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6BONDSCHARACTERISTICS CHAPTER AND VALUATION
TRUE/FALSE
1. Typically, debentures have higher interest rates than mortgage bonds primarily because the mortgage bonds are backed by assets while debentures are unsecured.
DIF: Easy TOP: Mortgage bonds
2. A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates. DIF: Easy TOP: Call provision
3. Issuing zero coupon bonds might appeal to a company that is considering investing in a long-term project that will not generate positive cash flows for several years. DIF: Easy TOP: Zero coupon bonds
4. The motivation for floating rate bonds arose out of the costly experience of the early 1980s when inflation pushed interest rates to very high levels causing sharp declines in the prices of long-term bonds. DIF: Easy TOP: Floating rate debt
5. Because junk bonds are such high-risk instruments, the returns on such bonds aren't very high and the existence of this market detracts from social welfare. DIF: Easy TOP: Junk bonds and social welfare
6. There is an inverse relationship between bond ratings and the required return on a bond. The required return is lowest for AAA rated bonds, and required returns increase as the ratings get lower (worse). DIF: Easy TOP: Bond ratings and required returns
7. LIBOR is an acronym for London Interbank Offer Rate, which is an average of interest rates offered by London banks to U.S. corporations. DIF: Easy TOP: LIBOR
8. In general, long-term unsecured debt is less costly than long-term secured for a particular firm. DIF: Easy TOP: Types of debt
9. Foreign debt is a debt instrument sold by a foreign borrower but denominated in the currency of the country in which it is sold. DIF: Easy TOP: Foreign debt
10. Foreign debt is debt sold in a country other than the one in whose currency the debt is denominated. DIF: Easy TOP: Foreign debt
11. Eurobonds have a higher level of required disclosure than normally is found for bonds issued in domestic markets, particularly the United States.
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DIF: Easy
TOP: Foreign debt
12. Eurobonds are typically issued as registered bonds rather than bearer bonds. DIF: Easy TOP: Foreign debt
13. Eurocredits are bank loans that are denominated in the currency of a country other than where the lending bank is located. DIF: Easy TOP: Foreign debt
14. Although common stock represents a riskier investment to an individual than do bonds, in the sense of exposing the firm to the risk of bankruptcy, bonds represent a riskier method of financing to a corporation than does common stock. DIF: Medium TOP: Types of financing
15. Restrictive covenants are designed so as to protect both the bondholder and the issuer even though they may constrain the actions of the firm's managers. Such covenants are contained in the bond's indenture. DIF: Medium TOP: Restrictive covenants
16. One of the disadvantages to a firm in issuing zero coupon bonds is that the tax shield associated with the bonds' appreciation cannot be claimed until the bond matures. DIF: Medium TOP: Zero coupon interest
17. Floating rate debt is advantageous to investors because the interest rate moves up if market rates rise. Floating rate debt shifts interest rate risk to companies and thus has no advantages for issuers. DIF: Medium TOP: Floating rate debt
18. If a firm raises capital by selling new bonds, the buyer is called the "issuing firm," and the coupon rate is generally set equal to the required rate. DIF: Easy TOP: Issuing bonds
19. A 20-year original maturity bond with 1 year left to maturity has more interest rate price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates.) DIF: Easy TOP: Interest rate risk
20. Regardless of the size of the coupon payment, the price of a bond moves in the opposite direction from interest rate movements. For example, if interest rates rise, bond prices fall. DIF: Easy TOP: Prices and interest rates
21. Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, be subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond. DIF: Easy TOP: Interest rate risk
22. A bond's value will increase as interest rates rise over time. DIF: Easy TOP: Bond value
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23. You have just noticed in the financial pages of the local newspaper that you can buy a bond ($1,000 par) for $800. If the coupon rate is 10 percent, with annual interest payments, and there are 10 years to maturity, should you make the purchase if your required return on investments of this type is 12 percent?
Tabular solution: Vd = $100 (PVIFA12%, 10) + $1,000 (PVIF12%, 10) = $100 (5.6502) + $1,000 (0.3220) = $877.02. Thus, the value is significantly higher than the market price and the bond should be purchased. Financial calculator solution: Inputs: N = 10; I = 12; PMT = 100; FV = 1,000. Output: PV = -$887.00. DIF: Medium TOP: Bond value
24. If two bonds have the same maturity and the same expected rate of return, but one has a higher coupon, the price of the low coupon bond will be more affected by a given change in interest rates. DIF: Medium TOP: Prices and interest rates
25. A bond with a $100 annual interest payment and $1,000 face value with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates were greater than 11%. DIF: Medium TOP: Bond premium and discounts
26. Call provisions on corporate bonds are generally included to protect the issuer against large declines in interest rates. They affect the actual maturity of the bond but not its price. DIF: Medium TOP: Callable bonds
27. Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10 percent currently have a yield to maturity (YTM) equal to 8 percent. Based on this information, BB&C's bonds must currently be selling at a premium in the financial markets. DIF: Medium TOP: Bond premium and discounts
28. If a bond is callable, and if interest rates in the economy decline, then the company can sell a new issue of low-interest-rate bonds and use the proceeds to "call" the old bonds in and have effectively refinanced at a lower rate. DIF: Medium TOP: Call provision
29. If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be selling at a discount; i.e., the bond's market price should be less than its face (maturity) value. DIF: Medium TOP: Bond premium and discounts
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30. If you buy a bond that is selling for less than its face, or maturity, value then the price (value) of the bond will increase the maturity date nears if market interest rates do not change during the life of the bond. DIF: Medium TOP: Bond value
31. The longer the maturity of a bond, the more its price will change in response to a given change in interest rates; this is called interest rate price risk. DIF: Medium TOP: Bond prices and interest rates
32. Bonds with long maturities expose the investor to high interest rate reinvestment risk, which is the risk that income will differ from what is expected because the cash flows received from bonds will have to be reinvested at different interest rates. DIF: Medium TOP: Bond prices and interest rates
33. If we have two bonds with a simple interest rate yield of 9% where one bond is compounded quarterly and the other bond is compounded monthly, the bond compounded quarterly will have a higher effective annual yield. DIF: Medium TOP: Bond yields
34. All else equal, a zero-coupon bond's price is more sensitive to changes interest rates than a bond with a 10% annual coupon. DIF: Medium TOP: Bond prices and interest rates
MULTIPLE CHOICE
1. Which of the following are generally considered advantages of term loans over publicly issued bonds? a. Lower flotation costs. b. Speed, or how long it takes to bring the issue to market. c. Flexibility, or the ability to adjust the bond's terms after it has been issued. d. All of the above. e. Only answers b and c above. DIF: Easy OBJ: TYPE: Conceptual TOP: Term loans
2. Other things held constant, if a bond indenture contains a call provision, the yield to maturity that would exist without such a call provision will generally be __________ the YTM with it. a. Higher than b. Lower than c. The same as d. Either higher or lower, depending on the level of call premium, than e. Unrelated to DIF: Easy OBJ: TYPE: Conceptual TOP: Call provision
3. The terms and conditions to which a bond is subject are set forth in its a. Debenture. b. Underwriting agreement. c. Indenture. d. Restrictive covenants. e. Call provision.
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98
DIF: Easy
OBJ: TYPE: Conceptual
TOP: Bond indenture
4. A contract negotiated directly with a bank in which the borrower agrees to make a series of interest and principal payments on specific dates to the bank is called a. preferred stock. b. commercial paper. c. convertible debt. d. a term loan. e. a bond issue. DIF: Easy OBJ: TYPE: Conceptual TOP: Term loans
5. A bond differs from term in loans in that a. a bond issue is generally advertised. b. a bond is sold to many investors. c. a bond is offered to the public. d. All of the above. e. None of the above. DIF: Easy OBJ: TYPE: Conceptual TOP: Bonds
6. Which of the following types of debt are backed by some form of specific property? a. Debenture. b. Mortgage bond. c. Subordinated debt. d. All of the above. e. None of the above. DIF: Easy OBJ: TYPE: Conceptual TOP: Types of debt
7. A bond that has a claim on assets only after the senior debt has been paid off in the event of liquidation is called what? a. Debenture. b. Income bond. c. Indenture. d. Subordinated debenture. e. Mortgage bond. DIF: Easy OBJ: TYPE: Conceptual TOP: Types of debt
8. Bonds that can be exchanged for shares of equity at the owner's discretion are called what? a. Debenture. b. Indenture. c. Callable bond d. Convertible bond. e. Putable bond. DIF: Easy OBJ: TYPE: Conceptual TOP: Types of debt
9. A bond that only pays interest if the firm has sufficient earnings to cover the interest payments is called what? a. Callable bond. b. Putable bond. c. Convertible bond. d. Income bond. e. Indexed bond.
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DIF: Easy
OBJ: TYPE: Conceptual
TOP: Types of debt
10. A bond that can be redeemed for cash at the bondholder's option is called what? a. Convertible bond. b. Putable bond. c. Callable bond. d. Debenture. e. Income bond. DIF: Easy OBJ: TYPE: Conceptual TOP: Types of debt
11. Which of the following events would make it less likely that a company would choose to call its outstanding callable bonds? a. Increase in interest rates. b. Decrease in interest rates. c. Increase in price of outstanding convertible bonds. d. A decrease in call premium. e. Answers b and c only. DIF: Easy OBJ: TYPE: Conceptual TOP: Callable bonds
12. A bond that pays no annual interest but is sold at a discount below its par value is called what? a. Mortgage bond. b. Callable bond. c. Convertible bond. d. Putable bond. e. Zero coupon bond. DIF: Easy TOP: Zero coupon bonds OBJ: TYPE: Conceptual
13. __________ are high-risk, high-yield bonds used to finance mergers, leveraged buyouts, and troubled companies. a. Callable bonds b. Junk bonds c. Convertible bonds d. Floating rate bonds e. Putable bonds DIF: Easy OBJ: TYPE: Conceptual TOP: Junk bond
14. Which of the following ratings by Moody's represent bonds that are at least investment grade? a. Caa b. Baa c. B d. Ba e. None of the above. DIF: Easy OBJ: TYPE: Conceptual TOP: Bond ratings
15. Which of the following ratings by Standard & Poor's represent speculative grade debt? a. A b. B c. BB d. BBB e. None of the above.
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DIF: Easy
OBJ: TYPE: Conceptual
TOP: Bond ratings
16. Which of the following types of debt protect a bondholder against an increase in interest rates? a. Floating rate debt. b. Bonds that are redeemable ("putable") at par at the bondholders' option. c. Bonds with call provisions. d. All of the above. e. Only answers a and b above. DIF: Medium OBJ: TYPE: Conceptual TOP: Types of debt
17. Which of the following statements is correct? a. A zero coupon bond provides no interest payments during the life of the bond, but it provides its owner with a capital gain when the bond matures. In the United States, these bonds appeal to high-income investors because the tax on capital gains income is deferred until the bond matures or is sold. b. The "penalty" for having a low bond rating is more severe when the Security Market Line (SML) is relatively steep than when it is not so steep. c. A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond. d. A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells) at par, therefore providing compensation to investors in the form of capital appreciation. e. None of the above is a correct statement. DIF: Medium TOP: Miscellaneous concepts OBJ: TYPE: Conceptual
18. Which of the following statements is false? a. Any bond sold outside the country of the borrower is called an international bond. b. Foreign bonds and Eurobonds are two important types of international bonds. c. Foreign bonds are bonds sold by a foreign borrower but denominated in the currency of the country in which the issue is sold. d. The term Eurobond specifically applies to any foreign bonds denominated in U.S. currency. e. None of the above. DIF: Medium TOP: International bond markets OBJ: TYPE: Conceptual
19. Which type of investor would be most likely to purchase zero coupon bonds? a. Retired individuals seeking income for current consumption. b. Individuals in high tax brackets. c. Tax free investors such as pension funds. d. Risk averse individuals anticipating increases in interest rates. e. None of the above. DIF: Medium TOP: Zero coupon bonds OBJ: TYPE: Conceptual
20. Which of the following securities is the riskiest to investors? a. Floating rate notes. b. Income bonds. c. Treasury bills. d. First mortgage bonds.
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e. Common stock. DIF: Medium TOP: Types of securities OBJ: TYPE: Conceptual
21. Listed below are some provisions that are often contained in bond indentures: 1. 2. 3. 4. 5. 6. Fixed assets may be used as security. The bond may be subordinated to other classes of debt. The bond may be made convertible. The bond may have a sinking fund. The bond may have a call provision. The bond may have restrictive covenants in its indenture.
Which of the above provisions, each viewed alone, would tend to reduce the yield to maturity investors would otherwise require on a newly issued bond? a. 1, 2, 3, 4, 5, 6 b. 1, 2, 3, 4, 6 c. 1, 3, 4, 5, 6 d. 1, 3, 4, 6 e. 1, 4, 6 DIF: Tough OBJ: TYPE: Conceptual TOP: Bond indenture
22. Rollincoast Incorporated issued BBB bonds two years ago that provided a yield to maturity of 11.5 percent. Long-term risk-free government bonds were yielding 8.7 percent at that time. The current risk premium on BBB bonds versus government bonds is half what it was two years ago. If the risk-free long-term governments are currently yielding 7.8 percent, then at what rate should Rollincoast expect to issue new bonds? a. 7.8% b. 8.7% c. 9.2% d. 10.2% e. 12.9% Calculate the previous risk premium, RPBBB, and new RPBBB: RPBBB = 11.5% - 8.7% = 2.8%. New RPBBB = 2.8%/2 = 1.4%. Calculate new YTM on BBB bonds: YTMBBB = 7.8% + 1.4% = 9.2%. DIF: Easy OBJ: TYPE: Problem TOP: Risk premium on bonds
23. S. Claus & Company is planning a zero coupon bond issue. The bond has a par value of $1,000, matures in 2 years, and will be sold at a price of $826.45. The firm's marginal tax rate is 40 percent. What is the annual after-tax cost of debt to the company on this issue? a. 4.0% b. 6.0% c. 8.0% d. 10.0% e. 12.0%
Chapter6BondsCharacteristicsandValuation 102
Tabular solution: First, find the value of kd as the interest rate which will cause $826.45 to grow to $1,000 in 2 years. $1,000 = $826.45(FVIFi,2) FVIFi,2 = 1.2100 I = 0.10 = kd = 10%. kdT = kd(1 - T) = 0.10(0.6) = 0.06 = 6%. Analysis of cash flows method using calculated kd = 10% and financial calculator: Year: Accrued value Interest ((Vt 1.10) - Vt) Tax saving (Interest 0.40) Cash flows 0 $826.45 1 $909.10 82.65 33.06 +33.06 2 $1,000.00 90.90 36.36 +36.36 -1,000.00 -$ 963.64
+826.45
Financial calculator solution: (Using CFs from worksheet analysis) Inputs: = 826.45; = 33.06; = -963.64. Output: IRR% = 6.0%. kdT = 6.0%. DIF: Medium OBJ: TYPE: Problem TOP: Zero coupon bonds
24. GP&L sold $1,000,000 of 12 percent, 30-year, semiannual payment bonds 15 years ago. The bonds are not callable, but they do have a sinking fund which requires GP&L to redeem 5 percent of the original face value of the issue each year ($50,000), beginning in Year 11. To date, 25 percent of the issue has been retired. The company can either call bonds at par for sinking fund purposes or purchase bonds on the open market, spending sufficient money to redeem 5 percent of the original face value each year. If the yield to maturity (15 years remaining) on the bonds is currently 14 percent, what is the least amount of money GP&L must put up to satisfy the sinking fund provision? a. $43,856 b. $50,000 c. $37,500 d. $43,796 e. $39,422
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The company must call 5% or $50,000 face value each year. It could call at par and spend $50,000 or buy on the open market. Since the interest rate is higher than the coupon rate (14% vs. 12%), the bonds will sell at a discount, so open market purchases should be used.
Financial calculator solution: Inputs: N = 30; I = 7; PMT = 60; FV = 1,000. Output: PV = -875.91. The company would have to buy 50 bonds at $875.91 each = $43,795.50 DIF: Tough OBJ: TYPE: Problem $43,796. TOP: Bond sinking fund payments
25. Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10.65 percent currently have a yield to maturity (YTM) equal to 15.25 percent. Based on this information, BB&C's bonds must currently be selling at __________ in the financial markets. a. par value b. a discount c. a premium d. Not enough information is given to answer this question. e. None of the above is a correct answer. DIF: Easy TOP: Bond premium and discounts OBJ: TYPE: Conceptual
26. If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be a. selling at a discount; i.e., the bond's market price should be less than its face (maturity) value. b. selling at a premium; i.e., the bond's market price should be greater than its face value. c. selling at par; i.e., the bond's market price should be the same as its face value. d. purchased because it is a good deal. DIF: Easy TOP: Bond premium and discounts OBJ: TYPE: Conceptual
27. A 12-year bond that has a 12 percent coupon rate is currently selling for $1,000, which equals the bond's face value. If interest is paid semiannually, the bond's yield to maturity is a. equal to 12 percent. b. greater than 12 percent. c. less than 12 percent. d. More information is needed to answer this question. e. None of the above is correct. DIF: Easy OBJ: TYPE: Conceptual TOP: Bond yields
28. Which of the following statements is correct? a. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond. b. Other things held constant, a corporation would rather issue noncallable bonds than
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callable bonds. c. Reinvestment rate risk is worse from a typical investor's standpoint than interest rate price risk. d. If a 10-year, $1,000 par, zero coupon bond were issued at a price which gave investors a 10 percent rate of return, and if interest rates then dropped to the point where kd = YTM = 5%, we could be sure that the bond would sell at a premium over its $1,000 par value. e. If a 10-year, $1,000 par, zero coupon bond were issued at a price which gave investors a 10 percent rate of return, and if interest rates then dropped to the point where kd = YTM = 5%, we could be sure that the bond would sell at a discount below its $1,000 par value. A zero coupon bond will always sell at a discount below par, provided interest rates are above zero, which they always are. DIF: Medium OBJ: TYPE: Conceptual TOP: Bonds
29. Which of the following statements is correct? a. Rising inflation makes the actual yield to maturity on a bond greater than the quoted yield to maturity which is based on market prices. b. The yield to maturity for a coupon bond that sells at its par value consists entirely of an interest yield; it has a zero expected capital gains yield. c. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss. d. The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm enters bankruptcy. e. All of the above statements are false. DIF: Medium OBJ: TYPE: Conceptual TOP: Bond yields
30. Which of the following statements is correct? a. The discount or premium on a bond can be expressed as the difference between the coupon payment on an old bond which originally sold at par and the coupon payment on a new bond, selling at par, where the difference in payments is discounted at the new market rate. b. The price of a coupon bond is determined primarily by the number of years to maturity. c. On a coupon paying bond, the final interest payment is made one period before maturity and then, at maturity, the bond's face value is paid as the final payment. d. The actual capital gains yield for a one-year holding period on a bond can never be greater than the current yield on the bond. e. All of the above statements are false. DIF: Medium OBJ: TYPE: Conceptual TOP: Bond concepts
31. If you buy a bond that is selling for less than its face, or maturity, value what will happen to the price (value) of the bond as the maturity date nears if market interest rates do not change during the life of the bond? a. Because interest rates remain constant, nothing happens to the market value of the bond. b. The price of the bond should decrease even further below the bond's face value because the rates in the market are too high. c. The price of the bond will increase as the bond gets closer to its maturity because the bond's value has to equal its face value at maturity. d. This question cannot be answered without additional information. e. None of the above is a correct answer. DIF: Medium OBJ: TYPE: Conceptual
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TOP: Bond prices and interest rates 32. Omega Software Corporation's bond is currently selling at a discount in the financial markets. If the bond's yield to maturity is 11.5 percent, what is its coupon rate of interest? a. greater than 11.5 percent b. less than 11.5 percent c. equal to 11.5 percent d. There is not enough information to answer this question. e. None of the above is a correct answer. DIF: Medium TOP: Bond coupon rate OBJ: TYPE: Conceptual
33. Stephanie just purchased a corporate bond that matures in three years. The bond has a coupon interest rate equal to 9 percent and its yield to maturity is 6 percent. If market conditions do not changethat is market interest rates remain constantand Stephanie sells the bond in 12 months, what will be her capital gain from holding the bond? a. Positive; because she bought the bond for a discount, which means its price has to increase as the maturity date nears. b. Negative; because she bought the bond for a premium, which means its price has to decrease as the maturity date nears. c. Zero, because she must have bought the bond for par, which means its price will not change as the maturity date nears. d. This question cannot be answered, because the face (maturity) value of the bond is not given. e. None of the above is correct. DIF: Medium OBJ: TYPE: Conceptual TOP: Bond value
34. Which of the following is not true about bonds? In all of the statements, assume other things are held constant? a. Price sensitivity, that is, the change in price due to a given change in the required rate of return, increases as a bond's maturity increases. b. For a given bond of any maturity, a given percentage point increase in the interest rate (kd) causes a larger dollar capital loss than the capital gain stemming from an identical decrease in the interest rate. c. For any given maturity, a given percentage point increase in the interest rate causes a smaller dollar capital loss than the capital gain stemming from an identical decrease in the interest rate. d. From a borrower's point of view, interest paid on bonds is tax-deductible. e. A 20-year zero-coupon bond has less reinvestment rate risk than a 20-year coupon bond. DIF: Tough OBJ: TYPE: Conceptual TOP: Bonds
35. If interest rates fall from 8 percent to 7 percent, which of the following bonds will have the largest percentage increase in its value? a. A 10-year zero-coupon bond. b. A 10-year bond with a 10 percent semiannual coupon. c. A 10-year bond with a 10 percent annual coupon. d. A 5-year zero-coupon bond. e. A 5-year bond with a 12 percent annual coupon. Statement a is correct. The present value of the 10-year, zero-coupon bond at an 8 percent interest rate is $463.19, while its value at a 7 percent interest rate is $508.34. The percentage change is
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$45.15/$463.19 = 9.75%. If you work out the other percentage increases in values due to the change in interest rates, you'll obtain the following results: b. c. d. e. 10-year, 10% semiannual coupon: 6.80%. 10-year, 10% annual coupon: 6.75%. 5-year, zero-coupon: 4.76%. 5-year, 12% annual coupon: 3.91%. OBJ: TYPE: Conceptual TOP: Bond value
DIF: Tough
36. Which of the following statements is most correct? a. If a bond's yield to maturity exceeds its coupon rate, the bond's current yield must also exceed its coupon rate. b. If a bond's yield to maturity exceeds its coupon rate, the bond's price must be less than its maturity value. c. If two bonds have the same maturity, the same yield to maturity, and the same level of risk, the bonds should sell for the same price regardless of the bond's coupon rate. d. Answers b and c are both correct. e. None of the above answers are correct. Statement b is correct. If a bond's YTM exceeds its coupon rate, the n, by definition, the bond sells at a discount. Thus, the bond's price is less than its maturity value. Statement a is false. Consider zero-coupon bonds. A zero-coupon bond's YTM exceeds its coupon rate (which is equal to zero); however, its current yield is equal to zero which is equal to its coupon rate.
Statement c is false; a bond's value is determined by its cash flows: coupon payments plus principal. If the 2 bonds have different coupon payments, their prices would have to be different in order for them to have the same YTM. DIF: Tough OBJ: TYPE: Conceptual TOP: Bond concepts
37. Which of the following statements is most correct? a. All else equal, an increase in interest rates will have a greater effect on the prices of longterm bonds than it will on the prices of short-term bonds. b. All else equal, and increase in interest rate will have a greater effect on higher-coupon bonds than it will have on lower-coupon bonds. c. An increase in interest rates will have a greater effect on a zero-coupon bond with 10 years maturity than it will have on a 9-year bond with a 10 percent annual coupon. d. All of the above are correct. e. Answers a and c are both correct. Statements a and c are correct; therefore, statement e is the correct choice. The longer the maturity of a bond, the greater the impact an increase in interest rates will have on the bond's price. Statement b is false. To see this, assume interest rates increase from 7 percent to 10 percent. Evaluate the change in the prices of a 10-year, 5 percent coupon bond and a 10-year, 12 percent coupon bond. The 5 percent coupon bond's price decreases by 19.4 percent, while the 12 percent coupon bond's price decreases by only 16.9 percent. Statement c is correct. To see this, evaluate a 10-year, zero-coupon bond and a 9-year, 10 percent annual coupon bond at 2 different interest rates, say 7 percent and 10 percent. The zero-coupon bond's price decreases by 24.16 percent, while the 9-year, 10 percent coupon bond's price decreases by only 16.33 percent. DIF: Tough OBJ: TYPE: Conceptual TOP: Bond concepts
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38. Which of the following statements is correct? a. A 10-year bond would more have interest rate price risk than a 5-year bond, but all 10year bonds have the same interest rate price risk. b. A 10-year bond would have more reinvestment rate risk than a 5-year bond, but all 10year bonds have the same reinvestment rate risk. c. If their maturities were the same, a 5 percent coupon bond would have more interest rate price risk than a 10 percent coupon bond. d. If their maturities were the same, a 5 percent coupon bond would have less interest rate price risk than a 10 percent coupon bond. e. Zero-coupon bonds have more interest rate price risk than any other type bond, even perpetuities. Statement c is correct. For example, assume these coupon bonds have 10 years until maturity and the current interest rate is 12 percent. The 5 percent coupon bond's value is $604.48, while the 10 percent coupon bond's value is $887.00. Thus, the lower coupon bond has more price risk than the higher coupon bond. The lower the coupon, the greater the percentage of the cash flow that will come in the later years (from the maturity value), hence, the greater the impact of interest rate changes. Statement a is falseas we demonstrated above. Statement b is falseshorter-term bonds have more reinvestment rate risk than longer-term bonds because the principal payment must be reinvested sooner on the shorter-term bond. Statement d is falseas we demonstrated earlier. Statement e is false because perpetuities have no maturity date; therefore, they have more price risk than zero-coupon bonds. The longer a security's maturity, the greater its price risk. DIF: Tough OBJ: TYPE: Conceptual TOP: Price vs. reinvestment rate risk
39. You have just purchased a 10-year, $1,000 par value bond. The coupon rate on this bond is 8 percent annually, with interest being paid each 6 months. If you expect to earn a 10 percent simple rate of return on this bond, how much did you pay for it? a. $1,122.87 b. $1,003.42 c. $875.38 d. $950.75 e. $812.15
Financial calculator solution: Inputs: N = 20; I = 5; PMT = 40; FV = 1,000 Output: PV = -$875.38; Vd = $875.38. DIF: Easy OBJ: TYPE: Problem TOP: Bond valueannual payment
40. Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent simple yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? a. $619 b. $674 c. $761
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d. $828 e. $902
Financial calculator solution: Inputs: N = 40; I = 5; PMT = 40; FV = 1,000. Outputs: PV = -$828.41; Vd = $828. DIF: Easy OBJ: TYPE: Problem TOP: Bond valuesemiannual payment
41. A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If your simple annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond? a. $941.36 b. $1,051.25 c. $1,115.57 d. $1,391.00 e. $825.49
Financial calculator solution: Inputs: N = 40; I = 3; PMT = 35; FV = 1,000. Outputs: PV = -$1,115.57; Vd = $1,115.57. DIF: Easy OBJ: TYPE: Problem TOP: Bond valuequarterly payment
42. Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If you require a simple annual rate of return of 12 percent, with quarterly compounding, how much should you be willing to pay for this bond? a. $821.92 b. $1,207.57 c. $986.43 d. $1,120.71 e. $1,358.24
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Financial calculator solution: Inputs: N = 60; I = 3; PMT = 37.50; FV = 1,000 Output: PV = -$1,207.57; Vd = $1,207.57. Note: Tabular solution differs from calculator solution due to interest factor rounding. DIF: Medium OBJ: TYPE: Problem TOP: Bond valuequarterly payment
43. Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest being paid semiannually. The required simple rate on this debt has now risen to 16 percent. What is the current value of this bond? a. $1,273 b. $1,000 c. $7,783 d. $550 e. $450
Financial calculator solution: Inputs: N = 30; I = 8; PMT = 40; FV = 1,000. Output: PV = -$549.69; Vd = $549.69 = $550. DIF: Medium OBJ: TYPE: Problem TOP: Bond valuesemiannual payment
44. You are the owner of 100 bonds issued by Euler, Ltd. These bonds have 8 years remaining to maturity, an annual coupon payment of $80, and a par value of $1,000. Unfortunately, Euler is on the brink of bankruptcy. The creditors, including yourself, have agreed to a postponement of the next 4 interest payments (otherwise, the next interest payment would have been due in 1 year). The remaining interest payments, for Years 5 through 8, will be made as scheduled. The postponed payments will accrue interest at an annual rate of 6 percent, and they will then be paid as a lump sum at maturity 8 years hence. The required rate of return on these bonds, considering their substantial risk, is now 28 percent. What is the present value of each bond? a. $538.21 b. $426.73 c. $384.84 d. $266.88 e. $249.98
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Numerical solution: Find the compounded value at Year 8 of the postponed interest payments. FVDeferred interest = $80(1.06)7 + $80(1.06)6 + $80(1.06)5 + $80(1.06)4 = $441.83 payable at t = 8.
Now find the value of the bond considering all cash flows Vd = $80(1/1.28)5 + $80(1/1.28)6 + $80(1/1.28)7 + $80(1/1.28)8 + $1,000(1/1.28)8 + $441.83(1/1.28)8 = $266.86.
Financial calculator solution: Calculate FV of deferred interest Inputs: = 0; = 80; Nj = 4; Output: NFV = $441.828. = 0; Nj = 4; I = 6.
Calculate vB, which is the PV of scheduled interest, deferred accrued interest, and maturity value Inputs: = 0; = 0; Nj = 4; = 80; Nj = 3; = 1,521.83; I = 28. Output: NPV = $266.88; Vd = $266.88. Differences in tabular and financial calculator solutions are due to rounding of interest rate table figures. DIF: Medium OBJ: TYPE: Problem TOP: Bond value
45. You are contemplating the purchase of a 20-year bond that pays $50 in interest each six months. You plan to hold this bond for only 10 years, at which time you will sell it in the marketplace. You require a 12 percent annual return, but you believe the market will require only an 8 percent return when you sell the bond 10 years hence. Assuming you are a rational investor, how much should you be willing to pay for the bond today? a. $1,126.85 b. $1,081.43 c. $737.50 d. $927.68 e. $856.91
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Financial calculator solution: Calculate value of bond at Year 10 Inputs: N = 20; I = 4; PMT = 50; FB = 1,000. Output: PV = -1,135.90. Calculate value of bond at Year 0 using V10 as FV Inputs: N = 20; I = 6; PMT = 50; FV = 1,135.90. Output: PV = -$927.675 = $927.98; Vd = $927.68. DIF: Medium OBJ: TYPE: Problem TOP: Bond value
46. JRJ Corporation recently issued 10-year bonds at a price of $1,000. These bonds pay $60 in interest each six months. Their price has remained stable since they were issued, i.e., they still sell for $1,000. Due to additional financing needs, the firm wishes to issue new bonds that would have a maturity of 10 years, a par value of $1,000, and pay $40 in interest every six months. If both bonds have the same yield, how many new bonds must JRJ issue to raise $2,000,000 cash? a. 2,400 b. 2,596 c. 3,000 d. 5,000 e. 4,275
Number of bonds = $2,000,000 / $770.60 = 2,595.38 = 2,596. Financial calculator solution: Inputs: N = 20; I = 6; PMT = 40; FV = 1,000. Output: PV = -$770.60; Vd = $770.60. Number of bonds: $2,000,000 / $770.60 = 2,596 bonds.* * Rounded up to next whole bond. DIF: Medium OBJ: TYPE: Problem TOP: Bond value
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47. Assume that you are considering the purchase of a $1,000 par value bond that pays interest of $70 each six months and has 10 years to go before it matures. If you buy this bond, you expect to hold it for 5 years and then to sell it in the market. You (and other investors) currently require a simple annual rate of 16 percent, but you expect the market to require a rate of only 12 percent when you sell the bond due to a general decline in interest rates. How much should you be willing to pay for this bond? a. $842.00 b. $1,115.81 c. $1,359.26 d. $966.99 e. $731.85
Financial calculator solution: Solve for Vd at Time = 5 (V5) with 5 years to maturity. Inputs: N = 10; I = 6; PMT = 70; FV = 1,000. Output: PV = $1,073.60. Solve for Vd at Time = 0, assuming sale at Vd = $1,073.60. Inputs: N = 10; I = 8: PMT = 70; FV = 1,073.60. Output: PV = -$966.99; Vd = $966.99. DIF: Medium OBJ: TYPE: Problem TOP: Bond value
48. Cold Boxes Ltd. has 100 bonds outstanding (maturity value = $1,000). The required rate of return on these bonds is currently 10 percent, and interest is paid semiannually. The bonds mature in 5 years, and their current market value is $768 per bond. What is the annual coupon interest rate? a. 8% b. 6% c. 4% d. 2% e. 0%
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Tabular solution: $768 = 154.10 = (PVIFA5%, 10) + $1,000 (PVIF5%, 10) = (7.7217) (7.7217) + $1,000 (0.6139)
= $19.96 = $20 PMT $40 and coupon rate 4%. Financial calculator solution: Inputs: N = 10; I = 5; PV = -768; FV = 1,000. Output: PMT = $19,955 (semi-annual PMT). Annual coupon rate = PMT 2/M = $19,955 2/1,000 = 3.99% = 4%. DIF: Medium OBJ: TYPE: Problem TOP: Bond coupon rate 49. The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond is paid every six months, and the simple annual yield is 14 percent. Given these facts, what is the annual coupon rate on this bond? a. 10% b. 12% c. 14% d. 17% e. 21%
Financial calculator solution: Inputs: N = 20; I = 7; PV = -1,158.91; FV = 1,000. Output: PMT = $85.00 (Semiannual PMT). Annual coupon rate = $85 (2) / $1,000 = 17.0%. DIF: Medium OBJ: TYPE: Problem TOP: Bond coupon rate
50. Rick bought a bond when it was issued by Macroflex Corporation 14 years ago. The bond, which has a $1,000 face value and a coupon rate equal to 10 percent, matures in six years. Interest is paid every six months; the next interest payment is scheduled for six months from today. If the yield on similar risk investments is 14 percent, what is the current market value (price) of the bond? a. $841.15 b. $1,238.28 c. $904.67 d. $757.26 e. $844.45 DIF: Medium OBJ: TYPE: Problem
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TOP: Bond valuesemiannual payment 51. Devine Divots issued a bond a few years ago that has a face value equal to $1,000 and pays investors $30 interest every six months. The bond has eight years remaining until maturity. If you require a 7 percent rate of return to invest in this bond, what is the maximum price you should be willing to pay to purchase the bond? a. $761.15 b. $939.53 c. $940.29 d. $965.63 e. $1,062.81 DIF: Medium TOP: Bond valuesemiannual payment OBJ: TYPE: Problem
52. Recently, Ohio Hospitals Inc. filed for bankruptcy. The firm was reorganized as American Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue to be put into effect. The issue has 10 years to maturity and a coupon rate of 10 percent, paid annually. The new agreement allows the firm to pay no interest for 5 years. Then, interest payments will be resumed for the next 5 years. Finally, at maturity (Year 10), the principal plus the interest that was not paid during the first 5 years will be paid. However, no interest will be paid on the deferred interest. If the required return is 20 percent, what should the bonds sell for in the market today? a. $242.26 b. $281.69 c. $578.31 d. $362.44 e. $813.69
Financial calculator solution: Method1. Cash flows: Inputs: CF0 = 1; CF1 = 0; N = 5; CF2 = 100; Nj = 4; CF5 = 1,600; I = 20. Output: NPV = $362.44. Vd = $362.44. Method2. Time value discounting: (Calculate Vd as of Year 5, V5) Inputs: N = 5; I = 20; PMT = 100; FV = 1,500. Output: PV5 = -$901.878.
Calculate Vd or PV of V5 Inputs: N = 5; I = 20; FV = 901.878. Output: PV = -$362.44. Vd = $362.44.
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DIF: Tough
OBJ: TYPE: Problem
TOP: Bond value
Financial Calculator Section
The following question(s) may require the use of a financial calculator. 53. Trickle Corporation's 12 percent coupon rate, semiannual payment, $1,000 par value bonds which mature in 25 years. The bonds currently sell for $1,230.51 in the market, and the yield curve is flat. Assuming that the yield curve is expected to remain flat, what is Trickle's most likely beforetax cost of debt if it issues new bonds today? a. 4.78% b. 6.46% c. 7.70% d. 9.56% e. 12.92%
Financial calculator solution: Inputs: N = 50; PV = -1,230.51; PMT = 60; FV = 1,000 Outputs: I = 4.78 periodic rate (semiannual). The simple annual rate equals 2 4.78% = 9.56%. Thus, the before-tax cost of debt is 9.56%. DIF: Medium OBJ: TYPE: Financial Calculator TOP: Bond valuation 54. Leyland Enterprises has $5,000,000 in bonds outstanding. The bonds each have a maturity value of $1,000, an annual coupon of 12 percent, and 15 years left until maturity. The bonds can be called at any time at a call price of $1,100 per bond. If the bonds are called, the company must pay flotation costs of $50,000 ($10 for every $1,000 of bonds outstanding). Ignore tax considerations. Assume that the tax rate is zero. The company's decision whether to call the bonds depends critically on the current interest rate it would pay on new bonds issued. What is the breakeven interest rate, below which it is profitable to call in the bonds? a. 10.51% b. 11.21% c. 12.57% d. 13.33% e. 14.89% Step 1: Find present value of costs to call the issue: PV = Call Price + Flotation Costs = $5,500,000 + $50,000 = $5,550,000 Step 2: Find the IRR which equates the PV of the calling costs to the PV of not calling. This is the breakeven interest rate.
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With a financial calculator input the following: = -5,550,000 = 600,000 = 5,600,000 Solve for IRR = 10.51%. DIF: Medium OBJ: TYPE: Financial Calculator TOP: Refunding
55. U.S. Delay Corporation, a subsidiary of the Postal Service, must decide whether to issue zero coupon bonds or quarterly payment bonds to fund construction of new facilities. The 1,000 par value quarterly payment bonds would sell at $795.54, have a 10 percent annual coupon rate, and mature in ten years. At what price would the zero coupon bonds with a maturity of 10 years have to sell to earn the same effective annual rate as the quarterly payment bonds? a. $274.50 b. $271.99 c. $198.89 d. $257.52 e. $254.84
Financial calculator solution: Calculate simple periodic and annual interest rates Inputs: N = 40; PV = -795.54; PMT = 25; FV = 1,000 Output: I = 3.45% per period Knominal = 4 3.45 = 13.80% Calculate EAR using interest rate conversion feature Inputs: P/YR = 4; NOM% = 13.80. Output: EFF% = 14.53%
Calculate PV of zero coupon bond using EAR Inputs: N = 10; I = 14.53; PMT = 0; FV = 1,000. Output: PV = -257.518 -$257.52. Vd = $257.52.
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DIF: Medium
OBJ: TYPE: Financial Calculator TOP: Zero coupon and EAR
56. A 15-year zero coupon bond has a yield to maturity of 8 percent and a maturity value of $1,000. What is the amount of tax that an investor in the 30 percent tax bracket would pay during the first year of owning the bond? a. $7.57 b. $10.41 c. $15.89 d. $20.44 e. $25.22 Step 1: Find PV of bond: N = 15 I=8 PMT = 0 FV = 1,000 Solve for PV = -315.24. Step 2: Find interest for the first year: Value at t=0 Interest rate Interest income Step 3: Find tax due: Interest income Tax rate Tax due DIF: Medium $25.22 0.30 $ 7.57 $315.24 0.08 $ 25.22
OBJ: TYPE: Financial Calculator TOP: Zero coupon bonds
57. Two years ago, Targeau Corporation issued BBB rated bonds and the risk premium was 2.42 percentage points as marked up on long-term U.S. government bonds. The firm's bonds had a 10year maturity, were semiannual payment 9 percent coupon bonds with a $1,000 par value, and were originally priced at $973.17. Currently, Targeau's BBB-rated bonds have 8 years to maturity and are priced at $1,070.43. The current risk premium on BBB rated bonds is 1.3 percentage points. By how many percentage points did the long-term government bond rates change in two years? a. -0.38% b. -1.12% c. -0.62% d. -0.50% e. -1.50%
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Financial calculator solution: Calculate the YTM on the BBB bonds when they were issued: Inputs: N = 20; PV = -973.17; PMT = 45; FV = 1,000. Output: I = 4.71 semiannual; annual rate = 2(4.71%) = 9.42%. Calculate the rate on U.S. government bonds: U.S. government bond rate = Targeau's BBB bonds - RPBBB = 9.42% - 2.42% = 7.00%. Calculate the YTM today on the BBB bonds: Inputs: N = 16; PV = -1,070.43; PMT = 45; FV = 1,000. Output: I = 3.90 semiannual; annual rate = 2(3.90%) = 7.80%. Calculate the current U.S. government bond rate and the change from two years ago: Current U.S. government bond rate = 7.80% - 1.3% = 6.50%. Change in U.S. government bond rate = 6.50% - 7.00% = -0.50 percentage points. DIF: Tough OBJ: TYPE: Financial Calculator TOP: Changes in risk premiums
58. Semiannual payment bonds with the same risk (Aaa) and maturity (20 years) as your company's bonds have a simple (not EAR) yield of 9 percent. Your company's treasurer is thinking of issuing at par some $1,000 par value, 20-year, quarterly payment bonds. She has asked you to determine what quarterly interest payment, in dollars, the company would have to set in order to provide the same effective annual rate (EAR) as those on the 20-year, semiannual payment bonds. What would the quarterly interest payment be, in dollars? a. $45.00 b. $25.00 c. $22.25 d. $27.50 e. $23.00 Cash flow time lines:
Numerical solution: Step 1: Solve for the EAR of 9% simple compounded semiannually.
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Step 2:
Solve for kSimple of 9.2025% EAR but with quarterly compounding.
kSimple/4 = (1.092025)0.25 - 1 = 0.02225. kSimple = 0.02225 4 = 0.08901. Step 3: Calculate the quarterly payment using the periodic rate. Multiple 0.02225 $1,000 = $22.25 = quarterly payment Financial calculator solution: Step 1: Calculate the EAR of 9% simple yield bond compounded semi-annually. Use interest rate conversion feature. Inputs: P/YR = 2; NOM% = 9. Output: EFF% = 9.2025% Step 2: Calculate the simple rate, kSimple, of a 9.2025% EAR but with quarterly compounding. Inputs: P/YR = 4; EFF% = 9.2025. Output: NOM% = 8.90% Step 3: Calculate the quarterly periodic rate from kSimple of 8.9% and calculate the quarterly payment. kPer = kSimple/4 = 8.90%/4 = 2.225% Inputs: N = 80; I = 2.225; PV = -1,000; FV = 1,000. Output: PMT = $22.25. DIF: Tough OBJ: TYPE: Financial Calculator TOP: Bonds with differential payments 59. Assume that the State of Florida sold tax-exempt, zero coupon bonds with a $1,000 maturity value 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was 8 percent, compounded semiannually. The bonds are now callable at a premium of 4 percent over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today? a. 4.41% b. 6.73% c. 8.25% d. 9.01% e. 9.52%
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Calculate PV of zero coupon bond at Time 0: N = 50; I = 4; PMT = 0; and FV = 1,000. Solve for PV = $140.71. Calculate accrued value at Year 5: $140.71(1.04)2(5) = $208.29. Calculate EAR as follows: N = 10; PV = -140.71; PMT = 0; and FV = 216.62. Solve for I = 4.41%; however, this is a semiannual rate. EAR = (1.0441)2 - 1 = 9.01%. DIF: Tough OBJ: TYPE: Financial Calculator TOP: Zero coupon bonds
Gargoyle Unlimited
Gargoyle Unlimited is planning to issue a zero coupon bond to fund a project that will yield its first positive cash flow in three years. That cash flow will be sufficient to pay off the entire debt issue. The bond's par value will be $1,000, it will mature in 3 years, and it will sell in the market for $727.25. The firm's marginal tax rate is 40 percent. 60. Refer to Gargoyle Unlimited. What is the dollar value of the interest tax savings to the firm in the third year of the issue? a. $32.58 b. $40.29 c. $100.72 d. $60.43 e. $109.10 Cash flow time line:
Financial calculator solution: Inputs: N = 3; PV = 727.25; FV = -1,000. Output: I = 11.20%. 1) Accrued value 2) Interest expense 3) Tax savings (line 2 0.40) 4) Cash flows 0 727.25 1 808.70 81.45 32.58 +32.58 2 899.28 90.58 36.23 +36.23 3 1,000.00 100.72 40.29 +40.29 -1,000.00 -959.71
+727.25
DIF: Tough OBJ: TYPE: Financial Calculator TOP: Zero coupon interest tax shield
121 Chapter6BondsCharacteristicsandValuation
61. Refer to Gargoyle Unlimited. What is the expected after-tax cost of this debt issue? a. 11.20% b. 4.48% c. 6.72% d. 6.10% e. 4.00% Financial calculator solution: Solve for YTM using the information from the previous question Inputs: N = 3; PV = +727.25; FV = -1,000 Output: I = 11.20. Before-tax cost debt of this issue = 11.20% kdT = 11.20% (1-T) = 11.2% (0.6) = 6.72% Alternate solution using cash flows Inputs: = 727.25; = 32.58; Output: IRR% = 6.72%. DIF: Medium = 36.23; = -959.71
OBJ: TYPE: Financial Calculator TOP: After-tax cost of debt
62. You are offered a $1,000 par value bond which has a stepped-up coupon interest rate. The annual coupon rate is 10 percent coupon, payable semiannually ($50 each 6 months) for the first 15 years, and then the annual coupon increases to 13 percent, also payable semiannually, for the next 15 years. The first interest payment will be made 6 months from today, and the $1,000 principal amount will be returned at the end of Year 30. You currently have savings in an account which is earning a 9 percent simple rate, but with quarterly compounding; this is your opportunity cost for purposes of analyzing the bond. What is the value of the bond to you today? a. $1,614.53 b. $1,419.18 c. $1,306.21 d. $1,250.25 e. $1,155.98
Financial calculator solution: Step 1 Calculate the semiannual effective rate on the 9% account. We must discount the semiannual payment bond with a semiannual effective rate. Match the semiannual payment period with a semiannual rate, using the interest rate conversion feature: Inputs: NOM% = 9.0/2 = 4.5%; P/YR = 2. Output: EFF% = 4.55%. Step 2 Use the semiannual effective rate to discount the bond cash flows:
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Inputs: = 0; = 50; Nj = 30; Output: NPV = $1,155.98 = Vd.
= 65; Nj = 29;
= 1065; I = 4.55.
The value of the stepped-up coupon bond is $1,155.98. DIF: Tough OBJ: TYPE: Problem TOP: Bond value
63. Tony's Pizzeria plans to issue bonds with a par value of $1,000 and 10 years to maturity. These bonds will pay $45 interest every 6 months. Current market conditions are such that the bonds will be sold to net $937.79. What is the YTM of the issue as a broker would quote it to an investor? a. 11% b. 10% c. 9% d. 8% e. 7%
Financial calculator solution: Inputs: N = 20; PV = -937.79; PMT = 45; FV = 1,000 Output: I = 5.0% per period. kd = YTM = 5.0% 2 periods = 10% DIF: Easy OBJ: TYPE: Financial Calculator TOP: Yield to maturity 64. The current market price of Smith Corporation's 10 percent, 10-year bonds is $1,297.58. A 10 percent coupon interest rate is paid semiannually, and the par value is equal to $1,000. What is the YTM (stated on a simple, or annual, basis) if the bonds mature 10 years from today? a. 8% b. 6% c. 4% d. 2% e. 1%
Financial calculator solution: Inputs: N = 20; PV = -1,297.58; PMT = 50; FV = 1,000 Output: I = 3.0% per period. kd = YTM = 3.0% 2 periods = 6% DIF: Easy OBJ: TYPE: Financial Calculator TOP: Yield to maturity
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65. A $1,000 par value bond sells for $1,216. It matures in 20 years, has a 14 percent coupon, pays interest semiannually, and can be called in 5 years at a price of $1,100. What is the bond's YTM? a. 6.05% b. 10.00% c. 10.06% d. 8.59% e. 11.26%
Financial calculator solution: Inputs: N = 40; PV = -1,216; PMT = 70; FV = 1,000 Output: I = 5.6307 5.63% = kd/2. YTM 5.63% 2 = 11.26% DIF: Medium OBJ: TYPE: Financial Calculator TOP: Yield to maturity 66. You have just been offered a $1,000 par value bond for $847.88. The coupon rate is 8 percent, payable annually, and interest rates on new issues of the same degree of risk are 10 percent. You want to know how many more interest payments you will receive, but the party selling the bond cannot remember. Can you determine how many interest payments remain? a. 14 b. 15 c. 12 d. 20 e. 10
Financial calculator solution: Inputs: I = 10; PV = -$847.88; PMT = 80. FV = 1,000 Output: N = 15 Years. DIF: Medium OBJ: TYPE: Financial Calculator TOP: Interest payments remaining
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67. Assume that McDonald's and Burger King have similar $1,000 par value bond issues outstanding. The bonds are equally risky. The Burger King bond has interest payments of $80 paid annually and matures 20 years from today. The McDonald's bond has interest payments of $80 paid semiannually, and it also matures in 20 years. If the simple required rate of return, kd, is 12 percent, semiannual basis, for both bonds, what is the difference in current market prices of the two bonds? a. No difference. b. $2.20 c. $3.77 d. $17.53 e. $6.28
Financial calculator section: Burger King Vd Calculate EAR to apply to Burger King bonds using interest rate conversion feature, and calculate the value VBK, of Burger King bonds: Inputs: P/YR = 2; NOM% = 12. Output: EFF% = EAR = 12.36% Inputs: N = 20; I = 12.36; PMT = 80; FV = 1,000. Output: PV = -$681.54 McDonalds Inputs: N = 40; I = 6; PMT = 40; FV = 1.000 Output: PV = $699.07 Calculate the difference between the two bonds' PVs Difference: Vd(McD) - Vd(BK) = 699.07 - 681.54 = $17.53 DIF: Tough OBJ: TYPE: Financial Calculator TOP: Bond value
68. An 8 percent annual coupon, noncallable bond has ten years until it matures and a yield to maturity of 9.1 percent. What should be the price of a 10-year bond of equal risk which pays an 8 percent semiannual coupon? Assume both bonds have a maturity value of $1,000. a. $898.64 b. $736.86 c. $854.27 d. $941.08 e. $964.23 Step 1: Determine the interest rate to use in order to evaluate the semiannual bond's price:
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In order for the 2 bonds to be of equal risk, their effective YTM must be equal. The annual bond's nominal YTM = effective YTM = 9.1%. Thus, we need to calculate the semiannual bond's nominal YTM. With a financial calculator: EFF% = 9.1 P/YR = 2 Solve for NOM% = 8.9019%. Note that this is stated on an annual basis. To convert to a semiannual basis divide it by 2: 8.9019%/2 = 4.451%. Step 2: Calculate the semiannual bond's price: N = 20 I = 4.451 PMT = 40 FV = 1,000 Solve for PV = $941.08. DIF: Tough OBJ: TYPE: Financial Calculator TOP: Bond valuesemiannual payment 69. Fish & Chips Inc. has two bond issues outstanding, and both sell for $701.22. The first issue has a coupon rate of 8 percent and 20 years to maturity. The second has an identical yield to maturity as the first bond, but only 5 years until maturity. Both issues pay interest annually. What is the annual interest payment on the second issue? a. $120.00 b. $37.12 c. $56.42 d. $29.68 e. $11.16
Financial calculator solution: Calculate YTM or kd for first issue Inputs: N = 20; PV = -701.22; PMT = 80; FV = 1,000. Output: I = 12% Calculate PMT on second issue using 12% = kd = YTM Inputs: N = 20; PV = -701.22; FV = 1,000
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Output: PMT = $37.116 $37.12 DIF: Tough OBJ: TYPE: Financial Calculator TOP: Bond interest payments 70. A two-year zero-coupon Treasury bond with a maturity value of $1,000 has a price of $873.4387. A one-year zero-coupon Treasury bond with a maturity value of $1,000 has a price of $938.9671. If the pure expectations theory is correct, for what price should one-year zero-coupon Treasury bonds sell one year from now? a. $798.89 b. $824.66 c. $852.28 d. $930.23 e. $989.11 First find the yields on one-year and two-year zero-coupon bonds, so you can find the implied rate on a one-year bond, one year from now. Then use this implied rate to find its price. 1-year N= 1 PV = -938.9671 PMT = 0 FV = 1,000 Solve for I = 6.5% Therefore, if the implied rate = 2-year N= 2 PV = -873.4387 PMT = 0 FV = 1,000 Solve for I = 7.0%
Now find the price of a 1-year zero, 1 year from now: N I PMT FV Solve for PV DIF: Tough =1 = 7.5 =0 = 1,000 = $930.23. OBJ: TYPE: Financial Calculator TOP: Zeros and expectations theory
71. A four-year, zero-coupon Treasury bond sells at a price of $762.8952. A three-year, zero-coupon Treasury bond sells at a price of $827.8491. Assuming the pure expectations theory is correct, what does the market believe the price of one-year, zero-coupon bonds will be in three years? a. $921.66 b. $934.58 c. $938.97 d. $945.26 e. $950.47
127 Chapter6BondsCharacteristicsandValuation
Step 1
Calculate the YTM for the 3-year zero: N= PV = PMT = FV = Solve for I = 3 -827.8491 0 1,000 6.5%
Step 2
Calculate the YTM for the 4-year zero: N= PV = PMT = FV = Solve for I = 4 -762.8952 0 1,000 7%
Step 3
Calculate the interest rate on a 1-year zero, 3 years from now:
= 8.5%. Step 4 Calculate the price of a 1-year zero 3 years from now: N= I= PMT = FV = Solve for PV = DIF: Tough 1 8.5 0 1,000 $921.66.
OBJ: TYPE: Financial Calculator TOP: Zeros and expectations theory

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BAB II MENJALANKAN BISNISSYAFRIZAL HELMI Untuk memulai sebuah usaha memang harus didahului dengan taktik dan strategi. Membuat usaha yang besar tidak selalu membutuhkan modal yang besar. Mengawalinya dengan modal kecil pun sebuah usaha bisa tumbuh menja

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BAB I MERENCANAKAN BISNISSYAFRIZAL HELMIMembangun Mindset berbisnis Kampus sebagai tempat untuk Merubah Paradigma cara berfikir mahasiswa dari mencari pekerjaan menjadi pencipta lapangan pekerjaan Untuk itu diperlukan sebuah jiwa entrepreneurship (kewi

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BAHAN AJARKonten Mata Kuliah E-Learning USU INHERENT 2006 BUKU AJAR STUDI KELAYAKAN BISNIS PENGUSULSYAFRIZALHELMIS,SE,M.Si DEPARTEMENMANAJEMEN FAKULTASEKONOMIUNIVERSITASSUMATERAUTARA 2006iDAFTAR ISI HalamanBAB I. Merencanakan bisnis. 1 1.1. Membang

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