FIN4300 Ch 7 Smartbook

At what tax rate will an investor be indifferent between a 4.2 percent municipal bond and a 7 percent corporate bond?

40 percent Rationale: 0.07 = 0.042/(1 - Tax rate); Tax rate = 40%

Which one of the following bonds is subject to the least interest rate risk?

5-year, 5 percent coupon Rationale: The longer the term and the lower the coupon rate, the greater the interest rate risk.

A corporate bond pays $45 in interest every six months and matures in 11 years. What is the yield to maturity if the bond currently sells for $1,213?

6.29 percent Rationale: N = 22; PV = -1,213; PMT = 45; FV = 1,000; CPT I, I = 3.144, which is the semiannual rate Yield to maturity = 2 × 3.144% = 6.29%

You purchased a $5,000 face value corporate bond today at an asked bid of 98.76. The bond matures in 7.5 years and carries a 7 percent coupon. What annual rate of return will you earn if you hold the bond until maturity?

7.22 percent Rationale: Using a financial calculator: N = 15; PV = -4,938; PMT = 175; FV = 5,000; CPT I; I = 3.61, which is the semiannual rate Yield to maturity = 2 × 3.61% = 7.22%

A 7.5 percent corporate bond matures in 16 years and has a price quote of 102.3. What is the yield to maturity?

7.2547 percent Rationale: N = 32; PV = -1,023; PMT = 37.50; FV = 1,000; CPT I; I = 3.62735, which is the semiannual rate. YTM = 2 × 3.62735% = 7.2547%

At what tax rate will an investor begin to prefer the 5.2% municipal bond over the 8% corporate bond?

> 35% Rationale: 0.08 = 0.052/(1 - Tax rate); Tax rate > 35%

Which one of these is the best description of a 5-year zero coupon bond?

A bond with a current value equal to its discounted par value

What is an indenture agreement?

A legal contract between the issuer and the bondholders

What is a zero coupon bond?

A zero coupon bond is sold at a steep discount and pays no semiannual interest payments.

A corporate bond matures in 11 years and carries a 6 percent coupon. Which of these represent correct calculator input for computing the bond's current value at a discount rate of 5 percent? Select all that apply.

FV = 1,000; PMT = 30 N = 22

Interest rate risk is only a concern when market interest rates decline.

False

What is interest rate risk?

Interest rate risk is the chance that a bond's value will decline due to a rise in market interest rates.

Which one of these characteristics fits the definition of an agency bond?

Issued to support a sector of the U. S. economy

Which one of these characteristics fits the definition of an agency board?

Issued to support a sector of the U.S. economy

Which one of these characteristics fits the definition of an agency bond?

Issued to support a sector of the U.S. economy

One type of high-yield bond is a fallen angel. How is this type of bond defined?

Junk bond that was originally issued as a investment as an investment-grade bond.

Speculative bonds are frequently referred to as which type of bonds?

Junk bonds

Which one of these characteristics designates a premium bond?

Market price exceeds par value

Which one of these formulas correctly computes the equivalent taxable yield?

Muni yield/(1 - Tax rate)

You want to compute the value of a 5-year zero-coupon corporate bond given a market rate of 5.5 percent. Which of these represent correct calculator inputs? Select all that apply.

N = 10 Rationale: Zero-coupon bonds are priced using semiannual compounding. N = 5 × 2 = 10 FV = 1,000 Rationale: The assumed par value of a corporate bond is $1,000.

You want to calculate the current value of a 7-year, 6 percent coupon, corporate bond given the current discount rate of 8 percent. Which one of these is correct given the present value formula for a bond?

N = 14 Rationale: Since the interest payments are assumed to be paid semiannually, the problem is solved using semiannual time periods. N = 7 × 2 = 14

Where does the majority of trading volume in bonds in the secondary markets occur?

Over-the-counter

Which one of these represents correct calculator input for computing the current value of a 5 percent coupon compounded semi-annually? The corporate bond matures in 12.5 years. The current discount rate is 6.5 percent. Assume the face value of the bond as $1,000.

PMT = 25 Rationale: PMT = (0.05/2) × $1,000 = $25

Which one of these is the correct formula for computing the current value of a $1,000, 10-year, zero coupon bond if the discount rate is 8 percent?

PV = $1,000/[1 + (0.08/2)]^20

For a typical corporate bond, which one of these applies to the calculation of the bond's yield to maturity? Assume the PMT is input as a positive amount.

PV = -(Current bond price) Rationale: The PV represents cash flowing in the opposite direction of the PMT.

True or false: The financial status of the issuer will affect the coupon rate that issuer pays on its bonds.

True Rationale: The financial status of an issuer does affect the coupon rate on the issuer's bonds.

True or false: When computing the present value of a bond, both the par value and the interest payment amount are input as positive values in a financial calculator.

True Rationale: The interest payments and par value, or maturity value, are considered to be cash inflows and are input as positive values.

Which one of the following types of bonds is used to implement national monetary policy?

U. S. Treasury bonds

Which one of the following types of bonds is used to finance projects such as public buildings, schools and roads?

U.S. Treasury Bills

Which one of these descriptions defines a Treasury inflation- protection security (TIPS)

U.S. government bond with an inflation-adjusted par value and varying interest payments.

Which one of the following should be used to compare various corporate bonds if you plan to purchase a bond today, hold it until maturity, and want to select the bond with the highest rate of return?

Yield to maturity Rationale: The yield to maturity is the annual return that will be earned if a bond is purchased at the current price and held until maturity.

An investor buy bonds at the _______ price and sells them at the _____ price.

ask;bid

The interest and par value payments of mortgage-backed securities originate from ______.

real estate mortgage payments

A TIPS was issued with a par value of $1,000, a coupon rate of 2.5 percent, and a reference CPI of 204.89. Which one of these is the correct calculation of the current interest payment if the CPI is now 205.44?

$1,000 × (205.44/204.89) × (0.025/2) Rationale: Current interest payment = $1,000 × (205.44/204.89) × (0.025/2)

What is the current face value of a $1,000 Treasury inflation-protected security if the reference CPI is 203.19 and the current CPI is 205.47? The coupon rate is 3 percent and the bond was issued two years ago.

$1,011.22 Rationale: Price = $1,000 × (205.47/203.19) = $1,011.22

Sue purchased a 3.5 percent, $100,000 U. S. Treasury bond 6 months ago when the bid quote was 124.1850 and the asked quote was 124.2025. Today, she sold that bond when the bid quote was 124.2175 and the asked quote was 124.2225. What was her total dollar return on this investment?

$1,765.00 Rationale: Interest = [(0.035/2) × $100,000 = $1,750; Total return = [(124.2175% - 124.2025%) × $100,000] + $1,750 = $1,765

Sue purchased a 3.5 percent, $100,000 U. S. Treasury bond 6 months ago when the bid quote was 124.1850 and the asked quote was 124.2025. Today, she sold that bond when the bid quote was 124.2175 and the asked quote was 124.2225. What was her total dollar return on this investment?

$1,765.00 Rationale: Interest = [(0.035/2) × $100,000] = $1,750; Total return = [(124.2175% - 124.2025%) × $100,000] + $1,750 = $1,765

What is the price of a $100,000 par value U. S. Treasury security if the price quote is 102.1446?

$102,144.60 Rationale: 102.1446% × $100,000 = $102,144.60

What is the price of a $100,000 par value U. S. Treasury security if the price quote is 102.1446?

$102,144.60 Rationale: 102.1446% ×$100,000 = $102,144.60

A TIPS was issued with a face value of $5,000, a coupon rate of 3 percent, and a reference CPI of 201.42. The current CPI is 203.14. What is the current interest payment?

$75.64 Rationale: Current interest payment = $5,000 × (203.14/201.42) × (0.03/2) = $75.64

A corporate bond matures in 14.5 years and pays a 6.75 percent coupon. What is its current value if the market rate of interest is 7.5 percent?

$934.38 Rationale: PV = [(0.0675/2) × $1,000] × {1−1[1+(0.075/2)](14.5×2)0.075/2}1-1[1+(0.075/2)](14.5×2)0.075/2 + $1,000[1+(0.075/2)](14.5×2)$1,000[1+(0.075/2)](14.5×2) = $590.55 + $343.83 = $934.38

A $1,000 corporate bond has an asked price of 97.82 and a bid price of 97.81. What price will you receive if you sell this bond now

$978.10 Rationale: You sell at the bid and buy at the asked. Selling price = 97.81% of $1,000 = $978.10

How much will you pay to purchase a $100,000 U. S. Treasury bond that is quoted at 99.6250

$99,625.00 Rationale: 99.6250% × $100,000 = $99,625.00

How much will you pay to purchase a $100,000 U. S. Treasury bond that is quoted at 99.6250?

$99,625.00 Rationale: 99.6250% × $100,000 = $99,625.00

Sue purchased a 2%, $100,000 U. S. Treasury bond 1 year ago when the bid quote was 104.1850 and the asked quote was 104.2225. Today, she sold that bond when the bid quote was 103.2175 and the asked quote was 103.2275. What was her total dollar return on this investment?

$995 Rationale: Interest = [(0.02) × $100,000] = $2,000; Total return = [(103.2175% - 104.2225%) × $100,000] + $2,000 = $995

Which of these statements is correct? Select all that apply.

- A Treasury bond should have a higher yield to maturity than a comparable muni bond. Rationale: Muni bonds receive preferential tax treatment and thus have lower yields. - If the market interest rate rises, bond prices will fall, and yields to maturity will rise. Rationale: Market interest rates and bond prices are inversely related. Bond prices and yields to maturity are also inversely related. Thus, market interest rates and yields to maturity are directly related.

Which of these statements correctly applies to the NYSE bond market?

- Corporate bonds are the primary source of bond trading volume on the NYSE Rationale: The majority of the bond trading volume on the NYSE is in corporate debt. - The NYSE operates the largest centralized U.S. bond market Rationale: The NYSE does operate the largest centralized U. S. bond market. However, the majority of bond trading volume occurs in the decentralized, over-the-counter markets.

Which of the following are commonly included in an indenture agreement?

- Coupon rate - Call premium - Par value

Which of the following are commonly included in a indenture agreement?

- Coupon rate - Call premium - Par value

The market rate of interest that is used to compute the present value of a bond is affected which of the following?

- Credit quality of the bond - Tax status of the bond

The market rate of interest that is used to compute the present value of bond is affected by which of the following ?

- Credit quality of the bond - Tax status of the bond

The market rate of interest that is used to compute the present value of a bond is affected by which of the following?

- Credit quality of the bond - Tax status of the bond.

Which of the following are classified as asset-backed securities?

- Debt security with payments originating from a pool of auto loans - Security repaid from a group of credit card loans - Mortgage-backed security

Which of the following affect the coupon rate a firm must set on its bonds if the bonds are to be sold at par? Select all that apply.

- Default risk - Market rates of interest - Bond term

Which of these are basic assumptions that should be used when valuing a corporate coupon bond unless the problem states otherwise?

- Face value= $1,000 - Semiannual interest payments

Which of the following are sources of information on the bond markets? Select all that apply.

- Internet Rationale: This is a source of bond information. - The Wall Street Journal Rationale: This is a source of bond information. - Merrill Lynch Rationale: This is a source of bond information.

Which of the following apply to high-yield bonds?

- Low quality Rationale: High-yield bonds are low--quality, high-risk bonds. The higher yields compensate bondholders for accepting the higher risks. - Increased credit risk Rationale: High-yield bonds are low-quality, high-risk bonds. The higher yields compensate bondholders for accepting the higher risks.

Which of these characteristics apply to a discount bond?

- Market price is less than the principal amount of the loan - Selling for less than face value

Which of these characteristics apply to discount bond?

- Market price is less than the principal amount of the loan - Selling for less than face value

For a typical bond, which of the following values are expressed in semiannual terms when computing the yield to maturity?

- Number of the period, N - Discount rate, or rate of return, I - Interest payments, PMT

Which of the following may be financed with corporate bonds?

- Plants and equipment - Research and development -Inventory

Which of these are common features of a corporate bond? Select all that apply.

- Publicly traded debt security - Semi-annual interest payments - Face value of $1,000

Which of the following securities pay income which is exempt from federal income taxes?

- State bond to build a highway - County bond to build a school

How does the yield to call differ from the yield to maturity for the same bond? Select all that apply.

- The call price used in the yield to call usually exceeds the face value used in the yield to maturity. Rationale: The call price equals the face value plus the call premium. - There are fewer time periods in the yield to call. Rationale: Bonds are called prior to maturity, so there are less time periods when computing a yield to call as compared to a yield to maturity.

Which of the following correctly explains how a factor affects interest rate risk? Select all that apply.

- The longer the term to maturity, the greater the interest rate risk will be. - The lower the coupon rate, the greater the interest rate risk will be.

Which of the following correctly explains how a factor interest rate risk?

- The lower the coupon rate, the greater the interest rate will be. - The longer the term to maturity, the greater the interest rate risk will be.

Corporate bond A has a 6 percent coupon and matures in 3 years. Corporate bond B has a 6 percent coupon and matures in 15 years. The current interest rate is 6 percent. By how much will Bond A and Bond B change in price if the market rate increases to 6.5 percent? Assume both bonds are currently selling at par which is $1,000.

-$13.43; -$47.45 Rationale: Both bonds are currently selling at par, which is $1,000. At 6.5 percent: Bond A: N = 6; I = 3.25; PMT = 30; FV = 1,000; CPT PV; PV = 986.57 Bond B: N = 30; I = 3.25; PMT = 30; FV = 1,000; CPT PV; PV = 952.55 Bond B decreases more since it is the longer-term bond.

Willis purchased a 5 percent, $3,000 corporate bond when the asked quote was 101.16 and the bid quote was 101.15. He sold the bond when the asked quote was 101.08 and the bid quote was 101.06. What was his capital gain/loss?

-$3.00 Rationale: Capital loss = (101.06% of $3,000) - (101.16% of $3,000) = $3,031.80 - $3,034.80 = -$3

Franco purchased a $10,000 bond at a price quote of 100.23 and sold it at a price quote of 99.87. What is his capital gain/loss?

-$36 Rationale: Capital loss = (99.87% - 100.23%) × $10,000 = -0.36% × $100,000 = -$36

Assume a corporate bond pays a 5 percent coupon and matures in ten years. What will be the change in the current price of this bond if market interest rates increase from 5 to 5.5 percent?

-$38.07 Rationale: When the coupon rate matches the market rate, a bond sells at par, which is assumed to be $1,000. Using a financial calculator, the price at 5.5 percent is: N = 20; I = 2.75; PMT = 25; FV = 1,000, CPT PV; PV = -961.93 Change in price = $961.93 - $1,000 = -$38.07

Which of the following securities pay income which is exempt from federal income taxes? Select all that apply.

-County bond to build a school -State bond to build a highway

A bond has a par value of $1,000, a call premium of one year's interest, a call provision after 5 years, a coupon rate of 5 percent, semiannual interest payments, and a maturity of 20 years. Which of these is (are) correct? Select all that apply.

-Each interest payment will be $25. -The bond can be paid off in year 6 for a price of $1,050 plus any unpaid interest.

Which of these characteristics apply to a discount bond? Select all that apply.

-Selling for less than face value Rationale: Discount bonds sell for less than face, or par value. -Market price is less than the principal amount of the loan Rationale: Discount bonds sell for less than face value, also called par value, or the principal amount.

Which of the following securities pay income which is exempt from federal income taxes

-State bond to build a highway -County bond to build a school

A 20-year corporate bond is callable beginning in year 7 at a premium of $100. The coupon rate is 6 percent and the market rate is 5.5 percent. What is wrong with the following computation? Select all that apply.

-The call price should be $1,100. Rationale: The call price must include the call premium. Call price = Face value + Call premium = $1,000 + $100 = $1,100 -The interest rate, i, should be 0.0275 in three places. Rationale: The interest rate, i, should be 0.055/2 = 0.0275, as that is the semiannual discount rate.

A 10-year Treasury bond has a 4 percent coupon and a yield to maturity of 4.62 percent. A 10-year, A-rated corporate bond has a 4.5 percent coupon and a yield to maturity of 5.98 percent. What is the yield spread between these two bonds?

1.36 percent Rationale: Spread = 5.98% - 4.62% = 1.36%

What is the shortest maturity for a newly issued U. S. Treasury bond?

10 years

What is the shortest maturity for a newly issued U. S. Treasury bond

10 years Rationale: Treasury bonds are issued with maturities ranging from 10 to 30 years.

Which one of the following bonds is subject to the greatest interest rate risk?

10-year, zero coupon Rationale: The longer the term and the lower the coupon rate, the greater the interest rate risk.

Which one of the following bond quotes indicates a corporate bond is selling at a premium?

101.49 Rationale: Premium bonds sell for more than par value so their quotes must be greater than 100.

A typical municipal bond is selling at a price of $5,114.20. What is the price quote for this bond?

102.284 Rationale: Price quote = $5,114.20/$5,000 = 1.02284 = 102.284%, or a price quote of 102.284

A TIPS was issued with a face value of $1,000 and a reference CPI of 204.89. The current par value of this TIPS is $1,001.37. What is the current CPI?

205.17 Rationale: Current price = $1,000 × (Current CPI/204.89) = $1,001.37; Current CPI = 205.17

A corporate bond has a yield to maturity of 6.48 percent, a current price of $916.58, and matures in 5 years. What is the coupon rate?

4.50 percent Rationale: N = 10; I = 3.24; PV = -916.58; FV = 1,000; CPT PMT; PMT = 22.50, which is the semiannual interest payment. Coupon rate = (2 × $22.50)/$1,000 = 0.045 = 4.50%

What are the taxable equivalent yields (ETY) at tax rates of 25 percent and 35 percent if the muni yield is 3.5 percent?

4.67 percent; 5.38 percent Rationale: ETY = 0.035/(1 - 0.25) = 0.0467 = 4.67% ETY = 0.035/(1 - 0.35) = 0.0538 = 5.38%

What rate does an investor need to earn on a corporate bond to earn the same return as he can on a 3.5 percent muni if his tax rate is 28 percent?

4.86 percent Rationale: Equivalent taxable yield = 0.035/(1 - 0.28) = 0.0486 = 4.86%

Which of these statements is correct?

The average daily trading volume of the U. S. bond market exceeds $800 billion.

The common-size values of both net income and costs of goods sold increased this year over last year. What does this mean?

As a percentage of sales, the cost of goods sold increased while the sum of total expenses, interest, and taxes decreased for the year.

You manage a trust fund and have a fiduciary responsibility to only purchase investment grade bonds. Which bond rating indicates a bond you could not purchase?

BB Rationale: BB bonds are below investment grade so you could not purchase them while complying with your fiduciary responsibilities.

Which of these Standard & Poor's bond ratings is the lowest investment grade rating of those shown here?

BBB Rationale: BBB is a medium grade rating which is classified as investment grade.

Which of these represents the compensation earned by a bond dealer?

Bid-ask spread

A bond's life span is typically referred to as (Blank 1) to (Blank 2)

Blank 1: time Blank 2: maturity

Most secondary trades in the U. S. bond market occur between which two parties?

Bond dealers and large institutions

Which statement related to bonds is true?

Bond have varying levels of risk

Why might a corporation issue bonds?

Bond may offer a lower aftertax cost than equity securities.

The funding of which one of these would be provided by a general obligation municipal bond?

City school Rationale: Schools are funded by general obligation bonds.

If a bond is selling at a premium which one of these rates will be the highest?

Coupon rate Rationale: Premium bond: Coupon rate > Current yield > Yield to maturity

Which one of these is correct if a bond is selling at a premium?

Coupon rate > Current yield > Yield to maturity

What does a bond rating measure?

Credit quality, or default risk

Which of the following yields or rates are inversely related to a bond's market price?

Current yield and yield to maturity only

Which of the following yields or rates are inversely related to a bonds market price?

Current yield and yield to maturity only

Which one of these terms indicates a bond is unsecured?

Debenture

What is the yield spread?

Difference between the yield to maturity on bonds with differing levels of credit risk

A $1,000 bond matures in 15 years and carries a 5 percent coupon. The bond is callable in 5 years at a premium equal to one year's interest payments. What is the correct formula for computing the current price given a market rate of 4.7 percent?

Price = $25 × {1−11.0235100.0235}1-11.0235100.0235 + $1,0501.023510

Which one of these defines the yield to call?

Rate earned by buying a bond at today's price and holding it until the first call date

The internet and par value payments of mortgage-backed securities originate

Real estate mortgage payments

Which one of these applies to agency bonds?

Relatively safe securities

Which specific characteristic identifies a security as an asset-backed security?

Repayment based on a pool of debt securities

Which specific characteristic identifies a security as an asset-backed security?

Repayment based on a pool of debt securities.

What is a common means of reporting the daily direction of overall bond price movements?

Reporting the yield-to-maturity on the 10-year Treasury bonds. Rationale: Since the rate of interest is the key factor that affects bond prices, it is common practice to report the latest rate and daily yield change for the 10-year Treasury. Remember, interest rates and bond prices are inversely related.

If you expect interest rates to increase significantly within the next two years, which one of these bonds would you prefer to own?

Short-term, high coupon

Which one of these is a key reason why issuers call bonds?

Significant drop in market interest rates

Which one of these is the key reason why issuers call bonds?

Significant drop in market interest rates

What is a call premium?

The additional amount an issuer pays in excess of par value if the issuer redeems a bond prior to maturity.

You need to select one of two premium bonds to purchase. You plan to hold whichever bond you select until it matures in 10 years. Which bond should you select and why?

The bond with the highest yield to maturity as you prefer to earn the highest rate of return over the 10 years. Rationale: The yield to maturity is the annual rate of return an investor will earn by purchasing a bond at the current price and holding it until maturity.

What is the definition of credit quality risk?

The chance that an issuer will either be late paying or will not pay an interest or principal payment.

Assume a $1,000 Treasury inflation-protected bond has a 2 percent coupon and a face value at issuance of $1,000. The reference CPI is 202.34 and the current CPI is 203.18. What do you know for certain about this bond?

The coupon rate is still 2 percent but the interest payments have increased.

Which of these best explains the current value of a bond?

The current value is the present value of the bonds expected future cash flows discounted at the market rate of interest.

Which one of these tends to occur when a BBB bond is downgraded to BB?

The market price of the bond declines

A municipal bond quote displays a price quote of 98.67. How is this quote interpreted? Assume a typical face value for a municipal bond.

The municipal bond is selling at a discounted price of $4,933.50.

Which one of these correctly defines equivalent taxable yield?

The pretax rate needed on a taxable bond to produce the same after-tax as a muni bond.

Which of these correctly defines a bond feature?

The principal value of a bond is referred to as the par value, or face value.

Which one of these correctly defines a bond feature?

The principal value of a bond is referred to as the par value, or face value.

What is the definition of yield to maturity?

The rate that will be earned if a bond is purchased today and held until maturity

What is the definition of current yield?

The return provided by the annual interest payments if the bond is purchased at the current price

You are in the 3rd year of a 10-year corporate bond has a 6% coupon, a call premium of $60, and a first call date in year 4. Market interest rates are 5.75% and are expected to drop dramatically for an extended period. If you plan to hold the bond, which yield should you most consider before buying the bond?

The yield to call as the bond will most likely be called

A 10-year corporate bond has a 6 percent coupon, a call premium of $60, and a first call date in year 4. Market interest rates are 6.5 percent and are expected to rise for an extended period. If you plan to hold the bond, which yield should you most consider before buying the bond?

The yield to maturity as it is unlikely the bond will be called Rationale: With market interest rates exceed the coupon rate and are rising, a bond is unlikely to be called.

Why are U. S. Treasury bonds considered to be safe?

They are secured by the full-faith-and-credit of the U. S. government.

What is the purpose of a call premium?

To compensate bondholders who have their bonds redeemed prior to maturity.

Which one of these explains why issuers call bonds?

To refinance debt at a lower rate

The financial status of the issuer will affect the coupon rate that issuer pays on its bonds. True or False?

True

True or false: If you buy a bond today at par value and sell it one year from today, also at par value, the rate of return you will earn will equal to current yield.

True