Chapter 05 Sample Qs:

01. Which of the following statements is correct?

a. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par.
b. All else equal, if a bond’s yield to maturity increases, its price will fall.
c. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.
d. All else equal, if a bond’s yield to maturity increases, its current yield will fall.

02. Which of the following events would make it more likely that a company would call its
outstanding callable bonds?
a. The company’s bonds are downgraded.
b. Market interest rates rise sharply.
c. Market interest rates decline sharply.
d. The company's financial situation deteriorates significantly.

03. AM Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not
convertible, not callable, and has no sinking fund. Alternatively, AM could issue a 20-year bond that
is convertible into common equity, may be called, and has a sinking fund. Which of the following
most accurately describes the coupon rate that AM would have to pay on the second bond, the
convertible, callable bond with the sinking fund, to have it sell initially at par?
a. The coupon rate should be exactly equal to 6%.
b. The coupon rate could be less than, equal to, or greater than 6%, depending on the specific
terms set, but in the real world the convertible feature would probably cause the coupon rate to
be less than 6%.
c. The rate should be slightly greater than 6%.
d. The rate should be over 7%.
Explanation: The second bond's convertible feature and sinking fund would tend to lower its required
rate of return, but the call feature would raise its rate. Given these opposing forces, the second
bond's required coupon rate could be above or below that of the first bond. However, the convertible
feature generally dominates in the real world, so convertibles' coupon rates are generally less than
comparable non-convertible issues' rates.

04. A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium.
Which of the following statements is correct?
a. If the yield to maturity remains at 8%, then the bond’s price will decline over the next year.
b. The bond’s coupon rate is less than 8%.
c. If the yield to maturity increases, then the bond’s price will increase.
d. If the yield to maturity remains at 8%, then the bond’s price will remain constant over the next
year.

05. Which of the following statements is correct?

a. If a bond is selling at a discount, the yield to call is a better measure of return than is the yield to
maturity.
b. On an expected yield basis, the expected capital gains yield will always be positive because an
investor would not purchase a bond with an expected capital loss.

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c. On an expected yield basis, the expected current yield will always be positive because an investor
would not purchase a bond that is not expected to pay any cash coupon interest.
d. If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected
capital gains yield is zero.

06. Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence
their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and
Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain
constant for the next 10 years, which of the following statements is CORRECT
a. Bond 8’s current yield will increase each year.
b. Since the bonds have the same YTM, they should all have the same price, and since interest rates
are not expected to change, their prices should all remain at their current levels until maturity.
c. Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over
the next year.
d. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the
next year.
Explanation: Note that Bond 10 sells at par, so the required return on all these bonds is 10%. 10's
price will remain constant; 8 will sell initially at a discount and will rise, and 12 will sell initially at a
premium and will decline.

07. Which of the following statements is correct?

a. The yield to maturity for a coupon bond that sells at a premium consists entirely of a positive
capital gains yield; it has a zero current interest yield.
b. Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to
maturity that is based on market prices.
c. The yield to maturity on a coupon bond that sells at its par value consists entirely of a current
interest yield; it has a zero expected capital gains yield.
d. The expected capital gains yield on a bond will always be zero or positive because no investor
would purchase a bond with an expected capital loss.

08. Which of the following statements is correct?

a. A bond’s current yield must always be either equal to its yield to maturity or between its yield
to maturity and its coupon rate.
b. If a bond sells at par, then its current yield will be less than its yield to maturity.
c. If a bond sells for less than par, then its yield to maturity is less than its coupon rate.
d. A discount bond’s price declines each year until it matures, when its value equals its par value.

09. Other things held constant, if a bond indenture contains a call provision, the yield to
maturity that would exist without such a call provision will generally be ____ the YTM with a call
provision.
Ans. lower than

10. You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6
months. If your nominal annual required rate of return is 10 percent with semiannual compounding,
how much should you be willing to pay for this bond? Ans. $1,124.62

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11. A corporate bond has a face value of $1,000, and pays a $50 coupon every six months (that
is, the bond has a 10 percent semiannual coupon). The bond matures in 12 years and sells at a price
of $1,080. What is the bond’s nominal yield to maturity? Ans. 8.90%

12. A 20-year bond with a par value of $1,000 has a 9 percent annual coupon. The bond
currently sells for $925. If the bond’s yield to maturity remains at its current rate, what will be the
price of the bond 5 years from now? Ans. $933.09

13. A bond matures in 12 years and pays an 8 percent annual coupon. The bond has a face
value of $1,000 and currently sells for $985. What is the bond’s current yield and yield to maturity?
Ans. Current yield = 8.12%; yield to maturity = 8.20%

14. A 10-year bond with a 9 percent semiannual coupon is currently selling at par. A 10-year
bond with a 9 percent annual coupon has the same risk, and therefore, the same effective annual
return as the semiannual bond. If the annual coupon bond has a face value of $1,000, what will be
its price?
Ans. $987.12

15. An 8 percent annual coupon, noncallable bond has 10 years until it matures and a yield to
maturity of 9.1 percent. What should be the price of a 10-year noncallable bond of equal risk that
pays an 8 percent semiannual coupon? Assume both bonds have a par value of $1,000. And. $
941.09

16. Gyro Corporation issued 20-year, noncallable, 7.8% annual coupon bonds at their par value
of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current
price of the bonds? Ans. $1,266.98

17. T-Corp.'s bonds currently sell for $840. They have a 6.35% annual coupon rate and a 20-year
maturity, but they can be called in 5 years at $1,067.50. Assume that no costs other than the call
premium would be incurred to call and refund the bonds, and also assume that current interest rates
in the market are expected to remain at current levels on into the future. Under these conditions,
what rate of return should an investor expect to earn if he or she purchases these bonds?
Ans. YTM = 7.98% Vs. YTC = 11.84% hence the investor should expect to earn YTM = 7.98%
Note that if the coupon rate exceeds the YTM, then it is likely that the bonds will be called and
replaced with new, lower coupon bonds. In that case, the YTC will be earned. Otherwise, one should
expect to earn the YTM.

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