Fin 3200- Chapter 6

A bond with a BB rating has a _________________ than a bond with a BBB rating.

higher risk of default

Suppose a bond's clean price is $1,050, and the bond currently has accrued interest of $30. What is the dirty price?

$1,080 $1,050+30= $1,080

Harrison Co. issued 13-year bonds one year ago at a coupon rate of 7 percent. The bonds make semiannual payments. If the YTM on these bonds is 5.3 percent, what is the current dollar price assuming $1,000 par value?

$1,149.53 N=(12x2), I/Y=(5.3%/2), PMT=(70/2), FV=1,000

Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?

1. Treasury bonds are issued by the US government while corporate bonds are issued by corporations 2. Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer 3. Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk

The US government borrows money by issuing:

1. Treasury notes 2. Treasury bonds

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

1. YTM is the expected return for an investor who buys the bond today and holds it until maturity 2. YTM is the prevailing market interest rate for bonds with similar features

A U.S. Treasury bond pays 3.05 percent interest. You are in the 28 percent marginal tax bracket. What is your after tax yield on this bond?

2.20 percent .0305(1-.28)= .02196 .02196 x 2= 2.20 percent

AB builders has 15-year bonds outstanding with a face value of $1,000 and market price of $974. The bonds pay interest annually and have a yield to maturity of 4.03 percent. What is the coupon rate?

3.80% N=15, I%=4.03, PV=-974, FV=1000 PMT=37.96 37.96/1000=.03796 x100= 3.80%

The price at which an investor can purchase in the bond market is called the ______________ price.

Asked

Equity represents a(n) ________________ interest of a firm.

Ownership

What are the cash flows involved in the purchase of a 5-year zero-coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5%.

Pay $800 today and receive $1,000 at the end of 5 years

What is the equation for approximating the nominal rate of return?

R=r+h

The term structure of interest rates examine the ______________.

Relationship between short-term and long-term interest rates

Which type of debt is given preference in the event of default?

Senior

When long-term rates are higher than short-term rates, which of the following shapes will the term structure of interest rates usually have?

Upward sloping

New Markets has $1,000 face value bonds outstanding that pay interest semiannually, mature in 14.5 years, and have a 4.5 percent coupon. The current price is quoted at 976. What is the yield to maturity?

4.73% N=(14.5x2), PV=-976, PMT=(.045x1000)=45 45/2=22.5, FV=1000 I/Y= 2.37 2.37x2= 4.73%

A bond yielded a real rate of return of 3.87 percent for a time period when the inflation rate was 3.75 percent. What was the actual nominal rate of return?

7.77 percent (1.0387)(1.0375)-1= .07765125 .07765125 x 2= 7.77 percent

What four variables are required to calculate the value of a bond?

1. Par value 2. Yield to maturity 3. Coupon rate 4. Time remaining to maturity

Union Local School District has bonds outstanding with a coupon rate of 3.6 percent paid semiannually and 12 years to maturity. The yield to maturity on these bonds is 2.4 percent and the bonds have a par value of $5,000. What is the price of the bonds?

$5,622.38 N=24, I/Y=1.2, PMT=90, FV=5000

What is the price of a U.S Treasury bond that is listed at 90 if the par value is $1,000?

$900 $1,000x90%=$900

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

$3.5 million 50,000 x $1,000 x .07= $3,500,000

Which of the following are bonds that have actually been issued?

1. A put bond 2. A CoCo bond 3. A convertible bond

Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact Treasury bond yields?

1. Default risk premiums 2. Liquidity premium

As a general rule, which of the following are true of debt and equity?

1. Equity represents an ownership interest 2. The maximum reward for owning debt is fixed

If you are in the 20% federal income tax bracket, what is your after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are not state or local taxes.

5% Interest income from munis is exempt from federal income tax

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% .07(1-.25)=.0252 x100=5.25%

What are crossover bonds?

Bonds that have both an investment grade and a junk bond rating

What are "fallen angel" bonds?

Bonds that have dropped from investment grade to junk bond status

Bond ratings classify bonds based on:

Default risk only

Which one of the following provides compensation to a bondholder when a bond is not readily marketable at its full value?

Liquidity premium

The purpose of a bond sinking fund is to:

Repay bonds early either through purchases or calls

The relationship between nominal rates, real rates, and inflation is called____________.

The Fisher Effect

What does a bond's ratings reflect?

The ability of the firm to repay its debt and interest on time

If you are holding two bonds - one with a 5% coupon rate and the other with a 8% coupon rate - which one is more sensitive to interest rate risk, all other things being equal?

The bond with a 5% coupon rate All other things being equal, the lower the coupon rate, the greater the interest rate risk

Bond ratings are based on the probability of default risk, which is the risk that _______________.

The bond's issuer may not be able to make all of the required payments

On which one of the following dates is the principle amount of a semiannual coupon bond repaid?

The entire bond is repaid on the maturity date

What does the clean price for a bond represent?

The quoted price excluding accrued interest

True of False: The price you actually pay to purchase a bond will generally exceed the clean price.

True

Most of the time, a floating-rate bond's coupon adjusts ______________.

With a lag to some base rate

True of False: A debenture is a bond secured with collateral .

False

A limitation of bond ratings is that they _____________.

Focus exclusively on default risk

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

Greater than

What is the nominal rate of return on an investment?

It is the actual percentage change in the dollar value of an investment unadjusted for inflation

What is the inflation premium?

It is the additional return demanded by investors to compensate for expected inflation

What is a premium bond?

A bond that sells for more than face value

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

What term is used to describe an account that a bond trustee manages for the sole purpose of redeeming bonds early?

Sinking fund

True or False: In general, the price that is paid for a bond will exceed its quoted price.

True

ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?

$60 is interest at the end of each year for 10 years an a $1,000 repayment of principal at the end of 10 years.

Lycan, Inc., has 7.8 percent coupon bonds on the market that have 7 years left to maturity. The bonds make annual payments and have a par value of $1,000. If the YTM on these bonds is 9.8 percent, what is the current bond price?

$901.99 N=7, I/Y= 9.8%, PMT=$78 (.078x1000), FV=$1,000

What are the three components that influence the Treasury yield curve?

1. Expected future inflation 2. The interest rate risk premium 3. The real rate of return

What is a real rate of return?

1. It is a rate of return that has been adjusted for inflation 2. It is a percentage change in buying power

What is the bid price?

1. It is the price an investor will receive if he sells a bond to a dealer 2. It is the price at which a dealer is willing to buy securities.

A bond has a $1,000 face value, a market price of $1,045, and pays interest payments of $74.50 every year. What is the coupon rate?

7.45% 74.50 / 1000= .0745 .0745 x 1000= 7.45%

If bonds for AT&T are quoted at 115, they can be purchased:

At 115% of par value plus accrued interest

If a $1,000 face value U.S Treasury bond is quoted at 99.5, then the bond can be purchased _________________.

At 99.5% of face value plus any accrued interest

What are municipal bonds?

Bonds that have been issued by state or local governments

If inflation is expected to steadily decrease in the future, the term structure of interest rates will most likely be:

Downward sloping

Barnes Enterprise has bonds on the market making annual payments, with 16 years to maturity, a par value of $1,000, and a price of $962. At this price, the bond yield 8.5 percent. What must the coupon rate be on bonds?

8.06%

What are some features of the OTC market for bonds?

1. The OTC has no designated physical location 2. OTC dealers are connected electronically

Junk bonds have the following features:

1. They have high probability of default 2. They pay a high rate of interest 3. They are rated below investment grade bonds

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

1. Time to maturity 2. Coupon rate

What are the two major forms of long-term debt?

1. Private issue 2. Public issue