CHAPTER 8 - FINANCE AND THEORY

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

- Coupon rate - Call premium - Par value

32. Which of the following may be financed with corporate bonds?

- Plants and equipment - Research and development -Inventory

36. 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

14. 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

31. What does a bond rating measure? .

Credit quality, or default risk

55. A TIPS was issued with a par value of $1000, 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?

$1000 x (205.44 / 204.89) x (0.025 / 2)

24. A corporate bond matures in 14 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

8. A $1000 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 Formula: Selling Price (BID) = 97.81% x 1000 = $978.10

42. Will purchased a 5 percent, $3000 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 he bid quote was 101.06. What was his capital gain/loss?

(-$3.00) Formula: Capital loss = (101.06% of $3000) - (101.16% of $3000) = $3031.80 - $3034.80 = -$3.00

38. Franco purchased a $10000 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) Formula: Capital Loss: (99.87% - 100.23%) x $10000 = -0.36% x $100,000 = (-$36)

53. A TIPS was issued with a $1000 par value, a 2 percent coupon rate, and a reference CPI of 204.39. You bought the bond on January 1, 2012 at a CPI of 205.26. You sold the bond on January 1, 2013 at a CPI of 204.98. What was your total return if the July 2012 CPI was 205.32$?

1.86 percent

18. A corporate bond pays $45 in interest every 6 months and matures in 11 years. what's the YTM if the bond currently sells for $1,213?

6.29% Formula: (N=22 PV= -1213 PMT=45 FV=1000 I=3.144 (which is the semiannual rate) YTM= 2 x 3.144% = 6.29%)

59. Which one of these is the current yield formula?

Annual interest / Current value

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

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

Bid-ask spread

63. What is correct if a bond is selling at premium?

Coupon rate > current yield > yield to maturity

48. Which one of these terms indicates a bond is unsecured?

Debenture

1. Which of these statements is correct?

During 2015, the average daily trading volume of the U.S. bond market exceeded $730 billion.

44. Which of the following are sources of information on the bond markets?

Internet Merrill Lynch The Wall Street Journal

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

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

6. Which one of these characteristics designates a premium bond?

Market price exceeds par value

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

Muni Yield/(1-tax rate)

23. Which one of these is the correct formula for computing the current value of a $1000, 20-year, zero coupon bond if the discount rate is 8 percent?

PV = $1000 / {1 + (0.08 / 2)]20 Formula: PV=FVN / (1 + i)N = $1,000 / 1.0340 = $1,000 / 3.262 = $306.56

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

Real estate mortgage payments.

64. 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 yied to maturity as you prefer to earn the highest rate of return over the 10 years

58. 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 Spread = 5.98% - 4.62% = 1.36%

46. Which of the following statements are correct?

-A Treasury bond should have a higher yield to maturity than a comparable muni bond -If the market interest rate rises, bond prices will fall, and yields to maturity will rise

34. 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 interest rate, I, should be 0.0275 in three places -The call price should be $1100

45. How does the yield to call differ from the yield to maturity for the same bond?

-There are fewer time periods in the yield to call -The price used in the yield to call usually exceeds the face value used in the yield to maturity

28. 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 $1000.

27. What is interest rate risk?

The chance that a bond's value will decline due to a rise in market interest rates

29. Which of the following apply to high-yield bonds?

- Low quality - Increased credit risk

12. You want to compute the value of a 5 year, zero-coupon corporate bond given a market rate of 5.5%. What are your inputs?

FV=$1000 (the assumed par value of a corporate bond is $1000) N=10 (5x2 because semiannual compounding)

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

Face value = $1000 Semiannual interest payments

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

$102,144.60 Formula: $100,000 x 102.1446%

39. 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?

$1765 Formula: Interest = [(0.035/2) x $100,000] = $1750; Total return = [(124.2175% - 124.2025%) x $100,000] + $1750 = $1765

52. A TIPS was issued with a face value of $5000, 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 Formula: Current Interest payment = $5000 x (203.14/201.42) x (0.03/2) = $75.64

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

- Corporate bonds are the primary source of bond trading volume on the NYSE - The NYSE operates the largest centralized U.S. bond market

11. Which of the following affect the coupon rate a firm must set on its bond if the bonds are to be sold at par?

- Default risk - Market rates of interest - Bond term

22. 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

26. 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

54. A bond has a par value of 1000 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?

-The bond can be paid off in year 6 for a price of $1050 plus any unpaid interest. -Each interest payment will be $25

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

0.07=0.042/(1-tax rate); tax rate = 40%

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

1. Credit quality of the bond 2. Tax status of the bond

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

10-year, zero coupon

43. A typical municipal bond is selling at a price of $5114.20. What is the price quote for this bond?

102.284 Formula: Price quote = $5114.250 / $5000 = 1.02284 x 100 = 102.284%

5. 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. Which is the current CPI?

205.17 Current Price = $1000 x (Current CPI/204.89) = $1001.37; Current CPI - 205.17

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

4.67 percent; 5.38 percent Formula: ETY = 0.035 / (1 - 0.25) ETY = 0.035 / (1 - 0.35)

61. 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 Equivalent taxable yield = 0.035 / (1 - 0.28) = 0.0486 = 4.86%

19. 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 Formula: Face Value = $1,000 Price Quote = 102.3 Current Price = 102.3% * $1,000 Current Price = $1,023 Annual Coupon Rate = 7.50% Semiannual Coupon Rate = 3.75% Semiannual Coupon = 3.75% * $1,000 Semiannual Coupon = $37.50 Time to Maturity = 16 years Semiannual Period = 32 Let semiannual YTM be i% $1,023 = $37.50 * PVIFA(i%, 32) + $1,000 * PVIF(i%, 32) Using financial calculator: N = 32 PV = -1023 PMT = 37.50 FV = 1000 I = 3.627% Semiannual YTM = 3.627% Annual YTM = 2 * 3.627% Annual YTM = 7.25%

17. A corporate bond matures in 11 years and carries a 6% coupon. What's the correct calculator input to find the bonds current value at a discount rate of 5%?

FV = 1000; PMT = 30 N= 22 (N= 11x2=22)

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

Repayment based on a pool of debt securities.

2. Which of these are common features of a corporate bond?

Semi-annual interest payments Semi-annual interest payments Publicly traded debt security

21. 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

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

Significant drop in market interest rates.

4. 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

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

TRUE

40. A municipal bond quote displays a price of 98.67. How is this quote interpreted?

The municipal bond is selling at a discounted price of $4933.50

10. 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.

47. What is the definition of yield to maturity?

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

15. What is the definition of yield to maturity?

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

49. Why are U.S. treasury bonds considered to be safe?

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

3. What is the purpose of a call premium?

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

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

U.S. Treasury bonds

51. 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