A =$#H=*)0 A *.1/B. Answer: c Diff: E
Step 2J +*.
Current yield
!he current yield is equal to the annual coupon divided by the price. !he annual coupon is givenJ 0.0$ =1,000 A =$0. 4ou need to find the price before calculating the current yield. Step 1J ;sing the !K5 inputs of your calculator, find the bond-s priceJ . A 1#; ' A +; I5! A $0; CK A 1000; and then solve for IK A =1,0*1.0$. K0 A =1,0*1.0$.
Step 2J <alculate the bond-s current yieldJ <urrent yield A Annual couponH<urrent price <urrent yield A =$0H=1,0*1.0$ A +.))B. $0. Current yield and yield to maturity <urrent yield is calculated asJ . A 12; IK A $1. =$0H=*$# A $.12B. Answer: b Diff: E
*$#; I5! A $0; CK A 1000; and then solve for 'H42 94!5: A $.20B. Answer: b Diff: E N
!"o years from no", there "ill be $ years left to maturity. ;se your financial calculator to determine its price by entering the follo"ing data as inputsJ . A $; ' A 10; I5! A $0; CK A 1000; and then solve for IK A =$*).)0. $2. )isk premium on bonds Answer: c =$*).)0. Diff: E K0 A
<alculate the previous ris, premium, 2I000, and ne" 2I000J 2I000 A 11.#B $.+B A 2.$B. .e" 2I000 A 2.$BH2 A 1./B. <alculate ne" 4!5 on 000 bondsJ $). Bond value%%annual payment 4!5000 A +.$B U 1./B A *.2B. Answer: e Diff: #
!he semiannual bond selling at par has a nominal yield to maturity equal to its annual coupon rate 9you can chec, this:. !hus the nominal 4!5 for the semiannual bond is $B. !o convert this to an effective annual rate for the annual bondJ .O5B A $; IH42 A 2; and then solve for 8CCB A $.11B. %e can no" value the annual bond using this rate, as the nominal rate is the same as the effective rate "hen compounding occurs annually. !hus; . A 1; ' A $.11; I5! A $0; CK A 1000; and then solve for IK A =**2.1/. K0 A =**2.1/. $/. Bond value%%annual payment Step 1J Answer: a Diff: #
Determine the effective annual rate of return on the semiannual bondJ !he semiannual bond has a 4!5 of * percent because it is selling at par. !his is equivalent to an effective annual rate of *.202#B A V91 U 0.0*H2:2 1W. Determine the value of the annual bondJ 8nter the follo"ing input data in the calculatorJ . A 10; ' A *.202#; I5! A *0; CK A 1000; and then solve for IK A =*$+.12. K0 A =*$+.12.
Step 2J
$#.

!ime 7ineJ 0 1 2 ) 2$B S S S S Deferred I5!s earn 1B $0 $0 $0 K0 A & CKDeferred / S $0 # S $0 1 S $0 1B 1B 1B 1B + S $0
Answer: d
$ 4ears S $0 101.00 10+.01 11)./$ 120.2* A //1.$) A 1,000.00
Diff: #
I5!s U 'nterest
CKIar
.umerical solutionJ Cind the compounded value at 4ear $ of the postponed interest payments CKDeferred interest A =$091.01:+ U =$091.01:1 U =$091.01:# U =$091.01:/ A =//1.$) payable at t A $. .o" find the value of the bond considering all cash flo"s K0 A =$091H1.2$:# U =$091H1.2$:1 U =$091H1.2$:+ U =$091H1.2$:$ U =1,00091H1.2$:$ U =//1.$)91H1.2$:$ A =211.$1. Cinancial calculator solutionJ <alculate CK of deferred interest in 2 stepsJ Step 1J 'nputsJ <C0 A 0; <C1 A $0; .G A /; <C2 A 0; .G A /; ' A 1. OutputJ .CK A =2++.20$. Step 2J 'nputsJ . A $; ' A 1; IK A 2++.20$; I5! A 0. OutputJ CK A =//1.$2$. <alculate K0, "hich is the IK of scheduled interest, deferred accrued interest, and maturity valueJ 'nputsJ <C0 A 0; <C1 A 0; .G A /; <C2 A $0; .G A ); <C) A $0 U //1.$) U 1,000 A 1#21.$); ' A 2$. OutputJ IK A =211.$$; K0 A =211.$$.
$1.
Bond value%%annual payment !ime 7ineJ 1H1H0) 12H)1H0) 0 12B 1 S S 2,000 K0 A & 12H)1H2022 20 4ears

Answer: a
Diff: #
2 S 2,000
S 2,000 CK A 100,000
Cinancial calculator solutionJ <alculate the IK of the bonds 'nputsJ . A 20; ' A 12; I5! A 2000; CK A 100000. OutputJ IK A =2#,)0#.#1. <alculate equal annuity due payments 08M'. mode 'nputsJ . A 2; ' A 10; IK A 2#)0#.#1; CK A 0. OutputJ I5! A =1),2##.2* =1),2##. $+. Bond value%%semiannual payment
!ime 7ineJ 0 S 1 2 S /0

Answer: d
)0 1 month S /0 CK A 1,000 Ieriods
Diff: #
S I5! A /0 K0 A &
$B
Cinancial calculator solutionJ 'nputsJ . A )0; ' A $; I5! A /0; CK A 1000. OutputJ IK A =#/*.1*; K0 A =#/*.1* =##0. $$. Bond value%%semiannual payment
!ime 7ineJ 0 1B 1 S S I5! A 10 K0 Old A 1,000 I5! A /0 K0 .e" A & 2 S 10 /0 20 1 month S Ieriods 10 CK A 1,000 /0 CK A 1,000
Answer: b
Diff: #
Cinancial calculator solutionJ 'nputsJ . A 20; ' A 1; I5! A /0; CK A 1000. OutputJ IK A =++0.10; K0 A =++0.10. .umber of bondsJ =2,000,000H=++0.10 2,#*1 bonds.X X2ounded up to ne(t "hole bond. $*. Bond value%%semiannual payment Answer: d Diff: #
!ime 7ineJ 0 !71 S K0 A & 10 S
,dH2 A $B
1 S I5! A +0
2 S +0
CK A K0# 11 S +0 12 S +0
10 1 month S Ieriods +0 A 1,0+).11
!72
,dH2 A 1B
K0# A &
5aturity 20 1 month S Ieriods +0 CK A 1,000
Cinancial calculator solutionJ Solve for K0 at !ime A # 9K#: "ith # years to maturity 'nputsJ . A 10; ' A 1; I5! A +0; CK A 1000. OutputJ IK A =1,0+).10. K0# A =1,0+).10. Solve for K0 at !ime A 0, assuming sale at K0# A =1,0+).10. 'nputsJ . A 10; ' A $; I5! A +0; CK A 10+).10. OutputJ IK A =*11.**; K0 A =*11.**.
*0.
Answer: d
Diff: #
!he $B annual coupon bond-s 4!5 is *.1B. !he effective annual rate 98A2: is *.1B because the bond is an annual bond. .o", "e need to find the nominal rate for the semiannual bond that has the same 8A2, so "e can calculate its price. 8CCB A *.1; IH42 A 2; and then solve for .O5B A $.*01*B. An equally ris,y $B semiannual coupon bond has the same 8A2. .o", solve for the semiannual bond-s price. . A 2 10 A 20; 'H42 A $.*01*H2 A /./#10; I5! A $0H2 A /0; CK A 1000; and then solve for IK A =*/1.0*. K0 A =*/1.0*. *1 . Bond value%%semiannual payment Answer: a Diff: # N
On the first bond, since the bond is selling at par, its coupon rate is the nominal annual rate charged in the mar,et. 6o"ever, this is for semiannual coupon bonds. So, this needs to be converted into an effective rate for annual coupon bonds. Step 1J Step 2J 8nter the follo"ing data as inputs in your calculatorJ .O5B A +; IH42 A 2; and then solve for 8CCB A +.122#B. ;se the effective rate calculated above to solve for the price of the second bond, "hich is an annual coupon bondJ . A 12; ' A +.122#; I5! A 0.0+ 1,000 A +0; CK A 1000; and then solve for IK A =**0.)). K0 A =**0.)). Answer: b Diff: #
*2.
!ime 7ineJ 0 1 2 )B S S S I5! A )+.# )+.# K0 A &
) S )+.#
/ S )+.#
10 Tuarters S )+.# CK A 1,000
Cinancial calculator solutionJ 'nputsJ . A 10; ' A ); I5! A )+.#0; CK A 1000. OutputJ IK A =1,20+.#+; K0 A =1,20+.#+. *). Bond value%%&uarterly payment
!ime 7ineJ 0 1 )B S S I5! A 2# K0 A & 2 S 2# ) S 2# / S 2#
Answer: b
20 S 2# CK A 1,000
Diff: #
Tuarters
Cinancial calculator solutionJ 'nputsJ . A 20; ' A ); I5! A 2#; CK A 1000. OutputJ IK A =*2#.11; K0 =*21. */. Call price%%&uarterly payment Answer: c Diff: #
Cirst, solve for the bond price today as follo"sJ . A 10 / A /0; ' A $H/ A 2; I5! A 100H/ A 2#; CK A 1000; and then solve for IK A =1,1)1.+$. K0 A =1,1)1.+$. .o", the call price can be solved for as follo"sJ . A # / A 20; ' A +.#H/ A 1.$+#; IK A 11)1.+$; I5! A 2#; and then solve for CK A =1,0/$.)/. Call price%%semiannual payment Step 1J Answer: e Diff: #
*# .
Cind the bond price using the 4!5J 8nter the follo"ing input data in the calculatorJ . A )0; ' A +.#H2 A ).+#; I5! A 0.10H2 1,000 A #0; CK A 1000; and then solve for IK A =1,222.$+. K0 A =1,222.$+. Solve for the call priceJ 8nter the follo"ing input data in the calculatorJ . A 10; ' A #.#/H2 A 2.++; IK A 1222.$+; I5! A #0; and then solve for CK A =1,0)*.*)$ Y =1,0/0. Answer: a Diff: #
Step 2J
*1.
'ield to call Step 1J
Cind the price of the semiannual bond today using the 4!5 and other information givenJ . A 12 2 A 2/; ' A +.#H2 A ).+#; I5! A /#; CK A 1000; and then solve for IK A =1,11+.))12. K0 A =1,11+.))12. Miven the bond-s price, calculate the yield to call by entering the follo"ing data as inputsJ . A / 2 A $; IK A 111+.))12; I5! A /#; CK A 10/#; and then solve for ' A ,H2 A ).)0+)B per 1 months , A ).)0+)B 2 A 1.11/1B Y 1.11B. Answer: a Diff: #
Step 2J
*+.
Cirst get the price based on the 4!5J . A 12; ' A +.#; I5! A *0; CK =1,111.0). K0 A =1,111.0).
1000;
and
then
solve
for
IK
.o" solve for the 4!<J . A /; IK A 1111.0); I5! A *0; CK A 10#0; and then solve for ' A 1.+)B. *$. 'ield to call%%annual bond Answer: b Diff: #
!he bond price today is found as . A 11; ' A +.#; I5! A $0; CK A 1000; and then solve for IK A =1,0)1.#$. K0 A =1,0)1.#$. Solve for the yield to call as follo"sJ 1010; and then solve for ' A $./1B. **. 'ield to call%%semiannual bond Step 1J . A ); IK A 10)1.#$; I5! A $0; CK A
Answer: a
Diff: #
Determine the stoc,-s current priceJ ;se the 4!5 to find the price today. 8nter the follo"ing input data in the calculatorJ . A 2/; ' A +H2 A ).#; I5! A *0H2 A /#; CK A 1000; and then solve for IK A =1,110.#$. K0 A =1,110.#$. Determine the bond-s yield to callJ ;se the IK found in Step 1 to find the 4!<. 8nter the follo"ing input data in the calculatorJ . A 1; IK A 1110.#$; I5! A *0H2 A /#; CK A 10/#; and then solve for ' A 2.)11B per 1 months or 2 2.)11B A /.122B /.12B. Answer: b Diff: #
Step 2J
100 .
Cirst, calculate the bond price as follo"sJ . A 20 2 A /0; ' A +H2 A ).#; I5! A 0.0$H2 1,000 A /0; CK A 1000; and then solve for IK A =1,101.+$. K0 A =1,101.+$. .o", "e can calculate the 4!< as follo"s, recogni3ing that the bond can be called in 1 years at a call price of 11#B 1,000 A 1,1#0J . A 1 2 A 12; IK A 1101.+$; I5! A /0; CK A 11#0; and then solve for ' A ).$+#$B 2 A +.+#B. 101. 'ield to call%%semiannual bond Answer: d Diff: #
Cind the current bond price using the 4!5J . A 12 2 A 2/; ' A *H2 A /.#; I5! A 100H2 A #0; CK A 1000; and then solve for IK A =1,0+2./$. K0 A =1,0+2./$. Solve for the 4!<J . A # 2 A 10; IK A 102. 10+2./$; I5! A #0; CK A 10#0; ' A /./*B
2 A $.*$B. Diff: #
Answer: c
Cirst calculate the bond priceJ . A 2 20 A /0; 'H42 A *H2 A /.#; I5! A 110H2 A ##; CK A 1000; and then solve for IK A =1,1$/.02. K0 A =1,1$/.02. .o", solve for the 4!<J
. A 2 10 A 20; IK A A /.2*B 2 A $.#$B. 10).
11$/.02; I5! A ##; CK A 10##; and then solve for 'H42 Answer: b Diff: #
Cirst "e need to find the bond priceJ . A 12 2 A 2/; ' A 10H2 A #; I5! A 10; CK A 1000; and then solve for IK A =1,1)+.**. K0 A =1,1)+.**. .o" use the bond price to figure the 4!<J . A $ 2 A 11; IK A 11)+.**; I5! A 10; CK A 10#0; and then solve for ' A /.*//1B 2 A *.$$$)B *.$*B. 'ield to call%%semiannual bond Answer: c Diff: # Step 1J Cind the bond price today, if held to maturityJ 8nter the follo"ing input data into the calculatorJ . A 2/, ' A +H2 A ).#, I5! A #0, CK A 1000, and then solve for IK A =1,2/0.$$. K0 A =1,2/0.$$. <alculate the yield to callJ 8nter the follo"ing input data into the calculatorJ . A 10, IK A 12/0.$$, I5! A #0, CK A 10#0, and then solve for ' A 2.11+B. 6o"ever, this is a si( month rate, not a one year rate. !o find the nominal yield to call, Gust multiply this rate by 2J 2.11+B 2 A #.))B. 10#. 'ield to call%%semiannual bond Step 1J Answer: c Diff: #
10/.
Step 2J
Cind the bond price today if it is not calledJ . A 2/; ' A ); I5! A /0; CK A 1000; and then solve for IK A =1,11*.)1. K0 A =1,11*.)1. Cind the yield to callJ . A 10; IK A 111*.)1; I5! A /0; CK A 10/0; and then solve for ' A 2./)B. !his is the nominal rate for 1 months. 2./)B A /.$1B. !he annual nominal rate is 2
Step 2J
101
'ield to call%%semiannual bond Answer: b Diff: # N
8nter the follo"ing data as inputs in your calculatorJ . A 2 # A 10; IK A 10+#; I5! A 0.0*H2 1,000 A /#; CK A 10)#; and then solve for ' A ,dH2 A ).$+/)B. Since this is a 1 month rate, Gust multiply by 2 to solve for the nominal yield to call. ' A ,d A 2 ).$+/)B A +.+/$1B +.+#B. 10+. 'ield to maturity Answer: c Diff: # N
Data givenJ . A 10; ' A & 9!his is "hat the problem is loo,ing for:; I5! A $#; IK A & 9Don-t have directly, but you can calculate it from the current yield:; CK A 1,000. Step 1J <alculate the bond-s current price from information given in the current yield.
<urrent yield A <ouponHIrice 0.0$ A =$#HIrice Irice A & A =1,012.#0. Step 2J Miven the bond-s price, calculate the bond-s yield to maturity using your financial calculator by entering the follo"ing data as inputsJ . A 10; IK A 1012.#0; I5! A $#; CK A 1000; and then solve for ' A +.#$#*B Y +.#*B. 'ield to maturity%%semiannual bond Answer: d Diff: # Step 1J Cirst determine "hat the bond is selling for today based on the information given about its call featureJ . A 1092: A 20; ' A 1.#H2 A ).2#; I5! A 100H2 A #0; CK A 10#0; and then solve for IK A =1,2$0.$1. K0 A =1,2$0.$1. ;se this current price solution to solve for the 4!5J . A 1#92: A )0; IK A 12$0.$1; I5! A 100H2 A #0; CK A 1000; and then solve for ' A )./++#B. Since this is a semiannual rate, multiply it by 2 to solve for the nominal, annual 4!5J 4!5 A )./++#B92: A 1.*##B Y 1.*#B. Answer: d Diff: # Once "e ,no"
10$.
Step 2J
Step )J
10*.
%e ,no" the 4!<, so from that "e can find the current price. the current price, "e can find the 4!5. Step 1J
;sing the 4!< information solve for the bond-s current priceJ 8nter the follo"ing input data in the calculatorJ . A 1/; ' A ).2#; I5! A )#; CK A 10/0; and then solve for IK A =1,0#).)). K0 A =1,0#).)). .o" use the bond-s current price to find the 4!5J 8nter the follo"ing input data in the calculatorJ . A 20; IK A 10#).)); I5! A )#; CK A 1000; and then solve for ' A ).1)+B. !his rate is a semiannual rate. !o find the nominal annual rate, multiply by t"o to get ).1)+B 2 A 1.2+/B 1.2+B. Answer: d Diff: # N
Step 2J
Step )J 110.
. A $ 2 A 11; ' A &; IK A &; I5! A 0.0*#H2 1,000 A /+.#0; CK A 1,000 Step 1J Determine the <urrent yield $.2B K0 K0 bond-s current price. A Annual interestH<urrent bond price A =*#.00HK0 A =*#.00H0.0$2 A =1,1#$.#/. Solve for ' A
Step 2J
Determine the bond-s yield to maturity. . A 11; IK A 11#$.#/; I5! A /+.#0; CK A 1000; ' A & ,dH2 A ).//B; ,d A ).//B 2 A 1.$*B.
111.
Annual interest payments remainin! !ime 7ineJ 0 1 10B S S I5! A $0 K0 A $/+.$$ 2 S $0 n A & S $0 CK A 1,000 4ears
Answer: b
Diff: #
112 .
Cinancial calculator solutionJ 'nputsJ ' A 10; IK A $/+.$$; I5! A $0; CK A 1000. OutputJ . A 1# years. Current yield and capital !ains yield Answer: c Diff: #
Cirst, calculate the bond price as follo"sJ . A 1 2 A 12; ' A $.#H2 A /.2#; I5! A 0.10H2 1,000 A #0; CK A 1000; and then solve for IK A =1,01*.)+$0. K0 A =1,01*.)+$. !he current yield 9<4: is then =100H=1,01*.)+$0 A *.)#B. 2ecogni3ing that the <4 and capital gains yield 9<M: constitute the total return 94!5: on the bond or <4 U <M A 4!5, solve for <M in the follo"ing equation *.)#B U <M A $.#B, <M A 0.$#B. 11). Current yield and '"# Step 1J <alculate the <urrent yield $B Irice price of the 11 year bondJ A <ouponHIrice A =100HIrice A =100H0.0$ A =1,2#0.00. Answer: c Diff: #
!his assumes a =1,000 face value. 't doesn-t matter "hat face value you select as long as you are consistent throughout your calculations. Step 2J <alculate the 11 year bond-s 4!5J 8nter the follo"ing input data in the calculatorJ . A 11; IK A 12#0; I5! A 100; CK A 1000; and then solve for ' A +.)B. Answer: b Diff: # N
11/.
+en!t$ of time until annual bonds called
Cor these ,inds of problems, set up the t"o valuations 9"ithout call and "ith call:. ;se the yield to maturity information to solve for the price of the bond. !hen, use the price of the bond to solve for the time until the call may be e(ercised. Step 1J Solve for the price of the bond. 'nput the follo"ing data into your calculatorJ . A 10; ' A +./; I5! A *0; CK A 1000; and solve for IK A =1,110.)2$#. K0 A =1,110.)2$#. ;se the price calculated in the first step to solve for the time until the bond can be called. 'nput the follo"ing data into your calculatorJ ' A 1.#; IK A 1110.)2$#; I5! A *0; CK A 10#0; and solve for . A ).1#1* or ).11 years. Answer: a Diff: #
Step 2J
11#.
#arket value of semiannual bonds
!ime 7ineJ 1H1H200) 0 1 1B S S I5! A 20 K0 A &
2 S 20
1H1H201) 20 1 month S Ieriods 20 CK A 1,000
Cinancial calculator solutionJ 'nputsJ . A 20; ' A 1; I5! A 20; CK A 1000. OutputJ IK A =#/1.20; K0 A =#/1.20. Since there are 10,000 bonds =#/1.20910,000: A =#,/12,000. 111. (uture bond value%%annual payment !he 4!5 A <urrent yield U <apital gain. !husJ <apital gain A 4!5 <urrent yield A *.+0+2B 10B A 0.2*2$B. !he price in 1 year A Irice no" 91 U <MB:. Irice no"J <urrent yield A Annual couponHIrice. !husJ Irice A Annual couponH<urrent yield A =110H0.10 A =1,100. Irice in one year A =1,100 91 U <MB: A =1,100 91 0.002*2$: 92emember to e(press the A =1,0*1.+$ =1,0*+. capital gain as a decimal.: 11+. Bond coupon rate
!ime 7ineJ 0 ,dH2 A #B 1 S S I5! A & K0 A +1$ 2 S I5! ) S I5! / S I5!
outstanding
the
total
value
of
debt
is
Answer: c
Diff: #
Answer: c
Diff: #
10 1 month S Ieriods I5! CK A 1,000
Cinancial calculator solutionJ 'nputsJ . A 10; ' A #; IK A +1$; CK A 1000. OutputJ I5! A =1*.*## 9semiannual I5!:. Annual coupon rate A 9I5! 2:H5 A 9=1*.*## 2:H=1,000 A ).**B 11$. Bond coupon rate !ime 7ineJ 0 ,dH2 A +B 1 S S I5! A & K0 A 1,1#$.*1 2 S I5! 20 1 month S Ieriods I5! CK A 1,000 Answer: d
/B. Diff: #
11*.
Cinancial calculator solutionJ 'nputsJ . A 20; ' A +; IK A 11#$.*1; CK A 1000. OutputJ I5! A =$#.00 9semiannual I5!:. Annual coupon rate A =$#92:H=1,000 A 1+.0B. Bond value
Answer: d
Diff: "
!ime 7ineJ 0 12.)1B 1 !70L S S I5! A $0 K0L A & !75cD K5cD 0 1B 1 2 S S S I5! A /0 /0 A & ) S /0
2 S $0 / S /0
) S $0 )$ S /0
20 4ears S $0 CK A 1,000 )* /0 1 month S S Ieriods /0 /0 CK A 1,000
0urger Ling K0J <alculate 8A2 to apply to 0urger Ling bonds using interest rate conversion feature, and calculate the value, K0L, of 0urger Ling bondsJ 'nputsJ IH42 A 2; .O5B A 12. OutputJ 8CCB A 8A2 A 12.)1B. 92emember to s"itch IH42 bac, to 1.: 'nputsJ . A 20; ' A 12.)1; I5! A $0; CK A 1000. OutputJ IK A =1$1.#/. K0 A =1$1.#/. 5cDonalds K0J 'nputsJ . A /0; ' A 1; I5! A /0; CK A 1000. OutputJ IK A =1**.0+. K0 A =1**.0+. <alculate the difference bet"een the t"o bondsQ IKsJ DifferenceJ K095cD: K090L: A =1**.0+ =1$1.#/ A =1+.#). 120. Bond value and effective annual rate Answer: b Diff: "
Since the securities are of equal ris,, they must have the same effective rate. Since the comparable 10 year bond is selling at par, its nominal yield is $ percent, the same as its coupon rate. 0ecause it is a semiannual coupon bond, its effective rate is $.11 percent. ;sing your calculator, enter .O5B A $; IH42 A 2; and solve for 8CCB. 92emember to change bac, to IH42 A 1.: So, since the bond you are considering purchasing has quarterly payments, its nominal rate is calculated as follo"sJ 8CCB A $.11; IH42 A /; and solve for .O5B. .O5B A +.*211B. 9Again, remember to change bac, to IH42 A 1.: !o determine the quarterly payment bond-s price you must use the cash flo" register because the payment amount changes. <C0 A 0, <C1 A 20; .G A 20; <C2 A 2#; .G A 1*; <C) A 102#; ' A +.*211H/ A 1.*$0/; and then solve for .IK A =1,010.+2.
121.
Bond value after reor!ani,ation
Answer: d
Diff: "
!ime 7ineJ 0 20B 1 S S 100 K0 A &
2 S 100
) S 100
i A 0B
/ S 100
# S 100
1 S 100
10 4ears S 100 #00
Deferred payments accruing no interest
CK A 1,000
Cinancial calculator solutionJ 'nputsJ <C0 A 0; <C1 A 0; .G A #; <C2 A 100; .G A /; <C# A 1100; ' A 20. OutputJ .IK A =)12.//. K0 A =)12.//. 122. Bond sinkin! fund payment Answer: d Diff: "
!he company must call # percent or =#0,000 face value each year. 't could call at par and spend =#0,000 or buy on the open mar,et. Since the interest rate is higher than the coupon rate 91/B vs. 12B:, the bonds "ill sell at a discount, so open mar,et purchases should be used.
!ime 7ineJ 0 +B 1 S S IK A & I5! A 10 )0 1 month S Ieriods 10 CK A 1,000 Cinancial calculator solutionJ 'nputsJ . A )0; ' A +; I5! A 10; CK A 1000. OutputJ IK A =$+#.*1. K0 A =$+#.*1.

2 S 10
!he company "ould have to buy =#0,000H=1,000 A #0 bonds at =$+#.*1 each A =/),+*#.#0 =/),+*1. 12). Bond coupon payment !ime 7ineJ 0 1 ,d A & !71 S S K01 A +01.22 I5! A $0 0 ,d A 12B 1 !72 S S K02 A +01.22 I5! A & 2 S I5! 2 S $0 20 S $0 CK A 1,000 Answer: b 4ears Diff: "
) S I5!
/ # 4ears S S I5! I5! CK A 1,000
<alculate 4!5 or ,d for first issueJ 'nputsJ . A 20; IK A +01.22; I5! A $0; CK A 1000. OutputJ ' A ,d A 4!5 A 12B. <alculate I5! on second issue using 12B A ,d A 4!5J 'nputsJ . A #; ' A 12; IK A +01.22; CK A 1000. OutputJ I5! A =)+.111 Y =)+.12. 12/. Bonds wit$ differential payments Answer: c Diff: "
!ime 7ineJ Semiannual 0 ,dH2 S <Cs 1,000 Tuarterly 0 ,dH/ S <Cs 1,000 Step 1J
A /.#B
I5! A &
1 S
2 S I5! ) S I5!
) S I5! / S I5!
/ /0 1 month S S Ieriods I5! I5! CK A 1,000 # S I5! 1 $0 Tuarters S S I5! I5! CK A 1,000
A 2.22#B
1 2 S S I5! A & I5!
<alculate the 8A2 of *B nominal yield bond compounded semi annually. ;se interest rate conversion feature. 'nputsJ IH42 A 2; .O5B A *. OutputJ 8CCB A *.202#B. 92emember to change bac, to IH42 A 1.: <alculate the nominal rate, ,.om, of a *.202#B 8A2 but "ith quarterly compounding. 'nputsJ IH42 A /; 8CCB A *.202#. OutputJ .O5B A $.*0B. 92emember to change bac, to IH42 A 1.: <alculate the quarterly periodic rate from ,.om of $.*B and calculate the quarterly payment. ,I82 A ,.omH/ A $.*0BH/ A 2.22#B. 'nputsJ . A $0; ' A 2.22#; IK A 1000; CK A 1000. OutputJ I5! A =22.2#. Current yield%%annual Diff: E N bond
Step 2J
Step )J
12#
Answer: a <urrent yield A Annual interestH<urrent bond price <urrent yield A =$0H=*2# <urrent yield A $.1#B. 121 . 'ield to
maturity%%annual Diff: # N
bond
Answer: c
8nter the follo"ing data as inputs in your calculator as follo"sJ . A 10; IK A *2#; I5! A $0; CK A 1000; ' A & Solve for ' A ,d A 4!5 A *.1$B. 12+ (uture bond value%%annual payment Answer: e Diff: # N K0 A
8nter the follo"ing data as inputs in your calculator as follo"sJ . A +; ' A *.1$; I5! A $0; CK A 1000; IK A & Solve for IK A =*/0.*+. Y =*/1.00. 12$ . Bond value%%annual payment Answer: d Diff: E N
12*
8nter the follo"ing data as inputs in your calculatorJ . A 12; ' A +; I5! A 0.0$ 1,000 A $0; CK A 1000; and then solve for IK A =1,0+*./). K0 A =1,0+*./). . (uture bond value%%annual payment Answer: e Diff: E N
) years have passed so . no" is 12 R ) A *. . A *; ' A +; I5! A 0.0$ 1,000 A $0; CK A 1000; and then solve for IK A =1,01#.1#. K0 A =1,01#.1#. 1)0 . 'ield to maturity%%semiannual bond Answer: d Diff: E N
'nput the follo"ing data in your calculatorJ . A )0; IK A 11*0; I5! A #0; CK A 1000; and then solve for ' A ).*12$B, but this interest rate is on a semiannual basis. !he nominal 4!5 is ).*12$B 2 A +.$2#+B +.$)B. 1)1 . 'ield to call%%semiannual bond Answer: a Diff: E N
'nput the follo"ing data in your calculatorJ . A 10; IK A 11*0; I5! A #0; CK A 10#0; and then solve for ' A ).1$/1B, but this interest rate is on a semiannual basis. !he nominal 4!< is ).1$/1B 2 A 1.)1$2B 1.)+B. 1)2. 'ield to maturity%%annual bond Answer: a Diff: E N
8nter the follo"ing data as inputs in the financial calculatorJ . A 12; IK A 102#; I5! A $0; CK A 1000; and then solve for ' A 4!5 A +.1+)$B +.1+B. 1)). Price risk%%annual bond Old 4!5 A +.1+)$B. .e" 4!5 A +.1+)$B Answer: e 1B A 1.1+)$B. Diff: # N
;sing the ne" 4!5, first solve for the ne" bond price by entering the follo"ing data in your financial calculatorJ . A 12; ' A 4!5 A 1.1+)$; I5! A $0; CK A 1000; and then solve for IK A =1,10+.1*. K0 A =1,10+.1*. .o", you can calculate the change in priceJ
=1, 10+.1* =1, 02#.00 A $.02B $B. =1, 02#.00
,E" APPE$D&. !A %#()T&#$%

1)/1A%. -ero coupon bond concepts Answer: a Diff: E !he 10 year bond has payments that come sooner than the 3ero coupon bond-s payments. !herefore, some of the 10 year bond-s cash flo"s "ill be discounted
for fe"er periods and "ill lose less of their value. !herefore, the value of the 10 year 3ero coupon bond "ill drop by more than the $ percent coupon bond. !herefore, statement a is correct. Statement b used to be true, but the '2S caught on that people "ere trying to avoid ta(es by buying 3ero coupon bonds, and they changed the ta( code. !herefore, statement b is false. 'f the 4!5 is higher than the coupon rate, then the bond is selling at a discount. !he company pays less buying it on the open mar,et than purchasing it at par value. So statement c is false. 1)#1A%. Coupon and ,ero coupon bond concepts Answer: d Diff: #
'f the 4!5 is $ percent, then the going interest rate is $ percent. 0ond A has a lo"er coupon than the going coupon rate on ne" bonds, and investors "on-t pay as much for it. !herefore, it is selling at a discount. !he opposite is true for 0ond 0. !herefore, statement a is true. 'f the 4!5 falls, then interest rates are falling, and bond prices "ill increase. !he bond that is most affected by this change "ill be the one "hose payments are discounted the most. !he 12 year 3ero coupon bond has all of its payments discounted at the ne" lo" rate for a period of 12 years 9since it only ma,es one payment at the end of the bond-s life:. 0ond 0 "ill have its final par value discounted for the entire 10 years of its life, but it has interest payments in the interim. One "ill be discounted for Gust one year, one for Gust t"o years, etc. !herefore, the IK of these earlier cash flo"s "ill be less affected by the drop in interest rates. Cor 0ond A, since its life is the shortest, it "ill be the least affected by the change in interest rates. !herefore, statement b is true. 2einvestment rate ris, means that there is a chance that "hen the bond matures interest rates "ill have fallen, and you "ill not be able to get as high a coupon rate on a replacement bond. !he 3ero coupon bond doesn-t mature for 12 years, and there are no coupon payments to reinvest, so you are assured of its return for 12 years. !he $ year bond has the most reinvestment rate ris, because you can only be assured of that rate for $ more years. !herefore, statement c is false. Since statements a and b are true, the correct choice is statement d. 1)11A%. tripped .. . "reasury bond Answer: e Diff: E
0 i A 10B 1 2 ) / # 4ears S S S S S S K0 A & CK A 1,000,000 Cinancial calculator solutionJ 'nputsJ . A #; ' A 10; I5! A 0; CK A 1000000. OutputJ IK A =),+2#,#2+.*/. K0 A =),+2#,#2$. 1)+1A%. -ero coupon bond Answer: b
Diff: E
Step 1J Cind out "hat "as paid for the bondJ IK A =1,000H91.01$:+ A =1)0.*#*. Step 2J Determine the 4ear 1 accrued interestJ !he accrued interest in the first year =/2.*0#. is =1)0.*#* 0.01$ A
Step )J <alculate the ta( on the accrued interestJ !a( on the accrued interest is =/2.*0# 0.) A =12.$+. 1)$1A%. -ero coupon bond Answer: d Diff: #
Cirst, find the value of the bond today as follo"sJ . A 12; ' A *; I5! A 0; CK A 1000; and then solve for IK A =)##.#). K0 A =)##.#).
Second, find the value of the bond at the end of the first year as follo"sJ . A 11; ' A *; I5! A 0; CK A 1000; and then solve for IK A =)$+.#). K01 A =)$+.#). !he ta(able income on the bond is the appreciation in value over the year or =)$+.#) =)##.#) A =)2. !hus, the ta( paid is 2#B =)2 A =$. 1)*1A%. -ero coupon bond
!ime 7ineJ Fero coupon bond 0 1 2 4ears ,d A & S S S IK A $21./# CK A 1,000
Answer: b
Diff: #
Cirst, find the value of ,d as the interest rate that "ill cause =$21./# to gro" to =1,000 in 2 years. 'nputsJ . A 2; IK A $21./#; I5! A 0; CK A 1000. OutputJ ' A ,d A 10B. ,d9After ta(: A ,d91 !: A 0.1090.1: A 0.01 A 1B.
Analysis of cash flo"s method using calculated ,d A 10B and financial calculatorJ 4ear 0 1 2 Accrued value =$21./# =*0*.10 =1,000.00 'nterest 99Kt 1.10: Kt: $2.1# *0.*0 !a( savings 9'nterest 0./0: )).01 )1.)1 <ash flo"s U$21./# U)).01 U)1.)1 1,000.00 = *1).1/
!ime lineJ 0 ,d9A!: A & 1 S S IK A $21./# U)).01
2 4ears S *1).1/
Cin ancial calculator solutionJ 9;sing <Cs from "or,sheet analysis: 'nputsJ <C0 A $21./#; <C1 A )).01; <C2 A *1).1/. OutputJ '22B A 1.0B. ,d9A!: A 1.0B. 1/01A%. -ero coupon bond Answer: a Diff: # Step 1J Cind IK of bondJ
. A 1#; ' A $; I5! A 0; CK A 1000; and then solve for IK A A =)1#.2/. =)1#.2/. K0
Step 2J Cind interest for the first yearJ Kalue at tA0 =)1#.2/ 'nterest rate 0.0$ 'nterest income = 2#.22 Step )J Cind ta( dueJ 'nterest income !a( rate !a( due 1/11A%. -ero coupon bond =2#.22 0.)0 = +.#+ Answer: d Diff: #
Step 1J Cind the price of the bond todayJ . A +; ' A 1; I5! A 0; CK A 1000; and then solve for IK A
=11#.0#+1.
K0 A =11#.0#+1.
Step 2J Cind the price of the bond in 1 yearJ . A 1; ' A 1; I5! A 0; CK A 1000; and then solve for IK A =+0/.*10#. K0 A =+0/.*10#. Step )J <alculate the ta(es due on the gainJ !he difference is =+0/.*10# =11#.0#+1 A =)*.*0)/. !he ta(es due are 0.2# =)*.*0)/ A =*.*+#* =*.*$. 1/21A%. -ero coupon bond and EA)
!ime lineJ 9Tuarterly payment bonds: 0 1 2 ) / # 1 + S S S S S S S S I5! A 2# 2# 2# 2# 2# 2# 2# IK A +*#.#/ $ S 2#
Answer: d
/0 S 2# CK A 1,000

Diff: #
Tuarters
<alculate nominal periodic and annual interest ratesJ 'nputsJ . A /0; IK A +*#.#/; I5! A 2#; CK A 1000. OutputJ ' A ,dH/ A )./#B per period. ,.om A / )./#B A 1).$0B. <alculate 8A2 using interest rate conversion featureJ 'nputsJ IH42 A /; .O5B A 1).$0. OutputJ 8CCB A 1/.#)B. change bac, to IH42 A 1.:
!ime lineJ 9Fero coupon bond: 0 1/.#)B 1 2 S S S IK A & I5! A 0 0 10 S CK A 1,000 4ears
92emember to
<alculate IK of 3ero coupon bond using 8A2J 'nputsJ . A 10; ' A 1/.#); I5! A 0; CK A 1000. OutputJ IK A =2#+.#1$ Y =2#+.#2. K0 A =2#+.#2. 1/)1A%. Callable ,ero coupon bond
Answer: c
Diff: #
!ime 7ineJ 0 # 10 1# 20 4ears S S S S S 21/.#0 today 1st call CK A 1,000 issue S date price mar,et price A 2)*.)* Cinancial calculator solutionJ 'nputsJ . A 20; IK A 21/.#0; I5! A 0; CK A 1000. OutputJ bonds "ere issued at $B.
' A $.0B.
!he
'nputsJ . A 1#; IK A 2)*.)*; I5! A 0; CK A 1000. OutputJ ' A 10.0B. At a current mar,et price of =2)*.)*, mar,et rates are 10.0B. !hus, the bond "ill not li,ely be called, so today at 4ear #, 4!5 of 10B is the most li,ely annual rate an investor "ill earn. 1//1A%. -ero coupon bond and ta/es Answer: a Diff: #
4ou need to figure out ho" much you "ould pay for the bond today, and "hat its price "ill be ne(t year to find the capital gain. Step 1J Determine the price of the 3ero coupon bond todayJ 8nter the follo"ing input data into the calculatorJ . A +; ' A 1; I5! A 0; CK A 1000; and then solve for IK A
=11#.0#+1.
K0 A =11#.0#+1.
Step 2J Determine the price of the 3ero coupon bond one year laterJ 8nter the follo"ing input data into the calculatorJ . A 1; ' A 1; I5! A 0; CK A 1000; and then solve for IK A =+0/.*10#. K01 A =+0/.*10#. Step )J Determine the ta(es due on the gainJ !he difference bet"een the t"o prices is the capital gainJ <apital gain A =+0/.*10# =11#.0#+1 A =)*.*0. !his gain is ta(ed at the rate of )0BJ !a(es A 0.) =)*.*0 A =11.*+. 1/# 1A%. Answer: e Diff: # N "a/es on ,ero coupon bond
Step 1J Determine the price of the bond todayJ . A 1#; ' A +; I5! A 0; CK A 1000; and then solve for IK A =)12.//1. K0 A =)12.//1. Step 2J Determine the price of the bond one year from no"J . A 1/; ' A +; I5! A 0; CK A 1000; and then solve for IK A =)$+.$1+. K01 A =)$+.$1+. Step )J Determine the capital gain on the bondJ <apital gain A =)$+.$1+ R =)12.//1 A =2#.)+1. Step /J <alculate the first year-s ta(esJ !a(es due A =2#.)+1 0.2# A =1.)/. 1/11A%. Accrued value and interest e/pense
0 i A *B 1 S S K0 A 1+$./) 2 S

Answer: a
$ 20 4ears S S K$ A & CK A 1,000
Diff: #
1 S
+ S K+ A &
Cinancial calculator solutionJ 'nputsJ . A $; ' A *; IK A 1+$./); I5! A 0. OutputJ CK A =)##.#) A K$. 'nputsJ . A +; ' A *; IK A 1+$./); I5! A 0. OutputJ CK A =)21.1$ A K+. DifferenceJ =)##.#) =)21.1$ A =2*.)#. Solution chec,J =2*.)#H=)21.1$ A *.0B. 1/+1A%. -eros and e/pectations t$eory Answer: d Diff: "
Cirst find the yields on one year and t"o year 3ero coupon bonds, so you can find the implied rate on a one year bond, one year from no". !hen use this implied rate to find its price. 1 . 2 . 4earJ A 1; IK A 4earJ A 2; IK A *)$.*1+1; I5! A 0; CK A 1000; and then solve for ' A 1.#B. $+)./)$+; I5! A 0; CK A 1000; and then solve for ' A +.0B.
!herefore, if the implied rate A E 1.#B U E A +.0B 2 E A +.#B. .o" find the price of a 1 year 3ero, 1 year from no"J
. A 1; ' A +.#; I5! A 0; CK A 1000; and then solve for IK A K01 A =*)0.2). 1/$1A%. -eros and e/pectations t$eory
0 S 1 S 2 S ) S / S
=*)0.2). Diff: "
Answer: a
) year 3ero; Irice A $2+.$/*1 / year 3ero; Irice A +12.$*#2
Step 1J <alculate the 4!5 for the ) year 3eroJ . A ); IK A $2+.$/*1; I5! A 0; CK A 1000; then solve for ' A 1.#B. Step 2J <alculate the 4!5 for the / year 3eroJ . A /; IK A +12.$*#2; I5! A 0; CK A 1000; then solve for ' A +B. Step )J <alculate the interest rate on a 1 year 3ero, ) years from no"J +B A
E A $.#B.
1.#B9): U E /
Step /J <alculate the price of a 1 year 3ero ) years from no"J . A 1; ' A $.#; I5! A 0; CK A 1000; and then solve for IK A =*21.11. K0 A =*21.11. 1/*1A%. -ero coupon bond Answer: d Diff: "
0 i A /B 2 S S Accrued value 1/0.+1 1#2.1* <all value / S 11/.11 1 S 1+$.0/ $ S 1*2.#+ 10 S 20$.2* 211.12
Step 1J <alculate IK of 3ero coupon bond at !ime 0J . A #0; ' A /; I5! A 0; CK A 1000; and then solve for IK A =1/0.+1. K0 A =1/0.+1. Step 2J <alculate accrued value at 4ear #J =1/0.+191.0/:29#: A =20$.2*. Step )J <all value at 4ear #J =20$.2*91.0/: A =211.12. Step /J <alculate 8A2 as follo"sJ . A 10; IK A 1/0.+1; I5! A 0; CK A 211.12; and then solve for ' A /./1B; ho"ever, this is a semiannual rate. 8A2 A 91.0//1:2 1 A *.01B. 1#01A%. -ero coupon bond
!ime 7ineJ 0 S IK A & A $+.20 10 S IK# A 1/2.0# U Iremium 1/.20 1#1.2# 4!< A &
Answer: e
#0 1 month S Ieriods CK A 1,000
Diff: "
Cin ancial calculator solutionJ Step 1J Determine 8A2 for discounting. ;sing interest rate featureJ 'nputsJ IH42 A 2; .O5B A 10B. OutputJ 8CCB A 10.2#B. conversion
Cormula methodJ
8A2 A 1 U
, 2
1 A 91.0#:2
1 A 0.102#.
Step 2J Determine price of bond "hen issued. 'nputsJ . A 2#; ' A 10.2#; I5! A 0; CK A 1000. =$+.20. K0 A =$+.20.
OutputJ
IK A
Step )J Determine accrued value of bond today, and calculate call price. 'nputsJ . A #; ' A 10.2#; IK A $+.20; I5! A 0. OutputJ CK A =1/2.0/. Iremium is 10B over accrued value. price A =1/2.0/ 1.10 A =1#1.2/. Step /J Determine the periodic rate 9semiannual compounding:. 'nputsJ . A 10; IK A $+.20; I5! A 0; CK A 1#1.2/. OutputJ ' A 1.00#B. .ominal annual rate A 2 1.00#B A 12.01B.
<all
Step #J Determine effective annual rate earned on bond using interest rate conversion featureJ 'nputsJ IH42 A 2; .O5B A 12.01. OutputJ 8CCB A 12.)+B. 1#11A%. "a/es on ,ero coupon bond Answer: a Diff: " Since 3ero coupon bonds do not ma,e annual interest payments, the ta( deduction is determined by the accumulated 9but unpaid: interest on the bond over the year. !o determine this "e "ill calculate the value of the bond at t A 1 and at t A 2. t A 1J t A 2J . A *; 'H42 A *.#; I5! A 0; CK A 1000; IK A . A $; 'H42 A *.#; I5! A 0; CK A 1000; IK A =//1.$#. =/$).$2. K01 A =//1.$#. K02 A =/$).$2.
So the accumulated interest isJ =/$).$2 !a( savings A )0B9=/1.*+: A =12.#*. 1#21A%. -ero coupon interest ta/ s$ield !ime 7ineJ 0 S IK A U+2+.2#
=//1.$# A =/1.*+. Answer: b Diff: "
1 S I5! A 0 !a( savings1
2 S 0 !a( savings2
) 4ears S 0 !a( savings) CK A 1,000 1000. OutputJ ' A 11.20B. 2 $**.2$ *0.#$ )1.2) U)1.2) ) 1,000.00 100.+2 /0.2* U/0.2* 1,000.00 *#*.+1 Diff: #
Cinancial calculator solutionJ 'nputsJ . A ); IK A +2+.2#; I5! A 0; CK A 0 1: Accrued value +2+.2# 2: 'nterest e(pense ): !a( savings 9line 2 0./0: /: <ash flo"s 1#)1A%. After%ta/ cost of debt U+2+.2#
1 $0$.+0 $1./# )2.#$ U)2.#$
Answer: c
Cinancial calculator solutionJ Solve for the 4!5 using the information from the previous question
'nputsJ . A ); IK A +2+.2#; I5! A 0; CK A 1000. OutputJ ' A 11.20. 0efore ta( cost debt of this issue A 11.20B. ,d9After ta(: A 11.20B91 !: A 11.2B90.1: A 1.+2B. Alternate solution using cash flo"sJ 'nputsJ <C0 A +2+.2#; <C1 A )2.#$; <C2 A )1.2); <C) A OutputJ '22B A 1.+2B. *#*.+1.
1#/ 1B%.
,E" APPE$D&. !" %#()T&#$%

+i&uidation procedures Answer: e Answer: d Answer: e Answer: c Diff: # Diff: # Diff: # Diff: "
1##1B%. Bankruptcy law 1#11B%. Bankruptcy issues 1#+1B%. Priority of claims

Bonds and Valuation

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Bonds and Valuation

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"#$D% A$D THE& 'A()AT&#$ CHAPTE !

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

Multiple Choice: Conceptual Easy:

Interest rates and bond prices

Interest rates and bond prices

Interest vs. reinvestment rate risk

Interest vs. reinvestment rate risk

Bond coupon rate

e. .one of the statements above is correct. Bond concepts

Bond yields and prices

inkin! fund provision

inkin! fund provision

e. A ) year bond "ith a 10 percent coupon. Price risk

Interest rates and bond prices

"ypes of debt and t$eir relative costs

Current yield and yield to maturity

Current yield and yield to maturity

Corporate bonds and default risk

Default risk and bankruptcy

Default risk and bankruptcy

Default risk and bankruptcy

inkin! funds and bankruptcy

Interest vs. reinvestment rate risk

Answer: d are some provisions that are often contained

Diff: " in bond

7isted belo" indenturesJ 1. 2. ). /. #. 1.

"ypes of debt and t$eir relative costs

Multiple Choice: P*o+lems Easy:

Bond value%%annual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%&uarterly payment

'ield to maturity%%annual bond

'ield to maturity%%semiannual bond

'ield to maturity%%semiannual bond

'"# and '"C%%semiannual bond

'ield to maturity and bond value%%annual bond

Current yield and yield to maturity

(uture bond value%%annual payment

)isk premium on bonds

Bond value%%annual payment

Bond value%%annual payment

Bond value%%annual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%semiannual payment

Bond value%%&uarterly payment

Bond value%%&uarterly payment

Call price%%&uarterly payment

Call price%%semiannual payment

'ield to call%%annual bond

'ield to call%%annual bond

'ield to call%%semiannual bond

'ield to call%*semiannual bond

'ield to call%%semiannual bond

'ield to call%%semiannual bond

'ield to call%%semiannual bond

2#; I5! A 0; CK A 1000; and then solve