Fina Chp 8

If you invest in a corporate bond, how many times can you expect, in general, to receive interest?

twice a year

What are the two unique features of a U.S. federal government bond?

U.S. Treasury issues are exempt from state income taxes. U.S. Treasury issues are considered to be default-free.

If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?

The 10-year bond

The interest from a municipal bond is exempt from ____ income taxes.

federal

Assume you own a bond currently valued at $989. If the market rate of interest drops, the bond's current market value will _____.

increase

A bond's yield to maturity considers the interest earnings and the change in the bond's price while the current yield considers ____.

interest earnings only

The relationship between bond prices and the market rate of interest is ____.

inverse

The federal government can raise money from financial markets to finance its deficits by ___.

issuing bonds

What will happen to a bond's time to maturity as the years go by?

it will decline

What is a premium bond?

A bond that sells for more than face value

If a bond is selling at a discount from its par value, the YTM must be _____ the coupon rate.

greater than

True or false: A bond's value is not affected by changes in the market rate of interest.

False

What is the yield on a 10-year zero-coupon bond with a par value of $1,000 if it is purchased for $490?

7.26%

What is the real value of an expected bond payment of $1,000 in 10 years if the rate of inflation is expected to be 5%?

613.91

What is the real value of an expected bond payment of $1,000 in 7years if the rate of inflation is expected to be 3%?

813.09

What is the difference between the quoted yield and the effective yield?

The quoted yield does not adjust for compounding, while the effective yield adjust for compounding

What is the promised yield on a corporate bond that is currently priced at $950 and will pay $1,050 in 1 year?

10.53

U.S. Treasury notes and bonds have initial maturities ranging from ___ years.

2 to 30

At what tax rate will you be indifferent between a muni that yields 7 percent and a comparable corporate bond yielding 9 percent?

22.22%

Assume you own a bond that was issued by a blue-chip company. If the market rate of interest rises, what will happen to the value of your bond?

the bond value will fall

If a $1,000 par value bond is trading at a premium, the bond is:

trading for more than $1,000 in the market

Assume you are holding a 1-year bond that is expected to pay $1075 if all goes well. However, there is a 75% probability that the corporation will file for bankruptcy and bondholders will receive only $400. If the required rate of return is 10%, what is the present value of the bond?

517.05

What is the effective annual rate on a bond with a yield to maturity of 6 percent that pays semiannual interest?

6.09%

What will your aftertax yield be on a corporate bond that is currently trading at par and yielding 8 percent if you are in the 20 percent tax bracket?

6.4%

Why does a bond's value fluctuate over time?

The coupon rate and par value are fixed, while market interest rates change

If you invest in a $1,000 corporate bond that has a 9 percent coupon and makes semi-annual payments, you can expect to receive ____ each six months.

$1,000 (.09/2) = $45

What is the present value of $1,000 to be received in 10 years if the interest rate is 12 percent, compounded semiannually?

$1,000/[1 +(.12/2)]^(10 × 2) = $311.80

What is the value of a zero coupon bond that matures in 15 years if it promises to pay $5,000 at maturity, assuming an interest rate of 7.5 percent compounded annually?

$5,000/(1.075)^15 = $1,689.83

A bond pays annual coupon payments of $50, has a face value of $1,000, and a market price of $1,200. How is the coupon rate computed?

$50/$1,000

What is the present value of $500 to be received every year for the next 10 years if the interest rate is 5 percent?

$500 × (1 - 1/1.05^(10))/.05 = $3,860.87

What is the real rate of return if the nominal rate is 7 percent and the rate of inflation is 2 percent?

(1.07/1.02) - 1 = 4.90%

What will your aftertax yield be on a corporate bond that is currently priced to yield 7% percent if you are in the 25 percent tax bracket?

5.25%

What is the aftertax yield on a U.S. Treasury bond yielding 7 percent if you are in the 20 percent tax bracket?

5.6%

What is the yield on a 5-year zero-coupon bond with a par value of $1,000 if it is purchased for $750?

5.84%

A corporation issues 50,000 bonds at $1,000 each. The bonds mature in 5 years and have a coupon rate of 7 percent. What will the total annual interest expense be for the corporation?

50,000 × $1,000 × .07 = $3,500,000

What is the effective annual rate for a bond with a 7 percent yield to maturity that makes semi-annual interest payments? (Hint: 7 percent annually is 3.5 percent per six-month period.)

7.12%

How is a conventional bond different from a zero coupon bond?

A conventional bond pays periodic coupon interest whiles zeroes make no interest payments. Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeroes can not.

If the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ____.

Bond value = $320 + 900 = $1,220

Which of these are required to calculate the current value of a bond?

Coupon Applicable market rate Time remaining to maturity Par value

What of the following terms apply to a bond?

Coupon rate Par value Time to maturity

What information is needed to compute a bond's yield to maturity?

Coupon rate Time to maturity The bond's current price

What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?

Coupon rate =$100/$1,000 = 10%

Which of these affect a bond's yield to maturity?

Current price Par value Coupon rate

What is a bond's current yield?

Current yield = annual coupon payment / current price

Which of the following institutions issue bonds that are traded in the bond market?

Public corporations State governments The federal government

Why is the YTM of a discount bond greater than the bond's current yield?

The current yield does not include the capital gain from the price discount.

Which of the following are features of municipal bonds?

The interest on municipal bonds is exempt from federal taxes. They are issued by state and local governments.

The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?

Time to maturity Coupon rate

A corporate bond's yield to maturity ____.

changes over time can be greater than, equal to, or less than the bond's coupon rate

A conventional bond's cash flows consist of:

coupon interest payments repayment of the bond's par value at maturity

Which of the following accounts for compounding?

effective annual rate effective monthly rate

In general, a corporate bond's coupon rate ____,

fixed until bond matures

If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ______$1,000.

less than

When using trial and error to compute the yield to maturity (YTM) for a 6 percent coupon bond that trades at a premium, the process can be shortened if the initial guess is ____ 6 percent.

lower than

What information is needed to compute the promised yield on a bond?

maturity, par, discount

What is the present value of the annual interest payments on a 10-year, $1,000 par value bond with a coupon rate of 10 percent paid annually, if the yield on similar bonds is 9 percent?

pv of coupons=C*((1-(1/1+r^t)/r)=641.77

If market interest rates ______, the bond price will ______.

rise; fall fall; rise

What is a discount bond?

Discount bonds are bonds that sell for less than the face value.

A 10-year AAA corporate bond is most apt to have a yield that ____ the yield on a 10-year AAA state government bond.

EXCEEDS

Which of the following are premiums determine the yield on a bond?

Interest rate risk Liquidity Expected future inflation Taxability Default risk

Which of the following is true about a multi-year typical bond's coupon?

It is a fixed annuity payment.

Which of the following are true about a bond's face value?

It is also known as the par value. It is the principal amount repaid at maturity.

What is the definition of a bond's time to maturity?

It is the number of years until the face value is paid off

What is an interest-only loan?

It's a loan in which the borrower pays interest periodically and repays the principal when the bond matures.

Which one of the following is the most important source of risk from owning bonds?

Market interest rate fluctuations

Which of the following variables are required to calculate the value of a bond?

Market yield Coupon rate Remaining life of bond

What is the principal amount of a loan if the monthly payment on a 30-year mortgage is $1,600? Assume an annual interest rate of 6 percent, compounded monthly.

PV = $1,600 × ({1 - 1/[1 + (.06/12)]^(30 × 12)}/(.06/12)) PV = $266,866.58

What is the present value of the annual interest payments on a 20-year, $1,000 par value bond with a 5 percent coupon paid annually, if the yield on similar bonds is 10 percent?

PV = (.05 × $1,000) × (1 - 1/1.10^20)/.10 = $425.68

Assume a bond has a $1,000 par value, a coupon rate of 6 percent, annual interest payments, and 7 years to maturity. If the yield on similar bonds is 8 percent, what is the current market value of this bond?

PV = (.06x1000) x (1-1/1.08^7)/.08 + (1000/1.08^7) = 895.87

A firm decides to raise money by issuing 5 million bonds with a par value of $5,000 each for 10 years at a coupon rate of 7 percent. At the time of issue, the bonds were sold for $5,500 each. What will the par value of the bonds be in year 5?

Par value is not affected by interest rates, market price, or time.$5,000 per bond

At what tax rate will you be indifferent between a muni that yields 5% and a comparable corporate bond yielding 6%?

16.67

Why did Disney issue 100-year bonds, dubbed "Sleeping Beauty" bonds, in the 1990s?

To lock-in historically low interest rates for a long time

What is the current yield on a $1,000 par value bond that sells for $900 if the coupon rate is 10 percent?

11.11%

Assume you are holding a 1-year bond that is expected to pay $1050 if all goes well. However, there is a 90% probability that the corporation will file for bankruptcy and bondholders will receive only $200. If the required rate of return is 15%, what is the present value of the bond?

247.83

A $1,000 par value bond has a coupon rate of 8 percent and pays interest semiannually. If the bond is sold 2 months before the next coupon payment, the accrued interest will be ___.

26.67

If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes.

5%

What is the effective annual yield for a bond that pays interest semiannually and has a quoted yield to maturity of 10 percent?

10.25%

The US government borrows money by issuing:

Treasury bonds, and treasury notes.

How is investing in U.S. Treasury bonds different from investing in corporate bonds?

Treasury issues have virtually no default risk. Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not.

What is a corporate bond's yield to maturity (YTM)?

YTM is the prevailing market interest rate for bonds with similar features. YTM is the expected return for an investor who buys the bond today and holds it to maturity.