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Unformatted text preview: End of Chapter 4 Questions, Problems and Solutions CORPORATE FINANCE Professor Megginson Spring Semester 2003 Questions [See problems in book] *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** Answers to End of Chapter 4 Questions 4.1. As required return increases, the price of a financial asset decreases, and visa versa. 4.2. Par value is the principal amount of a bond, which is repaid when the bond matures. Maturity date is the time when the principal amount is repaid. The bond coupon is the dollar interest payment made by the bond. The coupon yield is the coupon paid by the bond divided by the price of the bond and the yield to maturity is the discount rate of the bond, or the percent that the bond is returning to investors who hold the bond to maturity. A yield curve is a picture of what interest rates are paid on bonds of varying times to maturity. 4.3. A bonds coupon rate will exceed its coupon yield when the bond price is greater than face value. 4.4. A pure discount bond is one that is originally issued at a discount. For example, treasury bills are issued at a discount. A security with a face value of 10,000 might sell for $9,980. A bond selling at a discount is one that originally was selling for, say $1,000, but now is selling for $950 because interest rates have risen since the bond was first issued. 4.5. Using a numerical example to illustrate, you issue a $1,000 face value 10-year bond, with a coupon of $80. Interest rates fall to 6%. The coupon rate is still 8%. The bonds price is now $1,147. The coupon yield is 80/1147 = .07 or 7%. The yield to maturity is 6%, the going interest rate for bonds of this type. The coupon rate will be the highest number of the three and the yield to maturity the lowest. 4.6. The treasury bonds will all carry the same default risk none and the same maturity risk (5 years.) They all should be trading at about the same yield to maturity. 4.7. Interest rate risk is higher for longer term bonds. This is because you will be receiving the cash flows from the bond further in the future. A change in interest rates will result in a bigger price change for a longer term bond than for a shorter term bond. 4.8. Under the expectations hypothesis, there is no maturity risk premium, so interest rates are the same for bonds with the same risk but different maturities. 4.9. An upward sloping yield curve would mean that investors expect short term rates to rise. 4.10. Internet/newspaper exercise 4.11. The yield curve is typically upward sloping. 1 4.12. The yield curve is typically downward sloping preceding recessions....
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