FIN 311 Exam 2

Your aunt is about to retire, and she wants to sell some of her stock and buy an annuity that will provide her with income of $95,000 per year for 30 years, beginning a year from today. The going rate on such annuities is 7.25%. How much would it cost her to buy such an annuity today?

$1,149,847.96

Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 5.00%, based on semiannual compounding. What is the bond's price?

$1,235.47

You want to buy a new sports car 3 years from now, and you plan to save $6,200 per year, beginning one year from today. You will deposit your savings in an account that pays 5.2% interest. How much will you have just after you make the 3rd deposit, 3 years from now?

$19,583.96

You just inherited some money, and a broker offers to sell you an annuity that pays $18,200 at the end of each year for 20 years. You could earn 5% on your money in other investments with equal risk. What is the most you should pay for the annuity?

$226,812.23

Suppose you have $2,000 and plan to purchase a 10-year certificate of deposit (CD) that pays 11.1% interest, compounded annually. How much will you have when the CD matures?

$5,730.21

Kebt Corporation's Class Semi bonds have a 12-year maturity and an 8.50% coupon paid semiannually (4.25% each 6 months), and those bonds sell at their $1,000 par value. The firm's Class Ann bonds have the same risk, maturity, nominal interest rate, and par value, but these bonds pay interest annually. Neither bond is callable. At what price should the annual payment bond sell?

$986.86

Listed below are some provisions that are often contained in bond indentures. Which of these provisions, viewed alone, would tend to reduce the yield to maturity that investors would otherwise require on a newly issued bond? ​ 1. Fixed assets are used as security for a bond.2. A given bond is subordinated to other classes of debt.3. The bond can be converted into the firm's common stock.4. The bond has a sinking fund.5. The bond has a call provision.6. The indenture contains covenants that restrict the use of additional debt.

1,3,4,6

Kern Corporation's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.30%. The real risk-free rate is r* = 2.5%, the default risk premium for Kern's bonds is DRP = 1.90% versus zero for T-bonds, the liquidity premium on Kern's bonds is LP = 1.3%, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) 0.1%, where t = number of years to maturity. What is the inflation premium (IP) on all 5-year bonds?

1.40%

Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 1.80%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

2.35%

Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 4.10%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond. What is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.

2.42

Suppose the rate of return on a 10-year T-bond is 6.90%, the expected average rate of inflation over the next 10 years is 2.0%, the MRP on a 10-year T-bond is 0.9%, no MRP is required on a TIPS, and no liquidity premium is required on any Treasury security. Given this information, what should the yield be on a 10-year TIPS? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

4%

Keenan Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,045. What is the bond's nominal yield to call?

5.59%

Pace Co. borrowed $10,000 at a rate of 7.25%, simple interest, with interest paid at the end of each month. The bank uses a 360-day year. How much interest would Pace have to pay in a 30-day month?

60.42

The real risk-free rate is 3.55%, inflation is expected to be 3.60% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond? (Round your final answer to 3 decimal places.)

7.278%

Your father paid $10,000 (CF at t = 0) for an investment that promises to pay $750 at the end of each of the next 5 years, then an additional lump sum payment of $10,250 at the end of the 5th year. What is the expected rate of return on this investment?

7.93

Adams Enterprises' noncallable bonds currently sell for $910. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity?

9.66%

A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now?

930.11

Which of the following statements is CORRECT?

All else equal, long-term bonds have less reinvestment risk than short-term bonds.

You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest?

Bank 5; 6.0% with daily (365-day) compounding.

Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, an 8% yield to maturity, and are noncallable. Which of the following statements is CORRECT?

Bond A's current yield is greater than that of Bond B.

A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond.

False

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

False

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

False

Which of the following statements is CORRECT?

If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd= YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.

A company is planning to raise $1,000,000 to finance a new plant. Which of the following statements is CORRECT?

If debt is used to raise the million dollars, but $500,000 is raised as first mortgage bonds on the new plant and $500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds.

A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?

If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.

Which of the following statements is CORRECT?

If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.

Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that

Maturity risk premiums could help to explain the yield curve's upward slope.

Suppose the U.S. Treasury issued $50 billion of short-term securities and sold them to the public. Other things held constant, what would be the most likely effect on short-term securities' prices and interest rates?

Prices would decline and interest rates would rise.

Which of the following statements is CORRECT?

Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

The real risk-free rate of interest is expected to remain constant at 3% for the foreseeable future. However, inflation is expected to increase steadily over the next 30 years, so the Treasury yield curve has an upward slope. Assume that the pure expectations theory holds. You are also considering two corporate bonds, one with a 5-year maturity and one with a 10-year maturity. Both have the same default and liquidity risks. Given these assumptions, which of these statements is CORRECT?

The 10-year corporate bond must have a higher yield than the 5-year corporate bond.

Which of the following statements is CORRECT?

The higher the maturity risk premium, the higher the probability that the yield curve will be inverted. The most likely explanation for an inverted yield curve is that investors expect inflation to increase. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.ssup

Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?

The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities.

Which of the following statements is CORRECT?

The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.

Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?

This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.

A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%.

True

All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.

True

Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond.

True

Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.

True

During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining.

True

If the required rate of return on a bond (rd) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)

True

Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength.

True

One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant.

True

Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond's face value.

True

The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant.

True

The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant.

True

The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.

true