Chapter 2

A corporate bond has a bid-ask spread of 97 - 98. What is the dollar value of the spread?

$10 Bond quotes represent the percentage of the bond's par value. Par value for corporate bonds is $1,000. So this bid-ask spread, when converted to dollars is $970 - $980. The spread is the difference between the ask and the bid. Thus, the spread when converted to dollars is $980 - $970 = $10.

A corporate bond as a bid-ask spread of 101 - 103. What is the dollar value of the spread?

$20 Bond quotes represent the percentage of the bond's par value. Par value for corporate bonds is $1,000. So this bid-ask spread, when converted to dollars is $1,010 - $1,030. The spread is the difference between the ask and the bid. Thus, the spread when converted to dollars is $1,030 - $1,010 = $20.

A corporation issues a bond with a face value of $1,000 and a coupon rate of 4%. If the bond pays interest semi-annually, how much interest will the investor receive after the first six months?

$20 To find the annual interest rate of a bond, take the coupon rate times the face value of the bond ($1,000 x .04 = $40). Most bonds pay interest semi-annually, which means that the investor will receive half of the annual interest after the first six months of owning the bond. Half of $40 is $20.

A Treasury Bond is quoted at 95-12. The dollar price of a $1,000 par bond is:

$953.75 The bond is quoted at 95 and 12/32nds. 12/32nds = .375, so the bond is quoted at 95.375% of $1,000 par value = $953.75.

There is a $1,000 par bond that is sold at 96 7/8 bond points with a coupon rate of 6%. What is the current yield on the bond?

0.062 Current yield is calculated by taking the annual interest payment divided by the price of the bond. The annual interest payment is $60, which is calculated by taking .06 x $1,000. The price of the bond is calculated by thinking about each bond point as $10. This would equal $960 plus 7/8 of $10, which is $8.75. So the price of the bond is $968.75. Thus, the current yield is $60/$968.75 = .062 or 6.2%.

140 Basis points equal:

1.4% Since 1 basis point = .01% = $.10, 140 basis points = 1.4% = $14.00.

150 basis points equals:

1.50% Basis points are a measure of yield change. 1 basis point =.01%, therefore 150 basis points = 1.5%. Also not that a basis point on a $1,000 par bond = .01% x $1,000 = $.10 of annual interest. Therefore, 150 basis points = $15 of annual interest.

A basis point is equal to:

1/100 of a percent 100 basis points equals 1 percent.

A corporate bond yielding 8% interest was sold for $1,000 at issue. Bud buys the bond for $800 two years later on the secondary market. Bud's current yield is:

10% Current yield is the coupon rate on the bond divded by the price the investor bought the bond at. For Bud, he will get $80 in coupons per annum, so his current yield is given by $80/$800 = 10%.

Which of the following would be a quote for a U.S. Government bond with a dollar price of $1,012.50?

101-8 U.S. Government bonds are quoted on a percentage of par basis in 32nds. 101-8 = 101 8/32nds = 101.25% of $1,000 = $1,012.50 per bond.

How much would you pay for a $1,000 10-year treasury bond priced at 101-08 excluding accrued interest?

1012.5 Treasury bonds are typically priced in percentage points of par in fractions of 32nds of percentage points. For example the -08 of the quote should be understood as 8/32nds of a percentage point or .25%. Thus, 101-08 is equivalend to 101.25% of par which is $1000 x 101.25 which is $1012.50.

Julie buys a $5,000 municipal bond at a discount for $4,000. She receives a semiannual payment interest payment of $125. What is the nominal yield of the bond?

5% Since her $125 interest payments are semiannual, that means Julie receives $250 a year in interest. Nominal yield is expressed as a percentage of the principal of the bond, and $250 is 5% of $5.000, so the nominal yield of Julie's bond is 5%. The price that Julie paid for the bond at discount does not affect nominal yield.

A bond whose entire issue is scheduled to reach maturity on the same date and which offers a single interest rate is known as:

A term bond A term bond issue reaches maturity on the same date and is offered at a single interest rate.

A municipal bond that is offered at a yield-to-maturity lower than its coupon rate is recognized as trading:

At a premium When is trading at a premium, it's yield to maturity is lower than its coupon rate.

The difference between the price at which investors are willing to buy bonds and the price at which they are willing to sell them is called the:

Bid-ask spread A bid price is the maximum price a buyer is willing to pay. The ask price is the minimum price a seller is willing to accept. The spread thus represents the dealer's profit.

Governments cannot sell ownership; instead; they issue debt securities, such as ___, to raise money.

Bonds Debt financing (the issuing of debt securities) is commonplace for governments precisely because they cannot sell shares. The United States federal government issues bonds called treasury bonds, while state, county, and local governments issue bonds known as municipal bonds.

Which of the following statements is true regarding current yield?

Current yield decreases when a bond increases Current yield is the yearly coupon payment divided by the current price of the bond. Typically, bond prices and yields move in opposite directions. Therefore, an increase in bond prices results in lower current yield, and a decrease in bond prices results in a higher current yield.

When a company raises money by issuing debt securities, it is called ___ because the company will have to pay back the investor in the future.

Debt financing Debt securities are issued by a company to investors, and the company will ultimately repay the debt to the lender (investor) with interest. It is not only businesses who raise money through debt financing, however. Governments (federal, state, and local) also issue debt securities for the same purpose.

Which of the following is true?

For a premium bond, the nominal yield is greater than YTM For bonds that are purchased at a premium and held to maturity, the order of the yields from highest to lowest is nominal yield, current yield, YTM and YTC. For bonds that are purchased at a discount, the opposite order is true (YTC>YTM>current yield> nominal yield).

Which of the following is an advantage of serial bonds for the issuer when compared to term bonds?

Lower interest expenses over the life of the bond Term bonds are those in which the entire issue is scheduled to reach maturity on the same date and offers a single interest rate. Serial bonds offer an advantage to the issuer because they have lower interest expenses over the life of the bond. As the principal is paid off with its scheduled redemptions, the reduced principal proves a corresponding reduction of interest payments. Term bonds generally require that the issuer make periodic payments into a sinking fund to be assured that the issuer will have the required funds when the principal comes due. While serial bonds can sometimes be callable for those segments whose maturities come due in the later years of a long term issue, this characteristic is most common with term bonds.

When interest rates rise, bond prices fall. When interest rates fall, bond prices rise. This statement refers to:

Previously issued bonds selling in the secondary market. Bond prices are inversely related to interest rates so when interest rates rise, bond prices fall and when interest rates fall, bond prices rise. What this means is that when interest rates rise, the prices of previously issued bonds trading on the secondary market fall and when interest rates fall, the prices of previously issued bonds trading on the secondary market rise. This inverse relationship between interest rates and bond prices does not apply to newly issued bonds which are priced based on market conditions at the time of issue.

Bonds that mature at specified intervals over a pre-determined time period are known as which of the following?

Serial bonds With term bonds, the entire issue reaches maturity on the same date. Callable bonds allow the issuer to redeem all or a portion of a bond prior to the maturity date. Putable bonds allow the investor to redeem the bond at par before the maturity date. With serial bonds however, a bond issue matures at regular intervals over a specific time period. That means that specified portions of the total issue reach maturity at pre-determined dates that occur within the bond's lifespan.

ABC Corporation issues $1,000,000 of 8%, $1,000 par bonds, all maturing in 30 years. Each $1,000 bond within the issue is identical - each bond has the same maturity and the same interest rate. Which of the following best describes this kind of bond?

Term bond A bond issue for which every bond has the same interest rate and maturity is called a term bond issue.

Which of the following best describes the relationship between interest rates and the yield of already issued bonds?

When interest rates fall, the yields of already issued bonds generally fall. When interest rates rise, the value of already issued bonds generally declines and the yield on the already issued bonds generally rises. When interest rates fall, the value of already issued bonds generally increases and the yield on the already issued bonds generally falls. Current yield = annual coupon/bond purchase price. Thus bond yields and interest rates generally move in the same direction.

How are corporate bonds quoted?

Whole and fractional bond points Corporate bonds are quoted as a percentage of par value, with each "whole" bond point movement representing 1% of $1,000 par or $10. The minimum price increment is 1/8th of 1%, so it is a fraction of par. Thus corporate bonds are quoted in whole and fractional points.

A 10-year bond is issued with an initial price of $500. Ten years later the bondholder receives the $1,000 par value. The bondholder does not receive any interest along the way. Which of the following best descries this bond?

Zero-coupon bond Bonds that are issued at a deep discount to par, and have no regular interest payments are called zero-coupon bonds.

The nominal yield of a bond will:

remain unchanged as bond prices fluctuate The nominal yield is the stated rate of interest as a percentage or par value. It does not change as bonds prices move. However, the current yield and yield to maturity will be affected by changes in bond prices.

A serial bond is one that:

repays principal periodically over its life A serial structure ensures that the issuer is paying down principal over time.

When interest rates ___, bond prices ___.

rise, fall Bond prices are inversely related to interest rates so when interest rates rise, bond prices fall and when interest rates fall, bond prices rise. What this means is that when interest rates rise, the prices of previously issued bonds trading on the secondary market fall and when interest rates fall, the prices of previously issued bonds trading on the secondary market rise. This inverse relationship between interest rates and bond prices does not apply to newly issued bonds which are priced based on market conditions at the time of issue.

Mr. Workman buys a bond at a deep discount of $300. The bond does not pay interest, but Mr. Workman redeems the bond at maturity for $1,000. This is considered a:

zero-coupon bond As its name reflects, there are no interest payments paid to investors on zero-coupon bonds. However, zero coupon bonds are purchased at a deep discount yet are redeemable at the bond's full face value at maturity.