Test Questions & Answers Valuing Bonds Chapter 4

Chapter 4 – Valuing bonds

MULTIPLE CHOICE

1. A 15-year 9% bond with a face value of $1000 is currently trading at $958. The yield to maturity of this bond:

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

2. A bond that grants the investor the right to exchange their bonds for ordinary shares is called a:

REF: 4.3 Types of Bonds NAT: Reflective thinking

LOC: understand shares and bonds

3. Of the following bonds, which has the highest degree of interest rate risk?

REF: 4.2 Bond Prices and Interest Rates NAT: Reflective thinking

LOC: understand shares and bonds

4. Which of the following information cannot be found in a bond’s indenture?

REF: 4.3 Types of Bonds NAT: Reflective thinking

LOC: understand shares and bonds

5. Bavarian Sausage just issued a 12-year 6% coupon bond. The face value of the bond is $1000 and the bond makes annual coupon payments. If the required return on the bond is 11%, what is the bond’s price?

FV = 1000

PMT = 0.06 x 1000 = 60

I/Y = 11

N = 12

PV = 675.38

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

6. Bavarian Sausage just issued a 12-year 6% coupon bond. The face value of the bond is $1000 and the bond makes semiannual coupon payments. If the required return on the bond is 11%, what is the bond’s price?

FV = 1000

PMT = (0.06 x 1000)/2 = 30

I/Y = 11/2

N = 12 × 2

PV = 671.21

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

7. Bavarian Sausage just issued a 10-year 12% coupon bond. The face value of the bond is $1000 and the bond makes semiannual coupon payments. If the bond is trading at $1267.25, what is the bond’s yield to maturity?

FV = 1000

PV = 1267.25

PMT = 120

N = 10

I/Y = 8.06

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

8. Bavarian Sausage wants to issue a 10-year coupon bond. The face value of the bond is $1000 and the bond makes semiannual coupon payments. Outstanding Bavarian Sausage 8% bonds with a remaining maturity of 10 years are currently trading at $1145. These bonds also have a face value of $1000 and make semiannual payments. If Bavarian Sausage wants the new bonds to sell at par, what should be the coupon rate on these bonds?

FV = 1000

PV = 1145

PMT = 80/2

N = 10/2

I/Y = 3.025

Coupon rate = 3.025 × 2 = 6.05

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

9. You just bought a bond with a yield to maturity of 8.5%. If the rate of inflation is expected to be 4.5 %, what is the real return on your investment?

r = (1.085/1.045) – 1 = 0.0383

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

10. What is the value of a 20-year 12% coupon bond with a face value of $1000. The required return on the bond is 14% and the bond makes semiannual payments.

FV = 1000

PMT = (0.12 x 1000)/2 = 120/2 = 60

I/Y = 14/2

N = 20 × 2

PV = 866.68

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

11. You are offered a zero-coupon bond with a $1000 face value and six years left to maturity. If the required return on the bond is 9%, what is the most you should pay for this bond?

FV = 1000

PMT = 0

I/Y = 9

N = 6

PV =596.27

PTS: 1 DIF: E

REF: 4.3 Types of Bonds NAT: Analytic skills

LOC: understand shares and bonds

12. You just bought a six-year zero-coupon bond with a $1000 face value for $645.48. What is the yield to maturity of this bond?

FV = 1000

PV = 645.48

PMT = 0

N = 6

I/Y = 7.57

PTS: 1 DIF: E

REF: 4.3 Types of Bonds NAT: Analytic skills

LOC: understand shares and bonds

13. You just bought a six-year zero-coupon bond with a $1000 face value for $645.48. What is the taxable capital gain on this bond next year?

FV = 1000

PV = 645.48

PMT = 0

N = 6

I/Y = 7.57

FV = 1000

PMT = 0

N = 5

I/Y = 7.57

PV = 694.34

Capital gain = 694.34 – 645.48= 48.86

PTS: 1 DIF: M

REF: 4.4 Bond Markets NAT: Analytic skills

LOC: understand shares and bonds

14. If the real return is 8% and the expected rate of inflation is 3.5%, what is the nominal rate?

(1.08) x (1.035) = 1+r , r = 1.1178-1, r = 0.1178

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

15. A one-year bond offers a yield of 5% and a two-year bond offers a yield of 4.5%. Under the expectations theory what should be the yield on a one-year bond next year?

(1.045)² = (1.05)(1 + r)

r = 0.0400

PTS: 1 DIF: M

REF: 4.5 The Term Structure of Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

16. A two-year bond offers a yield of 5% and a three-year bond offers a yield of 4.5%. Under the expectations theory what should be the yield on a one-year bond in two years?

(1.045)³ = (1.05)² × (1 + r)

r = 0.0351

PTS: 1 DIF: H

REF: 4.5 The Term Structure of Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

17. You are looking up bond prices and find the following quote for a $1000 face value Treasury bond: 103:26. What is the price of this bond?

103:26 = 103.8125

1000(1.038125) = 1038.13

PTS: 1 DIF: M

REF: 4.4 Bond Markets NAT: Analytic skills

LOC: understand shares and bonds

18. McLaughlin Enterprises has an outstanding $1000 par value bond with a 12% coupon that pays at the end of each year. The bond matures in eight years. Bonds of similar risk have a required return of 9%. What is the market value of the McLaughlin bond?

FV = 1000

N =8

I/YR = 9

PMT = 0.12 x 1000 = 120

PV = 1166.04

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

19. Winburn Sports & Entertainment has an outstanding $1000 par value bond with a 12% coupon that pays semiannually at the end of each period. The bond matures in nine years. Bonds of similar risk have a required return of 9%. What is the market value of the Winburn bond?

P/YR = 2

FV = 1000

N = 18

I/YR = 9

PMT = (0.12*1000)/2 = 60

PV = 1195.70

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

20. A 10-year Treasury bond with par value of $1000 has a 6% coupon rate and pays interest every six months. The bond is three years old and has just made its sixth payment. The market now only requires a 5% return on the bond. What is the expected price of the bond?

P/YR = 2

FV = 1000

N = 14

I/YR = 5

PMT = 30

PV = 1058.45

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

21. A $1000 par value bond that makes annual interest payments of $70 and matures in six years sells for $950. What is the yield to maturity of the bond?

FV = 1 000

N =6

PMT = 70

PV = 950

I/YR = 8.08

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

22. Alexis Media issued five-year bonds one year ago with a 7.5% coupon that pays semiannually (the bonds just paid the second coupon payment). Alexis has revised its advertising revenue forecast, and it is quite bleak compared with the prevailing forecast at the time of the bond issuance. Investors now require a 9% return on Alexis bonds. What is the percentage change in price of the bonds associated with the change in business conditions?

P/YR = 2

FV = 1000

N = 8

I/YR = 9

PMT = 37.50

PV = 950.53

(950.53 – 1000)/1000 = –4.95%

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

23. A new one-year bond pays interest of 1.04%. A new two-year bond pays interest of 1.46%. Using the expectations theory of term structure and assuming the market is in equilibrium, what interest rate does the market expect a new one-year bond to have one year from now?

1.0146²/1.0104 – 1 = 0.0188

PTS: 1 DIF: E

REF: 4.5 The Term Structure of Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

24. The value of any asset:

REF: 4.1 Valuation Basics NAT: Reflective thinking

LOC: understand shares and bonds

25. The greater the uncertainty about an asset’s future benefits:

REF: 4.1 Valuation Basics NAT: Reflective thinking

LOC: acquire an understanding of risk and return

26. You will be receiving $204 000.00 at the end of each year for the next 20 years. If the correct discount rate for such a stream of cash flows is 10%, then what is the present value of the cash flows?

204 000 × (1/0.1) – [(1/0.1) × (1.1)²⁰] = 1 736 767.00

PTS: 1 DIF: E

REF: 4.1 Valuation Basics NAT: Analytic skills

LOC: understand the time value of money

27. WeOweYou, Inc. has a 12-year bond outstanding that makes 9.5% annual coupon payments. If the appropriate discount rate for such a bond is 7%, what the appropriate price for the bond?

95 × {(1/0.07) – [(1/0.07) × (1.07)^–12]} + 1000(1.07)^–12 = 1198.57

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

28. Astro Investors is interested in purchasing the bonds of the Jetson Company. Jetson’s bonds are currently priced at $1100.00 and have 14.5 years to maturity. If the bonds have a 6% coupon rate, what is the yield to maturity of these semiannual coupon paying bonds?

30 × {(1/y) – [(1/y) × (1+ y)^–29] } + 1000(1 + y)^–29 = 1100.00

y = 0.0251 ===> 2 × y = 5.02%

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

29. Elroy Investors is interested in purchasing the bonds of the Judy Company. Judy’s bonds are currently priced at $1100.00 and have 14 years to maturity. If the bonds have a 6% coupon rate, what is the yield to maturity of these annual coupon paying bonds?

60 × {(1/y) – [(1/y) × (1 + y)^–14]} + 1000(1 + y)^–14 = 1100.00

y = 4.99%

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

30. You earned a 13% return on an investment during the preceding year. If the rate of inflation during that period is 8%, what was your real return during that period?

[(1.13/1.08) – 1] = 0.0463

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

31. You are considering the purchase of a motorised scooter where the price of the scooter is based upon the kilometres per litre (km/L) of petrol that the scooter can achieve. That is, the current price of the scooter you want is $1000 because the scooter can achieve 100 km/L and the cost per litre is $10. Right before you are about to purchase the scooter, your best friend asks you loan him $1000 for one year. You make the loan in order to be able to buy a 105 km/L scooter at the conclusion of the loan. If you anticipate that the cost per litre will increase to $11, what rate of interest should you charge your friend?

Real rate = 5%, Inflation rate = 10% ===> [(1.05) × (1.1)] – 1 = 0.155

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand the time value of money

32. Unsecured bonds that have legal claims inferior to other outstanding bonds are:

REF: 4.2 Bond Prices and Interest Rates NAT: Reflective thinking

LOC: understand shares and bonds

33. With respect to the company that has issued a callable bond, the value of the call increases as:

REF: 4.2 Bond Prices and Interest Rates NAT: Reflective thinking

LOC: understand shares and bonds

34. With respect to the owner of a putable bond, the value of the put increases as:

REF: 4.2 Bond Prices and Interest Rates NAT: Reflective thinking

LOC: understand shares and bonds

35. You notice that the price of a 4.0% coupon, 12-year Treasury bond is priced at 90:16. What is the bond’s yield to maturity?

90:16 = 90 + 16/32 = 90.5 ===> $905

20 × {(1/y) – [(1/y) × (1 + y)^–24]} + 1000(1 + y)^–24 = 905

y = 0.02535 ===> 2 × y = 5.07%

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

36. You read in the financial press that a company’s Moody’s debt rating is one step above junk. What is the rating?

REF: 4.4 Bond Markets NAT: Reflective thinking

LOC: understand shares and bonds

37. The relationship between time to maturity and yield to maturity for bonds of equal risk is referred to as:

REF: 4.5 The Term Structure of Interest Rates NAT: Reflective thinking

LOC: acquire knowledge of financial markets and interest rates

38. You find that the yield on a four-year bond is 10% while that of a two-year bond is 8%. What should be the yield on a two-year bond beginning two years from now as predicted by the expectations theory?

(1.1)⁴ = (1.08)² × (1 + r)² ===> (1.1)⁴/(1.08)² = (1 + r)² ===> r = 0.1204

PTS: 1 DIF: M

REF: 4.5 The Term Structure of Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

39. You find that the yield on a six-year bond is 12% while that of a four-year bond is 9%. What should be the yield on a two-year bond beginning four years from now as predicted by the expectations theory?

(1.12)⁶ = (1.09)⁴ × (1 + r)² ===> (1.12)⁶/(1.09)⁴ = (1 + r)² ===> r = 0.1825

PTS: 1 DIF: H

REF: 4.5 The Term Structure of Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

40. You find that the yield on a four-year bond is 9% while the yield on a two-year bond beginning four years from now is 10%. What should be the yield on a six-year bond as predicted by the expectations theory?

(1 + r)⁶ = (1.09)⁴ × (1.1)² ===> (1 + r)⁶ = (1.7080137)⁶ ===> r = 0.0933

PTS: 1 DIF: M

REF: 4.5 The Term Structure of Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

41. If you were trying to describe the effect on the yield curve that certain investors have a definite preference for the maturity of the bonds that they invest in, then you would be referring to:

REF: 4.5 The Term Structure of Interest Rates NAT: Reflective thinking

LOC: acquire knowledge of financial markets and interest rates

42. Fence Place Diary Company (FPD) has a 15-year maturity bond outstanding that is currently convertible into 50 shares of FPD ordinary shares. FPD ordinary shares currently sell for $25 a share and the coupon rate (semiannual coupons) for the bond is 5%. If the yield on a similarly rated convertible bond (on the New York Calendar Corp.) is 5%, then what should be the correct price of the FPD convertible bond?

Conversion price = 50 × 25 = 1250

Pure bond price = Coupon rate = Yield ===> 1000

Max(1000, 1250) = 1250

PTS: 1 DIF: M

REF: 4.3 Types of Bonds NAT: Analytic skills

LOC: understand shares and bonds

43. You own a bond that pays a 12% annualised semiannual coupon rate. The bond has 10 years to maturity. If the discount rate suddenly moves from 14% to 16%, then what is the bond’s change in dollar value?

Price before shift = 60PVIFA(20,7%) + 1000PVIF(20,7%) = 894.06

Price after shift = 60PVIFA(20,8%) + 1000PVIF(20,8%) = 803.64

Difference = Price after shift – Price before shift = 803.64 – 894.06 = –90.42

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

44. You own a bond that pays a 12% annualised semiannual coupon rate and has 10 years to maturity. If the discount rate increases from 14% to 16% during the next two years of the bonds life, then what is the bond’s change in dollar value during the two-year period?

Price before = 60PVIFA(20,7%) + 1000PVIF(20,7%) = 894.06

Price after two years = 60PVIFA(16,8%) + 1000PVIF(16,8%) = 822.97

Difference = Price after two years – Price before = 822.97 – 894.06 = –71.09

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

45. Oogle Corp. has decided to do things differently with respect to its corporate bond issue. It has a bond outstanding that makes quarterly coupon payments instead of semiannually. The stated coupon rate on the bond is 10%, and the yield to maturity on the five-year bond is 12%. What is the price of the bond?

Price = 25PVIFA(20,3%) + 1000PVIF(20,3%) = 925.61

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

46. If investment A and investment B have identical cash flows, why would an investor pay more for investment A than investment B?

REF: 4.1 Valuation Basics NAT: Reflective thinking

LOC: acquire an understanding of risk and return

47. A bond pays an annual coupon rate of 8% with a face value of $1000. The bond is scheduled to mature in two years and currently trades at $960.00. What is the coupon yield of the bond currently?

0.08 × 1000/960= 0.0833

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

48. Consider the following details for a bond issued by Bravo Incorporated.

If today’s date is 8 May 2004, what should the current trading price be for this bond if investors want a 12% annual return?

N = 26

r = 12%

PMT = 9% × 1000

FV = 1000

PV = 763.13

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

49. Consider the following details for a bond issued by Bravo Incorporated.

If today’s date is 8 May 2004, what should the current trading price by for this bond if investors want a 12% annual return?

N = 52

r = 6%

PMT = 9% × 1000/2

FV = 1000

PV = 762.08

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

50. Which answer is false regarding bond prices and interest rates?

REF: 4.2 Bond Prices and Interest Rates NAT: Reflective thinking

LOC: understand shares and bonds

51. A bond is priced such that it has a 9% yield to maturity. However, inflation is expected to be 2% per year over the remaining life of the bond. What is the real return for this investment?

1 + Real return = (1.09)/(1.02)

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

52. The Treasury Department sells a zero-coupon bond that will mature in two years. The bond has a face value of $10 000, and sold at auction for $9400. What is the annual return for an investor buying the bond?

N = 2

PV = –9400

PMT = 0

FV = 10 000

r = YTM = 3.14%

PTS: 1 DIF: M

REF: 4.3 Types of Bonds NAT: Analytic skills

LOC: acquire an understanding of risk and return

53. A bond is trading on the secondary market and will mature in 10 years. The bond has a face value of $1000 that will be paid at maturity. Furthermore, the bond pays an annual coupon at 8% of face value. What should the trading price be for the bond if investors seek a 11% on their investment?

N = 10

r = 11%

PMT = 8% ×1000 = 80

FV = 1000

PV = 823.32

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

54. A bond currently trades at $935 on the secondary market. The bond has 10 years until maturity and pays an annual coupon at 8% of face value. The face value of the bond is $1000. What is the yield to maturity for this bond?

N = 10

PV = –-935

PMT = 0.08x1000= 80

FV = 1000

r = YTM = 9.01%

PTS: 1 DIF: E

REF: 4.4 Bond Markets NAT: Analytic skills

LOC: understand shares and bonds

55. A bond currently trades at $980 on the secondary market. The bond has 10 years until maturity and pays a semiannual coupon at 9% APR of face value. The face value of the bond is $1000. What is the yield to maturity for this bond?

N = 20

PV = –980

PMT = 9% × 1000/2

FV = 1000

r = YTM/2 = 4.656%

YTM = 4.656% × 2 = 9.31%

PTS: 1 DIF: H

REF: 4.4 Bond Markets NAT: Analytic skills

LOC: understand shares and bonds

Use the following information to answer questions 56 and 57.

In the finance section of your local paper, you see the following bond quotation:

56. What is the current ask yield of the Big City bond? Assume that it is currently August 2017.

N = 8

PV = –$1 042.50

PMT = 70

FV = 1000

r = 6.31%

PTS: 1 DIF: H

REF: 4.4 Bond Markets NAT: Analytic skills

LOC: understand shares and bonds

57. What is the current coupon yield of the Big City bond? Assume that it is currently August 2017.

70/1042.50 = 0.0671

PTS: 1 DIF: H

REF: 4.4 Bond Markets NAT: Analytic skills

LOC: understand shares and bonds

58. What is the minimum rating required for a bond to be considered investment grade?

REF: 4.4 Bond Markets NAT: Reflective thinking

LOC: understand shares and bonds

59. Your friend wants you to invest in his new sporting goods store. For an initial investment, he will pay you $2000 per year for the next 20 years. All payments are at the end of the year. You realise that this is a very risky investment and want a 20% return on each invested dollar. How much are you willing to loan him today for his new store?

N = 20

r = 20%

PMT = 2000

FV = 0

PV = 9739

PTS: 1 DIF: M

REF: 4.1 Valuation Basics NAT: Analytic skills

LOC: understand the time value of money

60. A $1000 par value bond makes two coupon payments per year of $70 each. What is the bond’s yield to maturity if the bond currently trades at $1250 and will mature in two years?

N = 4

PV = -1250–FV = 1000

PMT = -70

r = 0. 648%

YTM =1.29%

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

61. A one-year Treasury bond currently returns a 4.50% yield to maturity. A two-year Treasury bond offers a 4.80% yield to maturity. If the expectations hypothesis is true, what is the expected return on a one-year security next year?

(1.045) × (1 + x) = (1.048) × (1.048)

x = 0.0510

PTS: 1 DIF: H

REF: 4.5 The Term Structure of Interest Rates NAT: Analytic skills

LOC: acquire knowledge of financial markets and interest rates

62. A floating-rate bond issued by the Treasury Department was issued with an annual coupon of 5%. The bond has a par value of $1000 and will mature in 10 years. If inflation during the first year of the bond’s life were 3%, what would be the new coupon payment for this bond?

0.05 × 1000 = 50

50 × (1 + 0.03) = 51.50

PTS: 1 DIF: M

REF: 4.3 Types of Bonds NAT: Analytic skills

LOC: understand shares and bonds

63. Suppose you have a chance to buy a Treasury bond. The bond issued by the Australian government has a 7% coupon rate (face value of $1000). You will receive the coupon in one year and have a discount rate of 11%. What is the price you are willing to pay for this bond?

0.07 × 1000 = 70

PV = 70/1.11 = 63.06

PTS: 1 DIF: E

REF: 4.3 Types of Bonds NAT: Analytic skills

LOC: understand shares and bonds

Use the following information to answer questions 64 and 65.

On 4 October 2000, the telecom EarthCOM issued bonds to finance a new wireless product. The bonds were issued for 30 years (mature on 4 October 2030), with a face value of $1000, and semiannual coupons. The coupon rate on these bonds is 8% APR. Over the last four years, the company has experienced financial difficulty as the market has grown more competitive.

64. The risk associated with EarthCOM bonds has increased dramatically, as investors now want a 15% APR return to hold the bonds. At what price should the bonds trade today (4 October 2004)?

N = 26

r = 7.50%

PMT = 8% × 1000/2 = 40

FV = 1000

PV = 544.19

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

65. Today (4 October 2002), EarthCOM admitted to fraud in reporting revenues over the last three years. The price of EarthCOM immediately tumbled to $500. What is the new yield to maturity on EarthCOM bonds? (Express as an APR.)

N = 52

PV = –500

PMT = 8% × 1000/2 = $40

FV = 1000

r = YTM/2 = 8.104%

YTM = 16.21%

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

66. Which of these statements is/are correct?

REF: 4.2 Bond Prices and Interest Rates NAT: Reflective thinking

LOC: understand shares and bonds

67. A bond pays $60 interest payments twice a year. What is the coupon rate for the bond if the par value of the bond is $1000?

60 × 2 = 120

120/1000 = 0.12

PTS: 1 DIF: E

REF: 4.1 Valuation Basics NAT: Analytic skills

LOC: understand shares and bonds

68. Assuming a 28% lender’s affordability ratio, estimated monthly property taxes and insurance of $250, a 25% down payment (of the purchase price), and an annual gross income of $84 800, calculate the maximum purchase price of a property based on monthly income. The monthly payment will occur at the end of the month and you plan to pay off the mortgage over a 30-year period at a 6.25% annual interest rate.

84 800/12 = 7067 × 0.28 = 1978.67

1978.67 – 250 = 1728.67

Maximum mortgage:

N = 360

i = 6.25/12

PMT = 1728.67

FV = 0

PV = 280 757

x(0.75) = 280 757

x = 374 343

PTS: 1 DIF: H

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand the time value of money

69. Which of the following statements is true?

REF: 4.2 Bond Prices and Interest Rates NAT: Reflective thinking

LOC: understand shares and bonds

70. Yield spreads are quoted in terms of basis points. Which of the following is true for basis points?

REF: 4.4 Bond Markets NAT: Reflective thinking

LOC: understand shares and bonds

71. Roxy bonds have 14 years to maturity, with a coupon rate of 8%, paid annually. If the appropriate discount rate is 8%, what is the current value of Roxy bonds?

N = 14

I/Y = 8

CR × 1000 = PMT = 80

FV = 1000

PV = 1000

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

72. Louis bonds have 14 years to maturity, with a coupon rate of 8%, paid annually. If the appropriate discount rate is 12%, what is the current value of Louis bonds?

N = 14

I/Y = 12

CR × 1000 = PMT = 80

FV = 1000

PV = 734.87

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

73. Roxy bonds have 15 years to maturity, with a coupon rate of 4%, paid annually. If the bonds sell for $800, what is the yield to maturity of Roxy bonds?

N = 15

CR × 1000 = PMT = 40

FV = 1000

PV = 800

I/Y = YTM = 6.07

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

74. Emma bonds have 12 years to maturity, with a coupon rate of 9%, paid annually. If the bonds sell for $1050, what is the yield to maturity of Emma bonds?

N = 12

CR × 1000 = PMT = 90

FV = 1000

PV = 1050

I/Y = YTM = 8.33

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

75. Louis bonds have 14 years to maturity, with a coupon rate of 8%, paid annually. If the appropriate discount rate is 12%, what is the current yield of Louis bonds?

N = 14

I/Y = 12

CR × 1000 = PMT = 80

FV = 1000

PV = 734.87

CY = 80/734.87 = 10.84%

PTS: 1 DIF: M

REF: 4.4 Bond Markets NAT: Analytic skills

LOC: understand shares and bonds

76. Emma bonds will mature in eight years; the coupon rate of the bond is 6% paid semiannually. If the appropriate discount rate is 4%, what is the value of the bond?

N = 8 × 2 = 16

CR = 0.06/2 × 1000 = 30 = PMT

FV = 1000

I/Y = 4/2 = 2.0

PV = 1135.78

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

77. Emma bonds will mature in 8 years; the coupon rate of the bond is 6% paid semiannually. If bonds currently sell for $820, what is the bond’s yield to maturity?

N = 8 × 2 = 16

CR = 0.06/2 × 1000 = 30 = PMT

FV = 1000

PV = 820

I/Y = 4.61 × 2 = 9.23

PTS: 1 DIF: M

REF: 4.2 Bond Prices and Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

78. Roxy bonds will mature in 16 years; the coupon rate of the bond is 6% paid semiannually. If bonds currently sell for $1200, what is the bond’s current yield?

60/1200 = 0.05

PTS: 1 DIF: E

REF: 4.4 Bond Markets NAT: Analytic skills

LOC: understand shares and bonds

79. If a zero-coupon bond has a yield to maturity of 5%, what is the bond’s taxable capital gain in the last year of the bonds existence?

1000/1.05 = 952.38

1000 – 952.38 = 47.61

PTS: 1 DIF: M

REF: 4.3 Types of Bonds NAT: Analytic skills

LOC: understand shares and bonds

80. If a zero-coupon bond has a yield to maturity of 8%, what is the bond’s taxable capital gain in the last year of the bonds existence?

1000/1.08 = 925.25

1000 – 925.25 = 74.07

PTS: 1 DIF: M

REF: 4.3 Types of Bonds NAT: Analytic skills

LOC: understand shares and bonds

81. If a Treasury bond that matures in one year has a yield of 3% and another Treasury bond that matures in two years has a yield of 7%, what is the expected one-year rate one year from now?

(1.07)² = (1.03)(1 + x) 

x = 11.16

PTS: 1 DIF: M

REF: 4.5 The Term Structure of Interest Rates NAT: Analysis

LOC: understand shares and bonds

82. If a Treasury bond that matures in 5 years has a yield of 6% and another Treasury bond that matures in three years has a yield of 4%, what is the expected two-year rate three years from now?

(1.06)⁵ = (1.04)³ × (1 + x)²

x = 9.07

PTS: 1 DIF: H

REF: 4.5 The Term Structure of Interest Rates NAT: Analytic skills

LOC: understand shares and bonds

SHORT ANSWER

1. When a bond’s market price is trading for less than its face value, is this a premium or discount bond?

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates

2. What is interest rate risk?

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates

3. When a bond price increases, does the interest rate move in the same direction?

PTS: 1 DIF: E

REF: 4.2 Bond Prices and Interest Rates

4. What is a yield spread?

PTS: 1 DIF: E

REF: 4.4 Bond Markets

5. Explain the meaning of the ‘term structure of interest rates’.

PTS: 1 DIF: E

REF: 4.5 The Term Structure of Interest Rates

6. Briefly explain the notion of a coupon yield.

PTS:1 DIF: E

REF: 4.2 Bond prices and interest rates