Ch 6&7

Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 10.7% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

$901.80

McCue Inc.'s bonds currently sell for $1,175. They pay a $90 annual coupon, have a 25-year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM; it is possible to get a negative answer.)

1.68%

Niendorf Corporation's 5-year bonds yield 7.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Niendorf's bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) x 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf's bonds?

1.75%

Koy Corporation's 5-year bonds yield 8.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Koy's bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) x 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Koy's bonds?

2.10%

Kop Corporation's 5-year bonds yield 6.50%, and T-bonds with the same maturity yield 5.90%. The default risk premium for Kop's bonds is DRP = 0.40%, the liquidity premium on Kop's bonds is LP = 0.20% versus zero on T-bonds, the inflation premium (IP) is 1.50%, and the maturity risk premium (MRP) on 5-year bonds is 0.40%. What is the real risk-free rate, r*?

4.00%

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.

4.00%

Sadik Inc.'s bonds currently sell for $1,300 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)?

5.31%

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.80%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

8.30%

Radoski Corporation's bonds make an annual coupon interest payment of 7.35% every year. The bonds have a par value of $1,000, a current price of $920, and mature in 12 years. What is the yield to maturity on these bonds?

8.44%

Ryngaert Inc. recently issued noncallable bonds that mature in 15 years. They have a par value of $1,000 and an annual coupon of 5.7%. If the current market interest rate is 7.0%, at what price should the bonds sell?

881.60

Which of the following bonds has the greatest price risk?

A 10-year, $1,000 face value, zero coupon bond.

Which of the following statements is CORRECT? 5

All else equal, senior debt generally has a lower yield to maturity than subordinated debt.

Which of the following statements is CORRECT? 7

Convertible bonds generally have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.

Which of the following would be most likely to lead to a higher level of interest rates in the economy?

Corporations step up their expansion plans and thus increase their demand for capital.

Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows: T-bond = 7.72% A = 9.64%AAA = 8.72% BBB = 10.18% The differences in rates among these issues were most probably caused primarily by:

Default risk and liquidity differences.

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. T or F

False

Which of the following statements is CORRECT? 4

If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield is zero.

Which of the following statements is CORRECT, other things held constant?

If expected inflation increases, interest rates are likely to increase.

Which of the following statements is CORRECT?

If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.

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.

Bond X has an 8% annual coupon, Bond Y has a 10% annual coupon, and Bond Z has a 12% annual coupon. Each of the bonds is noncallable, has a maturity of 10 years, and has a yield to maturity of 10%. Which of the following statements is CORRECT?

If the bonds' market interest rate remains at 10%, Bond Z's price will be lower one year from now than it is today.

Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?

If the pure expectations theory holds, the Treasury yield curve must be downward sloping.

Bonds A, B, and C all have a maturity of 10 years and a yield to maturity of 7%. Bond A's price exceeds its par value, Bond B's price equals its par value, and Bond C's price is less than its par value. None of the bonds can be called. Which of the following statements is CORRECT?

If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline.

Which of the following statements is CORRECT? 8

Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds.

An investor is considering buying one of two 10-year, $1,000 face value, noncallable bonds: Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, and the YTM is expected to remain constant for the next 10 years. Which of the following statements is CORRECT?

One year from now, Bond A's price will be higher than it is today.

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? 3

Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued.

Amram Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not convertible, not callable, and has no sinking fund. Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the second bond, the convertible, callable bond with the sinking fund, to have it sell initially at par?

The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%.

If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?

The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat.

Which of the following statements is CORRECT? 2

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

The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT?

The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.

Which of the following statements is CORRECT? 6

The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.

If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward sloping yield curve. T or F

True

If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase. T or F

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.) T or F

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. T or F

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. T or F

True

Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds. T or F

True

The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond's remaining maturity. T or F

True

The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk."

True