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# week04_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

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FINS 1613 Tutorial Answers 1 SCHOOL OF BANKING AND FINANCE FINS1613 BUSINESS FINANCE Semester 2, 2010 TUTORIAL ANSWERS WEEK 4 - The Valuation of a Firm’s Securities Please note that some answers are exact when rounded to 2 or 3 decimal places because of the use of PV tables rather than calculators. Multiple-choice Questions Bond Valuation 1. One of the basic relationships in interest rate theory is that, other things held constant, for a given change in the required rate of return, the __________ the time to maturity, the __________ the change in price. a. longer; smaller b. shorter; larger c. longer; greater d. shorter; smaller e. Statements c and d are correct Answer is e interest rate theory 2. You are considering investing in three different bonds. Each bond matures in 10 years and has a face value of \$1,000. The bonds have the same level of risk, so the yield to maturity is the same for each. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming that interest rates are expected to remain at their current level for the next 10 years, which of the following statements is most correct? a. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year. b. Bond A's price is expected to decrease over the next year, Bond B's price is expected to stay the same, and Bond C's price is expected to increase over the next year. c. Since the bonds have the same yields to maturity, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until the bonds mature. d. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year. e. Statements b and d are correct. Answer is a Par value vs. Coupon

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FINS 1613 Tutorial Answers 2 3. A 12-year bond has a 9% annual coupon, a yield to maturity of 8%, and a face value of \$1,000. What is the price of the bond? a. \$1,469 b. \$1,000 c. \$ 928 d. \$1,075 e. \$1,957 Answer is d_ annual coupon payments  36 . 075 , 1 \$ 11 . 397 25 . 678 % 8 1 1000 % 8 1 % 8 1 % 8 1 90 1 ) 1 ( 1 %) 8 1 ( 1000 %) 8 1 ( 90 ) 1 ( ) 1 ( 12 12 1 12 1 12   t t t nn t t t B r F r r C r F r C V 4. You intend to purchase a 10-year, \$1,000 face value bond that pays interest of \$60 every 6 months. If your nominal annual required rate of return is 10% with semiannual compounding, how much should you be willing to pay for this bond? a. \$ 826.31 b. \$1,086.15 c. \$ 957.50 d. \$1,431.49 e. \$1,124.62 Answer is e Bond value—semi-annual payment Time Line: 6 month periods 0 1 2 3 4 20 5% V=? C=60 60 60 60 60 F=1000 Mathematical solution: 63 , 124 , 1 \$ 89 . 376 73 . 747 % 5 1 1000 % 5 %) 5 1 ( 1 60 1 ) 1 ( 1 %) 5 1 ( 1000 %) 5 1 ( 60 ) 1 ( ) 1 ( 20 20 1 20 1 20 t t t t t t B r F r r C r F r C V
FINS 1613 Tutorial Answers 3 5. A \$1,000 par value bond pays interest of \$35 each quarter and will mature in 10 years.

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week04_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

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