sm18 - CHAPTER 18 BOND FUNDAMENTALS Answers to Questions 1....

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CHAPTER 18 BOND FUNDAMENTALS Answers to Questions 1. A bond is said to be “called” when the issuer, at its own discretion, “calls” in the bond, and purchases it from the holder at a price stipulated in the bond indenture. When a bond is “refunded,” it is called, but the firm reissues bonds for the same amount with a lower coupon rate. On a pure call (without refunding), the issue is usually retired. 2. The three factors affecting the price of a bond are coupon, yield, and term to maturity. The relationship between price and coupon is a direct one - the higher the coupon, the higher the price. The relationship between price and yield is an inverse one - the higher the yield the lower the price, all other factors held constant. The relationship between price and maturity is not so clearly evident. Price changes resulting from changes in yields will be more pronounced, the longer the term to maturity. 3. For a given change in the level of interest rates, two factors that will influence the relative change in bond prices are the coupon and maturity of the issues. Bonds with longer maturity and/or lower coupons will respond most vigorously in a given change in interest rates. Other factors likewise cause differences in price volatility, including the call features, but these factors are typically much less important. 4. A call feature and a sinking fund are bond indenture provisions that can affect the maturity of the bond issue. Specifically there are three alternative call features: (1) freely callable provision that allows the issuer to retire the bond at any time during the life of the bond issue, (2) noncallable provision that does not allow the issuer to retire the bond prior to its maturity, and (3) deferred call provision that allows the issuer to retire the bond after a designated period of time. A sinking fund requires that a bond be paid off during the life of the issue rather than at maturity. 5.
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sm18 - CHAPTER 18 BOND FUNDAMENTALS Answers to Questions 1....

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