Chapter 7: interest rates and bond valuations
Dexter Mills issued 20-year bonds a year ago at a coupon rate of 11.4 percent. The bonds make semiannual payments. The yield-to-maturity on these bonds is 9.2 percent. What is the current bond price?
$1,195.84
The 7 percent, semi-annual coupon bonds offered by House Renovators are callable in 2 years at $1,054. What is the amount of the call premium on a $1,000 par value bond?
$54 call premium = 1,054 - 1,000 = 54
Today, you want to sell a $1,000 face value zero coupon bond you currently own. The bond matures in 4.5 years. How much will you receive for your bond if the market yield to maturity is currently 5.33 percent? Ignore any accrued interest.
$789.22
The Fisher effect is defined as the relationship between which of the following variables?
real rates, inflation rates and nominal rates
Grand Adventure Properties offers a 9.5 percent coupon bond with annual payments. The yield to maturity is 11.2 percent and the maturity date is 11 years from today. What is the market price of this bond if the face value is $1,000?
$895.43
A 10-year, 4.5 percent, semiannual coupon bond issued by Tyler Rentals has a $1,000 face value. The bond is currently quoted at 98.7. What is the clean price of this bond if the next interest payment will occur 2 months from today?
$987 Clean price = 0.987 x $1,000 = $987
Oil Well Supply offers 7.5 percent coupon bonds with semiannual payments and a yield to maturity of 7.68 percent. The bonds mature in 6 years. What is the market price per bond if the face value is $1,000?
$991.47
The break-even tax rate between a taxable corporate bond yielding 7 percent and a comparable nontaxable municipal bond yielding 5 percent can be expressed as:
0.05/(1 - t*) = 0.07
Getty Markets has bonds outstanding that pay a 5 percent semiannual coupon, have a 5.28 percent yield to maturity, and a face value of $1,000. The current rate of inflation is 4.1 percent. What is the real rate of return on these bonds?
1.13 percent r = 1.0528/1.041 - 1 = 1.13 percent
A bond that pays interest annually yielded 7.47 percent last year. The inflation rate for the same period was 6.10 percent. What was the actual real rate of return on this bond for last year?
1.29 percent r = 1.0747/1.0610 - 1 = 1.29 percent
Soo Lee Imports issued 17-year bonds 2 years ago at a coupon rate of 10.3 percent. The bonds make semiannual payments. These bonds currently sell for 102 percent of par value. What is the yield-to-maturity?
10.01 percent
Al is retired and enjoys his daily life. His one concern is that his bonds provide a steady stream of income that will continue to allow him to have the money he desires to continue his active lifestyle without lowering his present standard of living. Although he has sufficient principal to live on, he only wants to spend the interest income provided by his holdings and thus is concerned about the purchasing power of that income. Which one of the following bonds should best ease Al's concerns?
5-year TIPS
Blackwell bonds have a face value of $1,000 and are currently quoted at 98.4. The bonds have a 5 percent coupon rate. What is the current yield on these bonds?
5.08 percent
The yield to maturity on a bond is currently 8.46 percent. The real rate of return is 3.22 percent. What is the rate of inflation?
5.08 percent h = 1 + 0.0846 / 1 + 0.0322 - 1 = 5.08 percent
An investment offers a 10.5 percent total return over the coming year. Sam Bernanke thinks the total real return on this investment will be only 4.5 percent. What does Sam believe the inflation rate will be for the next year?
5.74 percent? (1 + 0.105) = (1 + 0.045) x (1 + h); h = 5.74 percent
The bonds issued by Stainless Tubs bear a 6 percent coupon, payable semiannually. The bonds mature in 11 years and have a $1,000 face value. Currently, the bonds sell for $989. What is the yield to maturity?
6.14 percent
Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment at maturity. What is the $1,000 called?
Face Value (FV)
Mary just purchased a bond which pays $60 a year in interest. What is this $60 called?
Coupon
A corporate bond is quoted at a price of 103.16 and carries a 6.50 percent coupon. The bond pays interest semiannually. What is the current yield on one of these bonds?
Current yield = (0.065 x $1,000)/(1.0316 x $1,000) = 6.30 percent
Which one of the following relationships is stated correctly?
Decreasing the time to maturity increases the price of a discount bond, all else constant.
Which of the following correctly describe U.S. Treasury bonds? I. have a "tick" size of 1/32 II. highly liquid III. quoted in dollars and cents IV. quoted at the dirty price
I and II only
Which of the following statements concerning bonds are correct? I. Bonds provide tax benefits to issuers. II. The risk of a firm financially failing increases when the firm issues bonds. III. Most long-term bond issues are referred to as unfunded debt. IV. All bonds are treated equally in a bankruptcy proceeding.
I and II only
An 8 percent corporate bond that pays interest semi-annually was issued last year. Which two of the following most likely apply to this bond today if the current yield-to-maturity is 7 percent? I. a structure as an interest-only loan II. a current yield that equals the coupon rate III. a yield-to-maturity equal to the coupon rate IV. a market price that differs from the face value
I and IV only
Recently, you discovered a put able income bond that is convertible. If you purchase this bond, you will have the right to do which of the following? I. force the issuer to repurchase the bond prior to maturity II. choose when you wish to receive interest payments III. convert the bond into a TIPS IV. convert the bond into equity shares
I and IV only
Which of the following increase the price sensitivity of a bond to changes in interest rates? I. increase in time to maturity II. decrease in time to maturity III. increase in coupon rate IV. decrease in coupon rate
I and IV only
Which of the following statements is correct concerning the term structure of interest rates? I. Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates. II. The term structure of interest rates includes both an inflation premium and an interest rate risk premium. III. The real rate of return has minimal, if any, affect on the slope of the term structure of interest rates. IV. The term structure of interest rates and the time to maturity are always directly related.
I, II, III only
Which of the following are negative covenants that might be found in a bond indenture? I. The company shall maintain a current ratio of 1.10 or better. II. No debt senior to this issue can be issued. III. The company cannot lease any major assets without approval by the lender. IV. The company must maintain the loan collateral in good working order.
II and III only
Which of the following defines a note? I. secured II. unsecured III. maturity less than 10 years IV. maturity in excess of 10 years
II and III only
A bond has a market price that exceeds its face value. Which of the following features currently apply to this bond? I. discounted price II. premium price III. yield-to-maturity that exceeds the coupon rate IV. yield-to-maturity that is less than the coupon rate
II and IV only
Which of the following are characteristics of a premium bond? I. coupon rate < yield-to-maturity II. coupon rate > yield-to-maturity III. coupon rate < current yield IV. coupon rate > current yield
II and IV only
Which of the following relationships apply to a par value bond? I. coupon rate < yield-to-maturity II. current yield = yield-to-maturity III. market price = call price IV. market price = face value
II and IV only
Texas Foods has a 6 percent bond issue outstanding that pays $30 in interest every March and September. The bonds are investment grade and sell at par. The bonds are callable at a price equal to the present value of all future interest and principal payments discounted at a rate equal to the comparable Treasury rate plus 0.50 percent. Which of the following correctly describe the features of this bond? I. bond rating of B II. "make whole" call price III. $1,000 face value IV. offer price of $1,000
II, III and IV only
Which two of the following factors cause the yields on a corporate bond to differ from those on a comparable Treasury security? I. inflation risk II. interest rate risk III. taxability IV. default risk
III and IV only
A Treasury bond is quoted at a price of 105:15. What is the market price of this bond if the face value is $5,000?
Price = 105:15 = 105 and 15/32 percent of face = 1.0546875 x $5,000 = $5,273.44
Which one of the following statements concerning bond ratings is correct?
Split rated bonds are called crossover bonds
Which one of the following statements is correct?
The real rate must be less than the nominal rate given a positive rate of inflation.
A 6 percent, annual coupon bond is currently selling at a premium and matures in 7 years. The bond was originally issued 3 years ago at par. Which one of the following statements is accurate in respect to this bond today?
The yield-to-maturity is less than the coupon rate.
The taxability risk premium compensates bond holders for which one of the following?
a bond's unfavorable tax status
All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to maturity.
a discount; less than
Bonds issued by the U.S. government
are considered to be free of default risk
Protective covenants:
are primarily designed to protect bondholders
You want to buy a bond from a dealer. Which one of the following prices will you pay?
asked price
Which one of the following bonds is the least sensitive to interest rate risk? A. 3-year; 4 percent coupon B. 3-year; 6 percent coupon C. 5-year; 6 percent coupon D. 7-year; 6 percent coupon E. 7-year; 4 percent coupon
b. 3-year; 6 percent coupon
bond that is payable to whomever has physical possession of the bond is said to be in:
bearer form
A $1,000 face value bond can be redeemed early at the issuer's discretion for $1,030, plus any accrued interest. The additional $30 is called which one of the following?
call premium
A bond that can be paid off early at the issuer's discretion is referred to as being which one of the following?
callable
A call-protected bond is a bond that:
cannot be called during a certain period of time
A bond is quoted at a price of $989. This price is referred to as which one of the following?
clean price
The Leeward Company just issued 15-year, 8 percent, unsecured bonds at par. These bonds fit the definition of which one of the following terms?
debenture
The Walthers Company has a semi-annual coupon bond outstanding. An increase in the market rate of interest will have which one of the following effects on this bond?
decrease the market price
Which one of the following risk premiums compensates for the possibility of nonpayment by the bond issuer?
default risk
Pete paid $1,032 as his total cost of purchasing a bond. This price is referred to as the:
dirty price
Today, June 15, you want to buy a bond with a quoted price of 98.64. The bond pays interest on January 1 and July 1. Which one of the following prices represents your total cost of purchasing this bond today?
dirty price
A sinking fund is managed by a trustee for which one of the following purposes?
early bond redemption
A bond's coupon rate is equal to the annual interest divided by which one of the following?
face value (FV)
A U.S. Treasury bond that is quoted at 100:11 is selling:
for 100 and 11/32nds percent of face value
Treasury bonds are:
generally issued as semi-annual coupon bonds
Green Roof Inns is preparing a bond offering with a 6 percent, semiannual coupon and a face value of $1,000. The bonds will be repaid in 10 years and will be sold at par. Given this, which one of the following statements is correct?
greater than 7 percent
zero coupon bond
has more interest rate risk than a comparable coupon bond
Callable bonds generally:
have a sinking fund provision
Atlas Entertainment has 15-year bonds outstanding. The interest payments on these bonds are sent directly to each of the individual bondholders. These direct payments are a clear indication that the bonds can accurately be defined as being issued:
in registered form
As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:
increases at a decreasing rate
Real rates are defined as nominal rates that have been adjusted for which of the following?
inflation
The Fisher Effect primarily emphasizes the effects of _____ on an investor's rate of return.
inflation
Which one of the following premiums is compensation for expected future inflation?
inflation
"Cat" bonds are primarily designed to help:
insurance companies fund excessive claims
Which one of the following risks would a floating-rate bond tend to have less of as compared to a fixed-rate coupon bond?
interest rate risk
A "fallen angel" is a bond that has moved from
investment grade to speculative grade
You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur?
long term; zero coupon
Last year, you purchased a "TIPS" at par. Since that time, both market interest rates and the inflation rate have increased by 0.25 percent. Your bond has most likely done which one of the following since last year?
maintained a fixed real rate of return
The current yield is defined as the annual interest on a bond divided by which one of the following?
market price
A Treasury yield curve plots Treasury interest rates relative to which one of the following?
maturity
The specified date on which the principal amount of a bond is payable is referred to as which one of the following?
maturity
Interest rates that include an inflation premium are referred to as:
nominal rates
municipal bonds
pay interest that is federally tax-free
The difference between the price that a dealer is willing to pay and the price at which he or she will sell is called the:
spread
The pure time value of money is known as the:
term structure of interest rates
The liquidity premium is compensation to investors for:
the lack of an active market wherein a bond can be sold for its actual value.
An indenture is:
the legal agreement between the bond issuer and the bondholders
A 6-year, $1,000 face value bond issued by Taylor Tools pays interest semiannually on February 1 and August 1. Assume today is October 1. What will the difference, if any, be between this bond's clean and dirty prices today?
two month's interest
Phil has researched TLM Technologies and believes the firm is poised to vastly increase in value. He wants to invest in this company. Phil has decided to purchase TLM Technologies bonds so that he can have a steady stream of interest income. However, he still wishes that he could share in the firm's success along with TLM's shareholders. Which one of the following bond features will help Phil fulfill his wish?
warrant
Currently, the bond market requires a return of 11.6 percent on the 10-year bonds issued by Winston Industries. The 11.6 percent is referred to as which one of the following?
yield to maturity
You own a bond that has a 6 percent annual coupon and matures 5 years from now. You purchased this 10-year bond at par value when it was originally issued. Which one of the following statements applies to this bond if the relevant market interest rate is now 5.8 percent?
you will realize a capital gain on the bond if you sell it today
A bond that has only one payment, which occurs at maturity, defines which one of the following?
zero coupon
You are trying to compare the present values of two separate streams of cash flows which have equivalent risks. One stream is expressed in nominal values and the other stream is expressed in real values. You decide to discount the nominal cash flows using a nominal annual rate of 8 percent. What rate should you use to discount the real cash flows?
comparable real rate
The interest rate risk premium is the:
compensation investors demand for accepting interest rate risk.
The collar of a floating-rate bond refers to the minimum and maximum:
coupon rates
Last year, Lexington Homes issued $1 million in unsecured, non-callable debt. This debt pays an annual interest payment of $55 and matures 6 years from now. The face value is $1,000 and the market price is $1,020. Which one of these terms correctly describes a feature of this debt?
note
A deferred call provision is which one of the following?
prohibition which prevents bond issuers from redeeming callable bonds prior to a specified date
The items included in an indenture that limit certain actions of the issuer in order to protect bondholder's interests are referred to as the
protective covenants
Which one of the following rates represents the change, if any, in your purchasing power as a result of owning a bond?
real rate
Roadside Markets has a 6.75 percent coupon bond outstanding that matures in 10.5 years. The bond pays interest semiannually. What is the market price per bond if the face value is $1,000 and the yield to maturity is 6.69 percent?
$1,004.47
A corporate bond was quoted yesterday at 102.16 while today's quote is 102.19. What is the change in the value of a bond that has a face value of $6,000?
$1.80 Market price = (1.0219-1.0216) x 6,000 =1.80
You are purchasing a 25-year, zero-coupon bond. The yield to maturity is 8.68 percent and the face value is $1,000. What is the current market price?
$119.52
A Treasury bond is quoted as 99:11 asked and 99:09 bid. What is the bid-ask spread in dollars on a $5,000 face value bond?
$3.13 Bid-ask spread = 99:11 - 99:09 = 2/32 of 1 percent of $5,000 = $3.13
Suppose the real rate is 9.5 percent and the inflation rate is 1.8 percent. What rate would you expect to see on a Treasury bill?
11.47 percent (1 + R) = (1 +0.095) x (1 + 0.018); R = 11.47
Kaiser Industries has bonds on the market making annual payments, with 14 years to maturity, and selling for $1,382.01. At this price, the bonds yield 7.5 percent. What is the coupon rate?
12 percent
Global Communications has a 7 percent, semiannual coupon bond outstanding with a current market price of $1,023.46. The bond has a par value of $1,000 and a yield to maturity of 6.72 percent. How many years is it until this bond matures?
12.53 years
The zero coupon bonds of D&L Movers have a market price of $319.24, a face value of $1,000, and a yield to maturity of 9.17 percent. How many years is it until these bonds mature?
12.73 years
A Treasury bond is quoted at a price of 106:23 with a 3.50 percent coupon. The bond pays interest semiannually. What is the current yield on one of these bonds?
3.28 percent 1.0671875 x $1,000 = $1,067.1875 (0.035 x $1,000)/$1,067.1875 = 3.28 percent
Northern Warehouses wants to raise $11.4 million to expand its business. To accomplish this, it plans to sell 40-year, $1,000 face value, zero-coupon bonds. The bonds will be priced to yield 8.75 percent. What is the minimum number of bonds it must sell to raise the $11.4 million it needs?
350,448
The outstanding bonds of The River Front Ferry carry a 6.5 percent coupon. The bonds have a face value of $1,000 and are currently quoted at 101.6. What is the current yield on these bonds?
6.40 percent
Green brier Industrial Products' bonds have a 7.60 percent coupon and pay interest annually. The face value is $1,000 and the current market price is $1,062.50 per bond. The bonds mature in 16 years. What is the yield to maturity?
6.94 percent
Mary is a retired widow who is financially dependent upon the interest income produced by her bond portfolio. Which one of the following bonds is the least suitable for her to own?
7- year income bond
Redesigned Computers has 5.25 percent coupon bonds outstanding with a current market price of $546.19. The yield to maturity is 16.28 percent and the face value is $1,000. Interest is paid semiannually. How many years is it until these bonds mature?
7.08 years
Bryceton, Inc. has bonds on the market with 13 years to maturity, a yield-to-maturity of 9.2 percent, and a current price of $895.09. The bonds make semiannual payments. What is the coupon rate?
7.80 percent
The outstanding bonds of Winter Time Products provide a real rate of return of 3.03 percent. The current rate of inflation is 4.68 percent. What is the actual nominal rate of return on these bonds?
7.85 percent (1 + 0.0303) x (1 + 0.0468) - 1 = 7.85 percent
Colling wood Homes has a bond issue outstanding that pays an 8.5 percent coupon and matures in 18.5 years. The bonds have a par value of $1,000 and a market price of $964.20. Interest is paid semiannually. What is the yield to maturity?
8.90 percent
Sylvan Trees has a 7 percent coupon bond on the market with ten years left to maturity. The bond makes annual payments and currently sells for $861.20. What is the yield-to maturity?
9.18 percent
Which one of the following is the price a dealer will pay to purchase a bond?
bid price