Finance 3332 | Topic 6

Jobby McJobberton's Inc. is selling bonds for $700. It has an 8% coupon rate and makes payments semi-annually. The bond matures in 25 years. What is the bond's expected rate of return?

Correct Answer: 11.74% PV = ($700.00) FV = $1,000.00 PMT = 40 N = 50 I = 5.87% X 2 = 11.74%

What is the price of the bond if market interest rates (i.e., required returns by bond holders) increase to 10%? Bond A: Face Value = $1,000, Coupon rate paid annually = 8%, Maturity = 15 years

Correct Answer: $847.88 Bond A: FV = $1,000, PMT = $80, N = 15, I/Y = 10% Compute PV = -$847.88

BLU-DAY Co. is currently issuing a $1,000 face-value bond that has an annual coupon of 6% and matures in 10 years. Interest payments are made annually. If the yield to maturity is 8%, then what is the current price of the bond?

Correct Answer: $865.80 FV = $1,000, PMT = $60, N = 10, I/Y = 8% Compute PV = -$865.80

T or F - Bond A has 20 years to maturity while bond B has 5 years to maturity. Given this information, if interest rates increase, then the price of Bond A will decrease more than the price of Bond B.

Correct Answer: True True - bonds with longer times to maturity are more sensitive to changes in interest rates.

The stated interest payment made on a bond is the:

Coupon

What is a bond that is unsecured called?

Debenture

If returns required by bondholders have increased 1.5% from last year, we should expect bond prices to have _______________.

Decreased

Definition of PAR in finance?

The face value of a bond, determines the maturity level as well as the dollar value

T/F: Bonds are also known as "fixed income."

True

T/F: Bonds are the backbone of the worlds pension funds.

True

T/F: The two main reasons the text states for the importance of understanding bonds are the bond market is an important source of financing and bonds play a role in most personal investment plans.

True

A bond for AJB Co. has a yield to maturity of 13.90 percent, a 9.5 percent annual coupon, a $1,000 face value, and a maturity date 5 years from today. What is the current yield?

First, let's find that price of the bond: FV = $1,000 PMT = $95 I/Y = 13.9% N = 5 Compute PV = -$848.58 With the current price of $848.58, we can now solve for the current yield. Recall that: Current Yield = Annual Coupon/Current Market Price of Bond. = 95/848.58 = 0.112 or 11.2%

The period of time for which a bond remains outstanding is called:

Maturity

A 15-year bond has a face value of $1,000, a coupon rate of 8%, and a yield to maturity of 8%. If the bond pays semiannual coupons, what is the bond's price?

Correct Answer: $1,000 Answer: (FV = -1000, PMT = -80/2=-40, I/Y = 8%/2=4%, N = 15*2=30, compute PV = $1000)

What is the price of the following bond if market interest rates (i.e. required returns by bond holders) increase from 7.8% to 10%? Face Value = $1,000, Coupon rate paid annually = 10%, Maturity = 10 years

Correct Answer: $1,000.00 Bond A: FV = $1,000, PMT = $100, N = 10, I/Y = 10% Compute PV = -$1,000

A company issued a 10-year bond three years ago that was priced at $1,012. The bond has a face value of $1,000 and a coupon rate of 9.5%. If interest rates have decreased by 1%, what is the price of this bond? (Assume coupons are paid annually)

Correct Answer: $1,061.30 Answer: Original Yield to maturity = 9.31% (FV = -1000, PMT = -95, PV = 1012, N = 10, compute I/Y = 9.31%) Price today = $1,061.30 (FV = -1000, PMT = -95, I/Y = 9.31%-1% = 8.31%, N = 10-3=7, compute PV = 1061.30).

A 25-year bond has a face value of $1,000, a coupon rate of 8.5%, and a yield to maturity of 7.5%. If the bond pays annual coupons, what is the bond's price?

Correct Answer: $1,111.47 Answer: (FV = -1000, PMT = -85, I/Y = 7.5%, N = 25, compute PV =$1,111.47)

A company issued a 10-year bond one year ago that was priced at par. The bond has a face value of $1,000 and a coupon rate of 10%. If interest rates have increased by 1%, the price of this bond has decreased ___________________. (Assume coupons are paid annually)

Correct Answer: $55.37 Answer: Price today = $944.63 (FV = -1000, PMT = -100, I/Y = 10%+1% = 11%, N = 10-1=9, compute PV = 944.63). Original price = $1,000. Difference = 1000-944.63 = 55.37

Calculate the value of a bond that matures in 30 years and has a face value of $1,000. The coupon rate is 7% paid annually, and the investor's required rate of return is 11%.

Correct Answer: $652.25 Using your financial calculator: N = 30 I/YR = 11% PMT = $70 FV = $1,000 CPT + PV = $652.25

What is the price of the following bond if market interest rates (i.e. required returns by bond holders) increase from 7.8% to 10%? Face Value = $1,000, Coupon rate paid annually = 5%, Maturity = 10 years

Correct Answer: $692.77 FV = $1,000, PMT = $50, N = 10, I/Y = 10% Compute PV = -$692.77

One year ago, you bought a 15-year $1,000 face-value bond that has an annual coupon rate of 7% and interest payments are paid semi-annually. If the yield to maturity was 9.1% when you bought the bond, but the yield to maturity is 8.2% today, then the price of the bond has increased ___________.

Correct Answer: $71.19 PV = ($829.97) FV = 1000 PMT = 35 N = 30 I = 4.10% 901.16-829.97 = $71.19 $71.19

Tonic Juice Corp.'s 15-year, $1,000 par value bonds pay 12% interest annually. The market price of the bonds is $1,062.20 and your required rate of return is 10%. Compute the bond's market expected rate of return.

Correct Answer: $71.19 PV = ($829.97) FV = 1000 PMT = 35 N = 30 I = 4.10% 901.16-829.97 = $71.19 $71.19

Calculate the current market price on the following bond - assume that the return required by bondholders is 7.8%: Face Value = $1,000, Coupon rate paid annually = 5%, Maturity = 10 years

Correct Answer: $810,41 FV = $1,000, PMT = $50, N = 10, I/Y = 7.8% Compute PV = -$810.41

A 20-year bond has a face value of $1,000, a coupon rate of 7.5%, and a yield to maturity of 9.5%. If the bond pays semiannual coupons, what is the bond's price?

Correct Answer: $822.37 Answer: (FV = -1000, PMT = -75/2=-37.50, I/Y = 9.5%/2=4.75%, N = 20*2=40, compute PV = $822.37)

A bond has a face value of $1,000, a coupon rate of 8%, and a yield to maturity of 9.5%. If the bond matures in 8 years, what is the bond's price? (assume coupons are paid annually)

Correct Answer: $918.50 Answer: (FV = -1000, PMT = -80, I/Y = 9.5%, N = 8, compute PV = $918.50)

A 10-year bond has a face value of $1,000, a coupon rate of 7.5%, and a yield to maturity of 8.5%. If the bond pays quarterly coupons, what is the bond's price?

Correct Answer: $933.09 Answer: (FV = -1000, PMT = -75/4=-18.75, I/Y = 8.5%/4=2.125%, N = 10*4=40, compute PV = $933.09)

A company issued a 20-year bond four years ago that was priced at $988. The bond has a face value of $1,000 and a coupon rate of 8%. If interest rates have decreased by 1%, the price of this bond has increased ___________________. (Assume coupons are paid annually)

Correct Answer: $94.18 Answer: Original Yield to maturity = 8.123% (FV = -1000, PMT = -80, PV = 988, N = 20, compute I/Y = 8.123%) Price today = $1,082.18 (FV = -1000, PMT = -80, I/Y = 8.123%-1% = 7.123%, N = 20-4=16, compute PV = 1082.18). Original price = $988. Difference = 1082.18-988 = $94.18

A company just issued a unique, 5-year bond with a face value of $1,000 that pays a coupon of $60 in year 1, $70 in year 2, $80 in year 3, $90 in year 4, $100 in year 5. The company also pays the face value of the bond at the end of year 5. If the yield to maturity is 8%, what is the price of this bond? (Assume coupons are paid annually)

Correct Answer: $993.87 Answer: The Bond Price is the present value of coupons + the present value of the face value or P = 60/(1.08)¹ + 70/(1.08)² + 80/(1.08)³ + 90/(1.08)⁴ + 100/(1.08)⁵ + 1000/(1.08)⁵ = $993.87

A company just issued a 15-year bond that has a face value of $1,000 and a coupon rate of 10%. Similar bonds are priced at 95% of par (or face) value. Given this information, what is the yield to maturity on this bond? (assume the bond pays annual coupons)

Correct Answer: 10.68% Answer: (FV = -1000, PMT = -100, PV = .95*1000 = 950, N = 15, compute I/Y = 10.68%)

Current Government Treasury bills (i.e. short-term bonds) are priced at 96.8% of par, where par is $1,000. If these bonds do not pay a coupon and mature in one year from today, then what is the yield to maturity on these bonds?

Correct Answer: 3.3% PV = -968 FV = 1000 PMT = 0 N = 1 I = 3.31%

A 7.5 percent semi-annual coupon bond is priced at $1,055.33. The bond has a $1,000 face value and an annual yield to maturity of 6.5 percent. How many years until this bond's maturity?

Correct Answer: 6.97 years FV = $1,000 PMT = $75/2 = $37.50 PV = -$1,055.33 I/Y = 6.5%/2 = 3.25% Compute N = 13.94 (this is in semi-annual time periods) = 13.94/2 = 6.97 years

AXE Inc. is planning to issue a $1,000 face-value bond with an annual coupon rate of 7.5% that matures in 20 years. AXE is planning to pay semi-annual interest payments. Similar AXE bonds are quoting at 95% of par. What is the yield to maturity for this bond?

Correct Answer: 8.0% PV = -950 FV = 1000 PMT = 37.5 N = 40 I = 4.00% YTM = 4.00% X 2 = 8.00%

Suppose you bought a 10-year $1,000 face-value bond for $925 one year ago. The annual coupon rate is 7% and interest payments are paid annually. If the price today is $1,004, the yield to maturity must have changed from _____________ to ______________.

Correct Answer: 8.12%; 6.94% Original: PV = -925 PMT = 70 N = 10 I = 8.12% FV = 1,000 New: PV = -1004 PMT = 70 N = 9 I = 6.94% FV = 1,000

A zero-coupon bond is currently priced at $456, has a face value of $1,000, and matures in 10 years. What is the yield to maturity of this bond?

Correct Answer: 8.17% FV = 1,000, PV = -$456, PMT = 0, N = 10, Compute I/Y = 8.17%

A company just issued a 10-year bond that has a face value of $1,000 and a coupon rate of 6.5%. Similar bonds are priced at 88% of par (or face) value. Given this information, what is the yield to maturity on this bond? (assume the bond pays semiannual coupons)

Correct Answer: 8.29% Answer: (FV = -1000, PMT = -65/2=-32.50, PV = .88*1000 = 880, N = 10*2=20, compute I/Y = 4.144*2 = 8.29%)

Another Co. expects to issue a $1,000 face-value bond that matures in 10 years. The annual coupon rate is 8.25% and interest payments are expected to be paid annually. Similar bonds are currently priced at 98.4% of face value. Given this information, what is the required return by bond holders?

Correct Answer: 8.49% PV = -984 FV = 1000 PMT = 82.5 N = 10 I = 8.49%

A company just issued a 20-year bond that has a face value of $1,000 and a coupon rate of 8.5%. Similar bonds are priced at 92.5% of par (or face) value. Given this information, what is the yield to maturity on this bond? (assume the bond pays semiannual coupons)

Correct Answer: 9.34% Answer: (FV = -1000, PMT = -85/2=-42.50, PV = .925*1000 = 925, N = 20*2=40, compute I/Y = 4.667*2 = 9.34%)

T or F - A bond with a longer time to maturity will have less sensitivity to changes in interest rates.

Correct Answer: False False - Bonds with longer times to maturity have more sensitivity to changes in interest rates.

T or F - Bond A has 20 years to maturity while Bond B has 5 years to maturity. Bond A and Bond B have identical coupon rates. Given this information, Bond A will have the same yield to maturity as Bond B.

Correct Answer: False False - Holding everything else constant, Bond A is more risky because it has a longer time to maturity. Therefore, Bond A will have a higher yield than Bond B.

T or F - Suppose a bond has a duration of 3.5 and a yield to maturity of 10%. If interest rates increase 1%, the bond price is expected to decrease .35%.

Correct Answer: False False - If interest rates increase 1% then the bond price will decrease by the amount of duration in percentage terms, or 3.5%.

T or F - A 20-year bond with a $1,000 face value pays an annual coupon of $50. The yield to maturity for the bond is 9.5%. Given this information, the final payment bond holders will receive will be $1,095.

Correct Answer: False False - The final payment will be the last coupon and the face value of the bond which is $50 and $1,000, respectively.

T or F - If interest rates increase then bond prices will also increase.

Correct Answer: False False - bond prices and interest rates are inversely related. The interest rate on the bond (or the yield to maturity) is the discount rate. As the discount rate gets larger, the price of the bond will decrease.

T or F - As the coupon rate increases, the bond price will increase.

Correct Answer: True True - Bond prices are calculated by taking the present value of the coupons and face value of bonds. If the coupons are larger, the present value of the coupons will also be larger. Therefore, price of the bond will be higher.

T or F - A bond with a face value of $1,000 will have a current price of $1,000 if the coupon rate is equal to the yield to maturity.

Correct Answer: True True - If the coupon rate is equal to the yield to maturity, the bond will be priced at par or face value.

T or F - A bond with a coupon rate that is less than the yield to maturity will be priced at a discount.

Correct Answer: True True - If the coupon rate is less than the yield to maturity, the bond must be priced at a discount.

T or F - A 20-year bond with a $1,000 face value has a coupon rate of 8.5% but pays coupons semiannually. The yield to maturity for the bond is 9.5%. Given this information, first coupon that will be paid will be $42.50.

Correct Answer: True True - The first semiannual coupon will be .5*(.085*$1000) = $42.50.

AXE Inc. is planning to issue a $1,000 face-value bond with an annual coupon rate of 7.5% that matures in 5 years. AXE is planning to pay quarterly interest payments. Similar AXE bonds are quoting at 95% of par. What is the amount of a single interest payment that AXE will make?

Coupon PMT = 1000 X 0.075/4 = $18.75

What is the written agreement between the bond issuer and its bondholders called?

Indenture

The relation between bond prices and yields to maturity can best be described as:

Inverse. As one rises, the other falls

In the bond market, firms raise debt financing directly from ________.

Investors

What are bonds issued by cities, counties, or states called?

Municipal bonds

AXE Inc. is planning to issue a $1,000 face-value bond with an annual coupon rate of 7.5% that matures in 5 years. AXE is planning to pay quarterly interest payments. Similar AXE bonds are quoting at 95% of par. Given this information, what is the amount for the final cash flow that a bondholder will receive?

The final CF is the last coupon payment + the face value = $18.75 + $1,000 = $1018.75

What is a bond called that has no coupon payments?

Zeros