Chapter05BondValuationSolutions

# Chapter05BondValuationSolutions - Bond Valuation Solutions...

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Bond Valuation - Solutions 1. Assume that you are given the upward sloping yield curve for Treasury securities shown below. Now assume that a firm has the option of issuing either Bond A or Bond B, where both bonds will have the same maturity, default risk, liquidity premium, etc. The only difference is that Bond A will have a 10 percent coupon rate, while Bond B has a 6 percent coupon rate: the duration of Bond A will be shorter than the duration of Bond B -- alternatively, we can refer to Bond A as an earlier bond and Bond B as a later bond. Given this information, we can say with some confidence that Bond B will have a higher Yield to Maturity than Bond A. * A. True B. False 2. Treasury Bonds and Municipal Bonds are similar in that they are all issued by federal, state, and local governments. Because of this, their yield to maturity does not include a default risk premium. A. True * B. False 3. Once a bond is issued by a firm, both its coupon rate and yield-to-maturity are fixed for the life of the bond; thus the name, fixed income security. A. True * B. False 4. If a firm privately places its debt (so that there is no flotation expense), then the yield to maturity on this debt will be equal to the firm’s before-tax cost of debt. * A. True B. False 5. If a 10-year bond is selling at a premium, then its price is higher than its par value, and this price must decrease in every future period. A. True * B. False Old Exam Questions - Bond Valuation - Solutions Page 1 of 42 Pages Bond A Bond B

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6. The duration of a zero-coupon bond will always be equal to its maturity, while the duration of a coupon paying bond will be less than its maturity. * 7. Because callable bonds can be called before the maturity date of the bond, and investors therefore will lose the coupon payments between the call date and the maturity date if the bond is called, the yield-to-call must be less than the yield-to-maturity. * 8. Assume that you buy a bond at par and hold it until it matures. If reinvestment rates decrease right after you purchase the bond, then your realized compounded yield should be less than the bond’s yield-to-maturity, whereas if reinvestment rates increase right after you purchase the bond, then your realized compounded yield should be greater than the bond’s yield-to-maturity. * A. True B. False 9. Assume that you buy a bond at par but do not hold it until it matures. If reinvestment rates decrease right after you purchase the bond, then your realized compounded yield should be less than the bond’s yield-to-maturity, whereas if reinvestment rates increase right after you purchase the bond, then your realized compounded yield should be greater than the bond’s yield-to-maturity. A. True * B. False
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