Chuong 2

(Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual

Easy:
Interest rates Anser: e Diff: E
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.
Interest rates and !ond prices Anser: c Diff: E
2
. Assume that a 10year !reasury bond has a 12 percent annual coupon, "hile a 1#year
!reasury bond has an $ percent annual coupon. !he yield curve is flat; all !reasury
securities have a 10 percent yield to maturity. %hich of the follo"ing statements is most
correct&
a. !he 10year bond is selling at a discount, "hile the 1#year bond is selling at a
premium.
b. !he 10year bond is selling at a premium, "hile the 1#year bond is selling at par.
c. 'f interest rates decline, the price of both bonds "ill increase, but the 1#year bond "ill
have a larger percentage increase in price.
d. 'f the yield to maturity on both bonds remains at 10 percent over the ne(t year, the
price of the 10year bond "ill increase, but the price of the 1#year bond "ill fall.
e. Statements c and d are correct.
Interest rates and !ond prices Anser: c Diff: E
)
. A 12year bond has an annual coupon rate of * percent. !he coupon rate "ill remain fi(ed
until the bond matures. !he bond has a yield to maturity of
+ percent. %hich of the follo"ing statements is most correct&
a. !he bond is currently selling at a price belo" its par value.
b. 'f mar,et interest rates decline today, the price of the bond "ill also decline today.
c. 'f mar,et interest rates remain unchanged, the bond-s price one year from no" "ill be
lo"er than it is today.
d. All of the statements above are correct.
e. .one of the statements above is correct.
Interest rates and !ond prices Anser: d Diff: E
Chapter 7 - Page 1
C"A#TE$ %
&'(D) A(D T"EI$ *A+,ATI'(
/
. A 10year !reasury bond has an $ percent coupon. An $year !reasury bond has a 10
percent coupon. 0oth bonds have the same yield to maturity. 'f the yields to maturity of
both bonds increase by the same amount, "hich of the follo"ing statements is most
correct&
a. !he prices of both bonds "ill increase by the same amount.
b. !he prices of both bonds "ill decrease by the same amount.
c. !he prices of the t"o bonds "ill remain the same.
d. 0oth bonds "ill decline in price, but the 10year bond "ill have a greater percentage
decline in price than the $year bond.
e. 0oth bonds "ill decline in price, but the $year bond "ill have a greater percentage
decline in price than the 10year bond.
Interest -s. rein-estment rate ris/ Anser: e Diff: E
#
. %hich of the follo"ing statements is most correct&
a. All else equal, longterm bonds have more interest rate ris, than shortterm bonds.
b. All else equal, highcoupon bonds have more reinvestment rate ris, than lo"coupon
bonds.
c. All else equal, shortterm bonds have more reinvestment rate ris, than do longterm
bonds.
d. Statements a and c are correct.
e. All of the statements above are correct.
Interest -s. rein-estment rate ris/ Anser: c Diff: E
1
a. 2elative to shortterm bonds, longterm bonds have less interest rate ris, but more
reinvestment rate ris,.
b. 2elative to shortterm bonds, longterm bonds have more interest rate ris, and more
reinvestment ris,.
c. 2elative to couponbearing bonds, 3ero coupon bonds have more interest rate ris, but
less reinvestment rate ris,.
d. 'f interest rates increase, all bond prices "ill increase, but the increase "ill be greatest
for bonds that have less interest rate ris,.
e. One advantage of 3ero coupon bonds is that you don-t have to pay any ta(es until you
sell the bond or it matures.
#rice ris/ Anser: a Diff: E
+
. %hich of the follo"ing bonds "ill have the greatest percentage increase in value if all
interest rates decrease by 1 percent&
a. 20year, 3ero coupon bond.
b. 10year, 3ero coupon bond.
c. 20year, 10 percent coupon bond.
d. 20year, # percent coupon bond.
e. 1year, 10 percent coupon bond.
Calla!le !ond Anser: a Diff: E
$
. %hich of the follo"ing events "ould ma,e it more li,ely that a company "ould choose to
Chapter 7 - Page 2
call its outstanding callable bonds&
a. A reduction in mar,et interest rates.
b. !he company-s bonds are do"ngraded.
c. An increase in the call premium.
d. Statements a and b are correct.
e. Statements a, b, and c are correct.
Call pro-ision Anser: ! Diff: E
*
. Other things held constant, if a bond indenture contains a call provision, the yield to
maturity that "ould e(ist "ithout such a call provision "ill generally be the 4!5
"ith a call provision.
a. 6igher than.
b. 7o"er than.
c. !he same as.
d. 8ither higher or lo"er 9depending on the level of the call premium: than.
e. ;nrelated to.
&ond coupon rate Anser: c Diff: E
10
. All of the follo"ing may serve to reduce the coupon rate that "ould other"ise be required
on a bond issued at par, e(cept a
a. Sin,ing fund.
b. 2estrictive covenant.
c. <all provision.
d. <hange in rating from Aa to Aaa.
e. .one of the statements above. 9All may reduce the required coupon rate.:
&ond concepts Anser: a Diff: E
11
a. All else equal, if a bond-s yield to maturity increases, its price "ill fall.
b. All else equal, if a bond-s yield to maturity increases, its current yield "ill fall.
c. 'f a bond-s yield to maturity e(ceeds the coupon rate, the bond "ill sell at a premium
over par.
Chapter 7 - Page 3
&ond concepts Anser: c Diff: E
12
a. 'f a bond-s yield to maturity e(ceeds its annual coupon, then the bond "ill be trading at
a premium.
b. 'f interest rates increase, the relative price change of a 10year coupon bond "ill be
greater than the relative price change of a 10year 3ero coupon bond.
c. 'f a coupon bond is selling at par, its current yield equals its yield to maturity.
&ond concepts Anser: e Diff: E
1)
. A 10year corporate bond has an annual coupon payment of * percent. !he bond is
currently selling at par 9=1,000:. %hich of the follo"ing statements is most correct&
a. !he bond-s yield to maturity is * percent.
b. !he bond-s current yield is * percent.
c. 'f the bond-s yield to maturity remains constant, the bond-s price "ill remain at par.
1/
. A 1#year bond "ith a face value of =1,000 currently sells for =$#0. %hich of the
follo"ing statements is most correct&
a. !he bond-s yield to maturity is greater than its coupon rate.
b. 'f the yield to maturity stays constant until the bond matures, the bond-s price "ill
remain at =$#0.
c. !he bond-s current yield is equal to the bond-s coupon rate.
d. Statements b and c are correct.
&ond concepts Anser: d Diff: E
1#
. A !reasury bond has an $ percent annual coupon and a yield to maturity equal to +.#
percent. %hich of the follo"ing statements is most correct&
a. !he bond has a current yield greater than $ percent.
b. !he bond sells at a price above par.
c. 'f the yield to maturity remains constant, the price of the bond is e(pected to fall over
time.
Chapter 7 - Page 4
11
. 4ou are considering investing in three different bonds. 8ach bond matures in 10 years and has
a face value of =1,000. !he bonds have the same level of ris,, so the yield to maturity is the
same for each. 0ond A has an
$ percent annual coupon, 0ond 0 has a 10 percent annual coupon, and 0ond < has a 12
percent annual coupon. 0ond 0 sells at par. Assuming that interest rates are e(pected to
remain at their current level for the ne(t 10 years, "hich of the follo"ing statements is most
correct&
a. 0ond A sells at a discount 9its price is less than par:, and its price is e(pected to
increase over the ne(t year.
b. 0ond A-s price is e(pected to decrease over the ne(t year, 0ond 0-s price is e(pected
to stay the same, and 0ond <-s price is e(pected to increase over the ne(t year.
c. Since the bonds have the same yields to maturity, they should all have the same price,
and since interest rates are not e(pected to change, their prices should all remain at
their current levels until the bonds mature.
d. 0ond < sells at a premium 9its price is greater than par:, and its price is e(pected to
increase over the ne(t year.
e. Statements b and d are correct.
&ond concepts Anser: d Diff: E
1+
. An investor is considering buying one of t"o bonds issued by <arson <ity Airlines. 0ond
A has a + percent annual coupon, "hereas 0ond 0 has a
* percent annual coupon. 0oth bonds have 10 years to maturity, face values of =1,000,
and yields to maturity of $ percent. Assume that the yield to maturity for both of the
bonds "ill remain constant over the ne(t 10 years. %hich of the follo"ing statements is
most correct&
a. 0ond A has a higher price than 0ond 0 today, but one year from no" the bonds "ill
have the same price as each other.
b. 0ond 0 has a higher price than 0ond A today, but one year from no" the bonds "ill
have the same price as each other.
c. 0oth bonds have the same price today, and the price of each bond is e(pected to
remain constant until the bonds mature.
d. One year from no", 0ond A-s price "ill be higher than it is today.
e. 0ond A-s current yield 9not to be confused "ith its yield to maturity: is greater than $
percent.
&ond concepts Anser: c Diff: E
1$
. A 10year bond "ith a * percent annual coupon has a yield to maturity of $ percent.
%hich of the follo"ing statements is most correct&
a. !he bond is selling at a discount.
b. !he bond-s current yield is greater than * percent.
c. 'f the yield to maturity remains constant, the bond-s price one year from no" "ill be
lo"er than its current price.
Chapter 7 - Page 5
&ond concepts Anser: a Diff: E (
1*
a. 7ongterm bonds have more interest rate price ris,, but less reinvestment rate ris, than short
term bonds.
b. 0onds "ith higher coupons have more interest rate price ris,, but less reinvestment rate
ris, than bonds "ith lo"er coupons.
c. 'f interest rates remain constant for the ne(t five years, the price of a discount bond "ill
remain the same for the ne(t five years.
&ond concepts Anser: d Diff: E (
20
a. 'f a bond is selling at par value, its current yield equals its yield to maturity.
b. 'f a bond is selling at a discount to par, its current yield "ill be less than its yield to
maturity.
c. All else equal, bonds "ith longer maturities have more interest rate 9price: ris, than do
bonds "ith shorter maturities.
&ond yield Anser: a Diff: E
21
. A 10year bond pays an annual coupon. !he bond has a yield to maturity of $ percent.
!he bond currently trades at a premiumits price is above the par value of =1,000. %hich
of the follo"ing statements is most correct&
a. 'f the yield to maturity remains at $ percent, then the bond-s price "ill decline over the
ne(t year.
b. !he bond-s current yield is less than $ percent.
c. 'f the yield to maturity remains at $ percent, then the bond-s price "ill remain the same
over the ne(t year.
d. !he bond-s coupon rate is less than $ percent.
e. 'f the yield to maturity increases, then the bond-s price "ill increase.
Chapter 7 - Page 6
&ond yields and prices Anser: d Diff: E
22
. 4ou are considering t"o !reasury bonds. 0ond A has a * percent annual coupon, and
0ond 0 has a 1 percent annual coupon. 0oth bonds have a yield to maturity of + percent.
Assume that the yield to maturity is e(pected to remain at + percent. %hich of the
follo"ing statements is most correct&
a. 'f the yield to maturity remains at + percent, the price of both bonds "ill increase by +
percent per year.
b. 'f the yield to maturity remains at + percent, the price of both bonds "ill increase over
time, but the price of 0ond A "ill increase by more.
c. 'f the yield to maturity remains at + percent, the price of both bonds "ill remain
unchanged.
d. 'f the yield to maturity remains at + percent, the price of 0ond A "ill decrease over
time, but the price of 0ond 0 "ill increase over time.
e. 'f the yield to maturity remains at + percent, the price of 0ond 0 "ill decrease over
time, but the price of 0ond A "ill increase over time.
)in/ing fund pro-ision Anser: e Diff: E
2)
a. Sin,ing fund provisions do not require companies to retire their debt; they only
establish >targets? for the company to reduce its debt over time.
b. Sin,ing fund provisions sometimes "or, to the detriment of bondholdersparticularly
if interest rates have declined over time.
c. 'f interest rates have increased since the time a company issues bonds "ith a sin,ing
fund provision, the company is more li,ely to retire the bonds by buying them bac, in
the open mar,et, as opposed to calling them in at the sin,ing fund call price.
e. Statements b and c are correct.
)in/ing fund pro-ision Anser: d Diff: E
2/
a. 2etiring bonds under a sin,ing fund provision is similar to calling bonds under a call
provision in the sense that bonds are repurchased by the issuer prior to maturity.
b. ;nder a sin,ing fund, bonds "ill be purchased on the open mar,et by the issuer "hen
the bonds are selling at a premium and bonds "ill be called in for redemption "hen the
bonds are selling at a discount.
c. !he sin,ing fund provision ma,es a debt issue less ris,y to the investor.
Types of de!t Anser: e Diff: E
2#
a. @un, bonds typically have a lo"er yield to maturity relative to investment grade bonds.
b. A debenture is a secured bond that is bac,ed by some or all of the firm-s fi(ed assets.
c. Subordinated debt has less default ris, than senior debt.
Chapter 7 - Page 7
Medium:
&ond yield Anser: ! Diff: M
21
a. 2ising inflation ma,es the actual yield to maturity on a bond greater than the quoted
yield to maturity, "hich is based on mar,et prices.
b. !he yield to maturity for a coupon bond that sells at its par value consists entirely of
an interest yield; it has a 3ero e(pected capital gains yield.
c. On an e(pected yield basis, the e(pected capital gains yield "ill al"ays be positive
because an investor "ould not purchase a bond "ith an e(pected capital loss.
d. !he mar,et value of a bond "ill al"ays approach its par value as its maturity date
approaches. !his holds true even if the firm enters ban,ruptcy.
&ond yield Anser: c Diff: M
2+
a. !he current yield on 0ond A e(ceeds the current yield on 0ond 0; therefore, 0ond A
must have a higher yield to maturity than 0ond 0.
b. 'f a bond is selling at a discount, the yield to call is a better measure of return than the
yield to maturity.
c. 'f a coupon bond is selling at par, its current yield equals its yield to maturity.
#rice ris/ Anser: c Diff: M
2$
. Assume that all interest rates in the economy decline from 10 percent to * percent. %hich
of the follo"ing bonds "ill have the largest percentage increase in price&
a. A 10year bond "ith a 10 percent coupon.
b. An $year bond "ith a * percent coupon.
c. A 10year 3ero coupon bond.
d. A 1year bond "ith a 1# percent coupon.
e. A )year bond "ith a 10 percent coupon.
2*
. %hich of the follo"ing has the greatest interest rate 9price: ris,&
a. A 10year, =1,000 face value, 10 percent coupon bond "ith semiannual interest
payments.
b. A 10year, =1,000 face value, 10 percent coupon bond "ith annual interest payments.
c. A 10year, =1,000 face value, 3ero coupon bond.
d. A 10year =100 annuity.
e. All of the above have the same price ris, since they all mature in 10 years.
Chapter 7 - Page 8
)0
. 'f the yield to maturity decreased 1 percentage point, "hich of the follo"ing bonds "ould
have the largest percentage increase in value&
a. A 1year bond "ith an $ percent coupon.
b. A 1year 3ero coupon bond.
c. A 10year 3ero coupon bond.
d. A 10year bond "ith an $ percent coupon.
e. A 10year bond "ith a 12 percent coupon.
#rice ris/ Anser: a Diff: M
)1
. 'f interest rates fall from $ percent to + percent, "hich of the follo"ing bonds "ill have the
largest percentage increase in its value&
a. A 10year 3ero coupon bond.
b. A 10year bond "ith a 10 percent semiannual coupon.
c. A 10year bond "ith a 10 percent annual coupon.
d. A #year 3ero coupon bond.
e. A #year bond "ith a 12 percent annual coupon.
)2
. %hich of the follo"ing !reasury bonds "ill have the largest amount of interest rate ris,
9price ris,:&
a. A + percent coupon bond that matures in 12 years.
b. A * percent coupon bond that matures in 10 years.
c. A 12 percent coupon bond that matures in + years.
d. A + percent coupon bond that matures in * years.
e. A 10 percent coupon bond that matures in 10 years.
Chapter 7 - Page 9
))
. All treasury securities have a yield to maturity of + percentso the yield curve is flat. 'f
the yield to maturity on all !reasuries "ere to decline to 1 percent, "hich of the follo"ing
bonds "ould have the largest percentage increase in price&
a. 1#year 3ero coupon !reasury bond.
b. 12year !reasury bond "ith a 10 percent annual coupon.
c. 1#year !reasury bond "ith a 12 percent annual coupon.
d. 2year 3ero coupon !reasury bond.
e. 2year !reasury bond "ith a 1# percent annual coupon.
&ond concepts Anser: e Diff: M
)/
a. Other things held constant, a callable bond "ould have a lo"er required rate of return
than a noncallable bond.
b. Other things held constant, a corporation "ould rather issue noncallable bonds than
callable bonds.
c. 2einvestment rate ris, is "orse from a typical investor-s standpoint than interest rate
ris,.
d. 'f a 10year, =1,000 par, 3ero coupon bond "ere issued at a price that gave investors a
10 percent rate of return, and if interest rates then dropped to the point "here ,d A
4!5 A #B, "e could be sure that the bond "ould sell at a premium over its =1,000
par value.
e. 'f a 10year, =1,000 par, 3ero coupon bond "ere issued at a price that gave investors a
10 percent rate of return, and if interest rates then dropped to the point "here ,d A
4!5 A #B, "e could be sure that the bond "ould sell at a discount belo" its =1,000
par value.
&ond concepts Anser: d Diff: M
)#
a. !he mar,et value of a bond "ill al"ays approach its par value as its maturity date
approaches, provided the issuer of the bond does not go ban,rupt.
b. 'f the Cederal 2eserve une(pectedly announces that it e(pects inflation to increase,
then "e "ould probably observe an immediate increase in bond prices.
c. !he total yield on a bond is derived from interest payments and changes in the price of
the bond.
Chapter 7 - Page 10
&ond concepts Anser: ! Diff: M
)1
a. 'f a bond is selling for a premium, this implies that the bond-s yield to maturity e(ceeds
its coupon rate.
b. 'f a coupon bond is selling at par, its current yield equals its yield to maturity.
c. 'f rates fall after its issue, a 3ero coupon bond could trade for an amount above its par
value.
&ond concepts Anser: ! Diff: M
)+
a. All else equal, a bond that has a coupon rate of 10 percent "ill sell at a discount if the
required return for a bond of similar ris, is
$ percent.
b. !he price of a discount bond "ill increase over time, assuming that the bond-s yield to
maturity remains constant over time.
c. !he total return on a bond for a given year consists only of the coupon interest
payments received.
&ond concepts Anser: e Diff: M
)$
a. %hen large firms are in financial distress, they are almost al"ays liquidated.
b. Debentures generally have a higher yield to maturity relative to mortgage bonds.
c. 'f there are t"o bonds "ith equal maturity and credit ris,, the bond that is callable "ill
have a higher yield to maturity than the bond that is noncallable.
&ond concepts Anser: d Diff: M
)*
. A 10year bond has a 10 percent annual coupon and a yield to maturity of 12 percent. !he
bond can be called in # years at a call price of =1,0#0 and the bond-s face value is =1,000.
a. !he bond-s current yield is greater than 10 percent.
b. !he bond-s yield to call is less than 12 percent.
c. !he bond is selling at a price belo" par.
Chapter 7 - Page 11
&ond concepts Anser: d Diff: M (
/0
. 0ond E has an $ percent annual coupon, 0ond 4 has a 10 percent annual coupon, and
0ond F has a 12 percent annual coupon. 8ach of the bonds has a maturity of 10 years and
a yield to maturity of 10 percent. %hich of the follo"ing statements is most correct&
a. 0ond E has the greatest reinvestment rate ris,.
b. 'f mar,et interest rates remain at 10 percent, 0ond F-s price "ill be 10 percent higher
one year from today.
c. 'f mar,et interest rates increase, 0ond E-s price "ill increase, 0ond F-s price "ill
decline, and 0ond 4-s price "ill remain the same.
d. 'f mar,et interest rates remain at 10 percent, 0ond F-s price "ill be lo"er one year
from no" than it is today.
e. 'f mar,et interest rates decline, all of the bonds "ill have an increase in price, and
0ond F "ill have the largest percentage increase in price.
&ond concepts Anser: ! Diff: M (
/1
. 0onds A, 0, and < all have a maturity of 10 years and a yield to maturity equal to +
percent. 0ond A-s price e(ceeds its par value, 0ond 0-s price equals its par value, and
0ond <-s price is less than its par value. %hich of the follo"ing statements is most
correct&
a. 'f the yield to maturity on the three bonds remains constant, the price of the three
bonds "ill remain the same over the course of the ne(t year.
b. 'f the yield to maturity on each bond increases to $ percent, the price of all three bonds
"ill decline.
c. 'f the yield to maturity on each bond decreases to 1 percent, 0ond A "ill have the
largest percentage increase in its price.
e. All of the above statements are correct.
Interest rates and !ond prices Anser: e Diff: M (
/2
. 0ond A has a * percent annual coupon, "hile 0ond 0 has a + percent annual coupon. 0oth
bonds have the same maturity, a face value of =1,000, and an $ percent yield to maturity.
a. 0ond A trades at a discount, "hereas 0ond 0 trades at a premium.
b. 'f the yield to maturity for both bonds remains at $ percent, 0ond A-s price one year
from no" "ill be higher than it is today, but 0ond 0-s price one year from no" "ill be
lo"er than it is today.
c. 'f the yield to maturity for both bonds immediately decreases to
1 percent, 0ond A-s bond "ill have a larger percentage increase in value.
Calla!le !ond Anser: d Diff: M
/)
a. Distant cash flo"s are generally ris,ier than nearterm cash flo"s. Curther, a 20year
Chapter 7 - Page 12
bond that is callable after # years "ill have an e(pected life that is probably shorter,
and certainly no longer, than an other"ise similar noncallable 20year bond. !herefore,
investors should require a lo"er rate of return on the callable bond than on the
noncallable bond, assuming other characteristics are similar.
b. A noncallable 20year bond "ill generally have an e(pected life that is equal to or
greater than that of an other"ise identical callable 20year bond. 5oreover, the
interest rate ris, faced by investors is greater the longer the maturity of a bond.
!herefore, callable bonds e(pose investors to less interest rate ris, than noncallable
bonds, other things held constant.
c. Statements a and b are correct.
d. .one of the statements above is correct.
Calla!le !ond Anser: ! Diff: M
//
a. A callable 10year, 10 percent bond should sell at a higher price than an other"ise
similar noncallable bond.
b. !"o bonds have the same maturity and the same coupon rate. 6o"ever, one is
callable and the other is not. !he difference in prices bet"een the bonds "ill be greater
if the current mar,et interest rate is belo" the coupon rate than if it is above the
coupon rate.
c. !"o bonds have the same maturity and the same coupon rate. 6o"ever, one is
callable and the other is not. !he difference in prices bet"een the bonds "ill be greater
if the current mar,et interest rate is above the coupon rate than if it is belo" the
coupon rate.
d. !he actual life of a callable bond "ill be equal to or less than the actual life of a
noncallable bond "ith the same maturity date. !herefore, if the yield curve is up"ard
sloping, the required rate of return "ill be lo"er on the callable bond.
e. <orporate treasurers disli,e issuing callable bonds because these bonds may require
the company to raise additional funds earlier than "ould be true if noncallable bonds
"ith the same maturity "ere used.
Chapter 7 - Page 13
Types of de!t and their relati-e costs Anser: c Diff: M
/#
. A company is planning to raise =1,000,000 to finance a ne" plant. %hich of the follo"ing
statements is most correct&
a. 'f debt is used to raise the million dollars, the cost of the debt "ould be lo"er if the
debt is in the form of a fi(ed rate bond rather than a floating rate bond.
b. 'f debt is used to raise the million dollars, the cost of the debt "ould be lo"er if the
debt is in the form of a bond rather than a term loan.
c. 'f debt is used to raise the million dollars, but =#00,000 is raised as a first mortgage
bond on the ne" plant and =#00,000 as debentures, the interest rate on the first
mortgage bonds "ould be lo"er than it "ould be if the entire =1 million "ere raised
by selling first mortgage bonds.
d. !he company "ould be especially an(ious to have a call provision included in the
indenture if its management thin,s that interest rates are almost certain to rise in the
foreseeable future.
Miscellaneous concepts Anser: c Diff: M
/1
a. Once a firm declares ban,ruptcy, it is liquidated by the trustee, "ho uses the proceeds
to pay bondholders, unpaid "ages, ta(es, and la"yer fees.
b. A firm "ith a sin,ing fund payment coming due "ould generally choose to buy bac,
bonds in the open mar,et, if the price of the bond e(ceeds the sin,ing fund call price.
c. 'ncome bonds pay interest only "hen the amount of the interest is actually earned by
the company. !hus, these securities cannot ban,rupt a company and this ma,es them
safer to investors than regular bonds.
d. One disadvantage of 3ero coupon bonds is that issuing firms cannot reali3e the ta(
savings from issuing debt until the bonds mature.
e. Other things held constant, callable bonds should have a lo"er yield to maturity than
noncallable bonds.
Chapter 7 - Page 14
Miscellaneous concepts Anser: ! Diff: M
/+
a. A 10year 10 percent coupon bond has less reinvestment rate ris, than a 10year #
percent coupon bond 9assuming all else equal:.
b. !he total return on a bond for a given year arises from both the coupon interest
payments received for the year and the change in the value of the bond from the
beginning to the end of the year.
c. !he price of a 20year 10 percent bond is less sensitive to changes in interest rates
9that is, has lo"er interest rate ris,: than the price of a #year 10 percent bond.
d. A =1,000 bond "ith =100 annual interest payments "ith five years to maturity 9not
e(pected to default: "ould sell for a discount if interest rates "ere belo" * percent
and "ould sell for a premium if interest rates "ere greater than 11 percent.
e. Statements a, b, and c are correct.
Miscellaneous concepts Anser: e Diff: M
/$
a. All else equal, a 1year bond "ill have a higher 9that is, better: bond rating than a 20
year bond.
b. A 20year bond "ith semiannual interest payments has higher price ris, 9that is,
interest rate ris,: than a #year bond "ith semiannual interest payments.
c. 10year 3ero coupon bonds have higher reinvestment rate ris, than 10year, 10 percent
coupon bonds.
d. 'f a callable bond "ere trading at a premium, then you "ould e(pect to earn the yield
to maturity.
e. Statements a and b are correct.
Current yield and yield to maturity Anser: e Diff: M
/*
a. 'f a bond sells for less than par, then its yield to maturity is less than its coupon rate.
b. 'f a bond sells at par, then its current yield "ill be less than its yield to maturity.
c. Assuming that both bonds are held to maturity and are of equal ris,, a bond selling for
more than par "ith 10 years to maturity "ill have a lo"er current yield and higher
capital gain relative to a bond that sells at par.
Chapter 7 - Page 15
Current yield and yield to maturity Anser: a Diff: M
#0
. 4ou Gust purchased a 10year corporate bond that has an annual coupon of 10 percent.
!he bond sells at a premium above par. %hich of the follo"ing statements is most
correct&
a. !he bond-s yield to maturity is less than 10 percent.
b. !he bond-s current yield is greater than 10 percent.
c. 'f the bond-s yield to maturity stays constant, the bond-s price "ill be the same one
year from no".
Corporate !onds and default ris/ Anser: c Diff: M
#1
a. !he e(pected return on corporate bonds "ill generally e(ceed the yield to maturity.
b. Cirms that are in financial distress are forced to declare ban,ruptcy.
c. All else equal, senior debt "ill generally have a lo"er yield to maturity than
subordinated debt.
Default ris/ and !an/ruptcy Anser: ! Diff: M
#2
. %hich of the follo"ing statements is incorrect&
a. Cirms "ill often voluntarily enter ban,ruptcy before they are forced into ban,ruptcy by
their creditors.
b. An indenture is a bond that is less ris,y than a subordinated debenture.
c. %hen a firm files for <hapter 11 ban,ruptcy, it may attempt to restructure its e(isting
debt by changing 9subGect to creditor approval: the interest payments, maturity, andHor
principal amount.
d. All else equal, mortgage bonds are less ris,y than debentures because mortgage bonds
provide investors "ith a lien 9that is, a claim: against specific property.
e. A company-s bond rating is affected by financial performance and provisions in the
bond contract.
Default ris/ and !an/ruptcy Anser: ! Diff: M
#)
a. 'f a company increases its debt ratio, this is li,ely to reduce the default premium on its
e(isting bonds.
b. All else equal, senior debt has less default ris, than subordinated debt.
c. %hen companies enter <hapter 11, their assets are immediately liquidated and the firm
no longer continues to operate.
Chapter 7 - Page 16
Default ris/ and !an/ruptcy Anser: d Diff: M
#/
a. !he e(pected return on a corporate bond is al"ays less than its promised return "hen
the probability of default is greater than 3ero.
b. All else equal, secured debt is considered to be less ris,y than unsecured debt.
c. ;nder <hapter 11 0an,ruptcy, the firm-s assets are sold and debts are paid off
according to the seniority of the debt claim.
)in/ing funds and !an/ruptcy Anser: d Diff: M
##
. %hich of the follo"ing statements is correct&
a. 'f a company is retiring bonds for sin,ing fund purposes it "ill buy bac, bonds on the
open mar,et "hen the coupon rate is less than the mar,et interest rate.
b. A bond sin,ing fund "ould be good for investors if interest rates have declined after
issuance and the investor-s bonds get called.
c. A company that files for <hapter 11 2eorgani3ation under the Cederal 0an,ruptcy Act
can temporarily prevent foreclosure and sei3ing of the assets of the company.
7iquidation may still occur for this company.
Tough:
&ond yields and prices Anser: ! Diff: T
#1
a. 'f a bond-s yield to maturity e(ceeds its coupon rate, the bond-s current yield must also
e(ceed its coupon rate.
b. 'f a bond-s yield to maturity e(ceeds its coupon rate, the bond-s price must be less than
its maturity value.
c. 'f t"o bonds have the same maturity, the same yield to maturity, and the same level of
ris,, the bonds should sell for the same price regardless of the bond-s coupon rate.
Chapter 7 - Page 17
&ond concepts Anser: ! Diff: T
#+
. %hich of the follo"ing statements is incorrect about bonds& 'n all of the statements,
assume other things are held constant.
a. Irice 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. Cor a given bond of any maturity, a given percentage point increase in the interest rate
9,d: causes a larger dollar capital loss than the capital gain stemming from an identical
decrease in the interest rate.
c. Cor 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. Crom a borro"er-s point of vie", interest paid on bonds is ta(deductible.
e. A 20year 3ero coupon bond has less reinvestment rate ris, than a 20year coupon
bond.
&ond concepts Anser: e Diff: T
#$
a. All else equal, an increase in interest rates "ill have a greater effect on the prices of
longterm bonds than it "ill on the prices of shortterm bonds.
b. All else equal, an increase in interest rates "ill have a greater effect on highercoupon
bonds than it "ill have on lo"ercoupon bonds.
c. An increase in interest rates "ill have a greater effect on a 3ero coupon bond "ith 10
years maturity than it "ill have on a *year bond "ith a 10 percent annual coupon.
e. Statements a and c are correct.
Interest -s. rein-estment rate ris/ Anser: c Diff: T
#*
a. A 10year bond "ould have more interest rate ris, than a #year bond, but all 10year
bonds have the same interest rate ris,.
b. A 10year bond "ould have more reinvestment rate ris, than a #year bond, but all 10
year bonds have the same reinvestment rate ris,.
c. 'f their maturities "ere the same, a # percent coupon bond "ould have more interest
rate ris, than a 10 percent coupon bond.
d. 'f their maturities "ere the same, a # percent coupon bond "ould have less interest
rate ris, than a 10 percent coupon bond.
e. Fero coupon bonds have more interest rate ris, than any other type bond, even
perpetuities.
Chapter 7 - Page 18
&ond indenture Anser: d Diff: T
10
. 7isted belo" are some provisions that are often contained in bond indenturesJ
1. Ci(ed assets may be used as security.
2. !he bond may be subordinated to other classes of debt.
). !he bond may be made convertible.
/. !he bond may have a sin,ing fund.
#. !he bond may have a call provision.
1. !he bond may have restrictive covenants in its indenture.
%hich of the above provisions, each vie"ed alone, "ould tend to reduce the yield to
maturity investors "ould other"ise require on a ne"ly issued bond&
a. 1, 2, ), /, #, 1
b. 1, 2, ), /, 1
c. 1, ), /, #, 1
d. 1, ), /, 1
e. 1, /, 1
Types of de!t and their relati-e costs Anser: e Diff: T
11
. Suppose a ne" company decides to raise its initial =200 million of capital as =100 million
of common equity and =100 million of longterm debt. 0y an ironclad provision in its
charter, the company can never borro" any more money. %hich of the follo"ing
statements is most correct&
a. 'f the debt "ere raised by issuing =#0 million of debentures and =#0 million of first
mortgage bonds, "e could be absolutely certain that the firm-s total interest e(pense
"ould be lo"er than if the debt "ere raised by issuing =100 million of debentures.
b. 'f the debt "ere raised by issuing =#0 million of debentures and =#0 million of first
mortgage bonds, "e could be absolutely certain that the firm-s total interest e(pense
"ould be lo"er than if the debt "ere raised by issuing =100 million of first mortgage
bonds.
c. !he higher the percentage of total debt represented by debentures, the greater the ris,
of, and hence the interest rate on, the debentures.
d. !he higher the percentage of total debt represented by mortgage bonds, the ris,ier
both types of bonds "ill be, and, consequently, the higher the firm-s total dollar interest
charges "ill be.
e. 'n this situation, "e cannot tell for sure ho", or "hether, the firm-s total interest
e(pense on the =100 million of debt "ould be affected by the mi( of debentures versus
first mortgage bonds. 'nterest rates on the t"o types of bonds "ould vary as their
percentages "ere changed, but the result might "ell be such that the firm-s total
interest charges "ould not be affected materially by the mi( bet"een the t"o.
Chapter 7 - Page 19
Multiple Choice: #ro!lems
Easy:
Annual coupon rate Anser: d Diff: E (
12
. An annual coupon bond "ith a =1,000 face value matures in 10 years. !he bond currently
sells for =*0).+)#1 and has a * percent yield to maturity. %hat is the bond-s annual coupon
rate&
a. 1.+B
b. +.0B
c. +.2B
d. +.#B
e. +.+B
&ond -alue00annual payment Anser: d Diff: E
1)
. A 12year bond has a * percent annual coupon, a yield to maturity of
$ percent, and a face value of =1,000. %hat is the price of the bond&
a. =1,/1*
b. =1,000
c. = *2$
d. =1,0+#
e. =1,*#+
&ond -alue00semiannual payment Anser: e Diff: E
1/
. 4ou intend to purchase a 10year, =1,000 face value bond that pays interest of =10 every 1
months. 'f your nominal annual required rate of return is 10 percent "ith semiannual
compounding, ho" much should you be "illing to pay for this bond&
a. = $21.)1
b. =1,0$1.1#
c. = *#+.#0
d. =1,/)1./*
e. =1,12/.12
&ond -alue00semiannual payment Anser: d Diff: E
1#
. Assume that you "ish to purchase a 20year bond that has a maturity value of =1,000 and
ma,es semiannual interest payments of =/0. 'f you require a 10 percent nominal yield to
maturity on this investment, "hat is the ma(imum price you should be "illing to pay for
the bond&
a. =11*
b. =1+/
c. =+11
d. =$2$
e. =*02
Chapter 7 - Page 20
&ond -alue00semiannual payment Anser: e Diff: E (
11
. A bond that matures in 12 years has a * percent semiannual coupon 9i.e., the bond pays a
=/# coupon every si( months: and a face value of =1,000. !he bond has a nominal yield to
maturity of $ percent. %hat is the price of the bond today&
a. = *2+.#2
b. = *2$.)*
c. =1,0+).**
d. =1,0+#.)1
e. =1,0+1.2)
&ond -alue00semiannual payment Anser: ! Diff: E (
1+
. A bond "ith 10 years to maturity has a face value of =1,000. !he bond pays an $ percent
semiannual coupon, and the bond has a * percent nominal yield to maturity. %hat is the
price of the bond today&
a. =*0$.+1
b. =*)/.*1
c. =*)#.$2
d. =*#2.)+
e. =*10.//
&ond -alue00semiannual payment Anser: c Diff: E
1$
. A corporate bond "ith a =1,000 face value pays a =#0 coupon every si( months. !he
bond "ill mature in 10 years, and has a nominal yield to maturity of * percent. %hat is the
price of the bond&
a. = 1)/.$1
b. =1,01/.1$
c. =1,01#.0/
d. =1,0+$.2)
e. =1,0*/.#1
&ond -alue00semiannual payment Anser: ! Diff: E
1*
. A bond "ith a =1,000 face value and an $ percent annual coupon pays interest
semiannually. !he bond "ill mature in 1# years. !he nominal yield to maturity is 11
percent. %hat is the price of the bond today&
a. = +$/.2+
b. = +$1.**
c. =1,2#*.)$
d. =1,000.00
e. = +)*.1*
Chapter 7 - Page 21
&ond -alue00semiannual payment Anser: c Diff: E (
+0
. A 12year bond has an $ percent semiannual coupon and a face value of =1,000. !he bond
pays a =/0 coupon every si( months. !he bond has a nominal yield to maturity of +
percent. %hat is the price of the bond&
a. =1,11/.1*
b. = +11.+2
c. =1,0$0.2*
d. = 1##.*2
e. =1,0+*./)
&ond -alue001uarterly payment Anser: c Diff: E
+1
. A =1,000 par value bond pays interest of =)# each quarter 9 thanh toKn hLng quM: and "ill
mature in 10 years. 'f your nominal annual required rate of return is 12 percent "ith
quarterly compounding, ho" much should you be "illing to pay for this bond&
a. = */1.)1
b. =1,0#1.2#
c. =1,11#.#+
d. =1,)*1.00
e. = $2#./*
2ield to maturity00annual !ond Anser: a Diff: E
+2
. Ialmer Iroducts has outstanding bonds "ith an annual $ percent coupon. !he bonds have
a par value of =1,000 and a price of =$1#. !he bonds "ill mature in 11 years. %hat is the
yield to maturity on the bonds&
a. 10.0*B
b. 11.1)B
c. *.2#B
d. $.00B
e. *.$*B
2ield to maturity00semiannual !ond Anser: c Diff: E
+)
. A corporate bond has a face value of =1,000, and pays a =#0 coupon every si( months
9that is, the bond has a 10 percent semiannual coupon:. !he bond matures in 12 years and
sells at a price of =1,0$0. %hat is the bond-s nominal yield to maturity&
a. $.2$B
b. $.1#B
c. $.*0B
d. *.)1B
e. 10.+$B
Chapter 7 - Page 22
2ield to maturity00semiannual !ond Anser: ! Diff: E
+/
. 4ou Gust purchased a =1,000 par value, *year, + percent annual coupon bond that pays
interest on a semiannual basis. !he bond sells for =*20. %hat is the bond-s nominal yield
to maturity&
a. +.2$B
b. $.2$B
c. *.10B
d. $.1+B
e. /.1)B
2TM and 2TC00semiannual !ond Anser: e Diff: E
+#
. A corporate bond matures in 1/ years. !he bond has an $ percent semiannual coupon and
a par value of =1,000. !he bond is callable in five years at a call price of =1,0#0. !he
price of the bond today is =1,0+#. %hat are the bond-s yield to maturity and yield to call&
a. 4!5 A 1/.2*B; 4!< A 1/.0*B
b. 4!5 A ).#+B; 4!< A ).#2B
c. 4!5 A +.1/B; 4!< A +.)/B
d. 4!5 A 1.1/B; 4!< A /.+$B
e. 4!5 A +.1/B; 4!< A +.0#B
2ield to maturity and !ond -alue00annual !ond Anser: d Diff: E
+1
. A 20year bond "ith a par value of =1,000 has a * percent annual coupon. !he bond
currently sells for =*2#. 'f the bond-s yield to maturity remains at its current rate, "hat
"ill be the price of the bond # years from no"&
a. = *11.+*
b. = $)1.)#
c. =1,0*0.00
d. = *)).0*
e. = *2#.00
Current yield Anser: ! Diff: E
++
. <onsider a =1,000 par value bond "ith a + percent annual coupon. !he bond pays interest
annually. !here are * years remaining until maturity. %hat is the current yield on the bond
assuming that the required return on the bond is 10 percent&
a. 10.00B
b. $./1B
c. +.00B
d. $.#2B
e. $.)+B
Current yield Anser: d Diff: E
+$
. A 12year bond pays an annual coupon of $.# percent. !he bond has a yield to maturity of
*.# percent and a par value of =1,000. %hat is the bond-s current yield&
Chapter 7 - Page 23
a. 1.)1B
b. 2.1#B
c. $.*#B
d. *.1/B
e. 10.21B
Current yield Anser: c Diff: E
+*
. A 1#year bond "ith an $ percent annual coupon has a face value of =1,000. !he bond-s
yield to maturity is + percent. %hat is the bond-s current yield&
a. ).))B
b. #.00B
c. +.))B
d. +.#0B
e. $.00B
Current yield and yield to maturity Anser: ! Diff: E
$0
. A bond matures in 12 years and pays an $ percent annual coupon. !he bond has a face
value of =1,000 and currently sells for =*$#. %hat is the bond-s current yield and yield to
maturity&
a. <urrent yield A $.00B; yield to maturity A +.*2B
b. <urrent yield A $.12B; yield to maturity A $.20B
c. <urrent yield A $.20B; yield to maturity A $.)+B
d. <urrent yield A $.12B; yield to maturity A $.)+B
e. <urrent yield A $.12B; yield to maturity A +.*2B
3uture !ond -alue00annual payment Anser: ! Diff: E (
$1
. A bond "ith a face value of =1,000 matures in 10 years. !he bond has an $ percent annual
coupon and a yield to maturity of 10 percent. 'f mar,et interest rates remain at 10
percent, "hat "ill be the price of the bond t"o years from today&
a. = $++.11
b. = $*).)0
c. =1,011.)0
d. = *12.##
e. =1,02).01
Chapter 7 - Page 24
$is/ premium on !onds Anser: c Diff: E
$2
. 2ollincoast 'ncorporated issued 000 bonds t"o years ago that provided a yield to
maturity of 11.# percent. 7ongterm ris,free government bonds "ere yielding $.+
percent at that time. !he current ris, premium on 000 bonds versus government bonds is
half of "hat it "as t"o years ago. 'f the ris,free longterm government bonds are
currently yielding +.$ percent, then at "hat rate should 2ollincoast e(pect to issue ne"
bonds&
a. +.$B
b. $.+B
c. *.2B
d. 10.2B
e. 12.*B
Medium:
&ond -alue00annual payment Anser: e Diff: M
$)
. A 1year bond that pays $ percent interest semiannually sells at par 9=1,000:. Another 1
year bond of equal ris, pays $ percent interest annually. 0oth bonds are noncallable and
have face values of =1,000. %hat is the price of the bond that pays annual interest&
a. =1$*.0$
b. =+12.0#
c. =*$0./)
d. =*$1.+2
e. =**2.1/
&ond -alue00annual payment Anser: a Diff: M
$/
. A 10year bond "ith a * percent semiannual coupon is currently selling at par. A 10year
bond "ith a * percent annual coupon has the same ris,, and therefore, the same effective
annual return as the semiannual bond. 'f the annual coupon bond has a face value of
=1,000, "hat "ill be its price&
a. = *$+.12
b. =1,000.00
c. = /+1.$+
d. =1,0$*.$/
e. = *1+.)/
Chapter 7 - Page 25
&ond -alue00annual payment Anser: d Diff: M
$#
. 4ou are the o"ner of 100 bonds issued by 8uler, 7td. !hese bonds have
$ years remaining to maturity, an annual coupon payment of =$0, and a par value of
=1,000. ;nfortunately, 8uler is on the brin, of ban,ruptcy. !he creditors, including
yourself, have agreed to a postponement of the ne(t / interest payments 9other"ise, the
ne(t interest payment "ould have been due in 1 year:. !he remaining interest payments,
for 4ears # through $, "ill be made as scheduled. !he postponed payments "ill accrue
interest at an annual rate of 1 percent, and they "ill then be paid as a lump sum at maturity
$ years hence. !he required rate of return on these bonds, considering their substantial
ris,, is no" 2$ percent. %hat is the present value of each bond&
a. =#)$.21
b. =/21.+)
c. =)$/.$/
d. =211.$$
e. =2/*.*$
&ond -alue00annual payment Anser: a Diff: M
$1
. 5arie Snell recently inherited some bonds 9face value =100,000: from her father, and soon
thereafter she became engaged to Sam Spade, a ;niversity of Clorida mar,eting graduate.
Sam "ants 5arie to cash in the bonds so the t"o of them can use the money to >live li,e
royalty? for t"o years in 5onte <arlo. !he 2 percent annual coupon bonds mature on
December )1, 2022, and it is no" @anuary 1, 200). 'nterest on these bonds is paid
annually on December )1 of each year, and ne" annual coupon bonds "ith similar ris, and
maturity are currently yielding 12 percent. 'f 5arie sells her bonds no" and puts the
proceeds into an account that pays 10 percent compounded annually, "hat "ould be the
largest equal annual amounts she could "ithdra" for t"o years, beginning today 9that is,
t"o payments, the first payment today and the second payment one year from today:&
a. =1),2##
b. =2*,+0$
c. =12,1#/
d. =2#,)0#
e. =1/,#$0
Chapter 7 - Page 26
&ond -alue00semiannual payment Anser: d Diff: M
$+
. Due to a number of la"suits related to to(ic "astes, a maGor chemical manufacturer has
recently e(perienced a mar,et reevaluation. !he firm has a bond issue outstanding "ith 1#
years to maturity and a coupon rate of $ percent, "ith interest paid semiannually. !he
required nominal rate on this debt has no" risen to 11 percent. %hat is the current value
of this bond&
a. =1,2+)
b. =1,000
c. =+,+$)
d. = ##0
e. = /#0
&ond -alue00semiannual payment Anser: ! Diff: M
$$
. @2@ <orporation recently issued 10year bonds at a price of =1,000. !hese bonds pay =10
in interest each si( months. !heir price has remained stable since they "ere issued, that is,
they still sell for =1,000. Due to additional financing needs, the firm "ishes to issue ne"
bonds that "ould have a maturity of 10 years, a par value of =1,000, and pay =/0 in
interest every si( months. 'f both bonds have the same yield, ho" many ne" bonds must
@2@ issue to raise =2,000,000&
a. 2,/00
b. 2,#*1
c. ),000
d. #,000
e. /,2+#
$*
. Assume that you are considering the purchase of a =1,000 par value bond that pays
interest of =+0 each si( months and has 10 years to go before it matures. 'f you buy this
bond, you e(pect to hold it for # years and then to sell it in the mar,et. 4ou 9and other
investors: currently require a nominal annual rate of 11 percent, but you e(pect the mar,et
to require a nominal rate of only 12 percent "hen you sell the bond due to a general
decline in interest rates. 6o" much should you be "illing to pay for this bond&
a. = $/2.00
b. =1,11#.$1
c. =1,)#*.21
d. = *11.**
e. = +)1.$#
Chapter 7 - Page 27
*0
. An $ percent annual coupon, noncallable bond has 10 years until it matures and a yield to
maturity of *.1 percent. %hat should be the price of a 10year noncallable bond of equal
ris, that pays an $ percent semiannual coupon& Assume both bonds have a par value of
=1,000.
a. = $*$.1/
b. = +)1.$1
c. = $#/.2+
d. = */1.0*
e. = *1/.2)
&ond -alue00semiannual payment Anser: a Diff: M (
*1
. A bond "ith 12 years to maturity has a + percent semiannual coupon and a face value of
=1,000. 9!hat is, the bond pays a =)# coupon every si( months.: !he bond currently sells
for =1,000. %hat should be the price of a bond "ith the same ris, and maturity that pays
a + percent annual coupon and has a face value of =1,000&
a. = **0.))
b. = **1.#0
c. =1,000.00
d. =1,002.2*
e. =1,012.$2
&ond -alue001uarterly payment Anser: ! Diff: M
*2
. Assume that a 1#year, =1,000 face value bond pays interest of =)+.#0 every ) months. 'f
you require a nominal annual rate of return of 12 percent, "ith quarterly compounding,
ho" much should you be "illing to pay for this bond& 96intJ !he IN'CA and IN'C for )
percent, 10 periods are 2+.1+#1 and 0.11*+, respectively.:
a. = $21.*2
b. =1,20+.#+
c. = *$1./)
d. =1,120.+1
e. =1,)#$.2/
&ond -alue001uarterly payment Anser: ! Diff: M
*)
. 4our client has been offered a #year, =1,000 par value bond "ith a 10 percent coupon.
'nterest on this bond is paid quarterly. 'f your client is to earn a nominal rate of return of
12 percent, compounded quarterly, ho" much should she pay for the bond&
a. = $00
b. = *21
c. =1,02#
d. =1,211
e. = *$1
Chapter 7 - Page 28
Call price001uarterly payment Anser: c Diff: M
*/
. Oennedy Pas %or,s has bonds that mature in 10 years, and have a face value of =1,000.
!he bonds have a 10 percent quarterly coupon 9that is, the nominal coupon rate is 10
percent:. !he bonds may be called in five years. !he bonds have a nominal yield to
maturity of $ percent and a yield to call of +.# percent. %hat is the bonds- call price&
a. = )+*.2+
b. =1,02#.00
c. =1,0/$.)/
d. =1,0)1.++
e. =1,1)1.+$
Call price00semiannual payment Anser: e Diff: M
*#
. A 1#year bond "ith a 10 percent semiannual coupon and a =1,000 face value has a
nominal yield to maturity of +.# percent. !he bond, "hich may be called after five years,
has a nominal yield to call of #.#/ percent. %hat is the bond-s call price&
a. = #1/
b. =1,110
c. =1,100
d. =1,1+)
e. =1,0/0
2ield to call Anser: a Diff: M (
*1
. A bond "ith a face value of =1,000 matures in 12 years and has a
* percent semiannual coupon. 9!hat is, the bond pays a =/# coupon every si( months.:
!he bond has a nominal yield to maturity of +.# percent, and it can be called in / years at a
call price of =1,0/#. %hat is the bond-s nominal yield to call&
a. 1.11B
b. 11.)1B
c. ).)1B
d. *.*$B
e. #.1$B
2ield to call00annual !ond Anser: a Diff: M
*+
. A corporate bond that matures in 12 years pays a * percent annual coupon, has a face
value of =1,000, and a yield to maturity of +.# percent. !he bond can first be called four
years from no". !he call price is =1,0#0. %hat is the bond-s yield to call&
a. 1.+)B
b. +.10B
c. +.#0B
d. 11.$1B
e. 1)./#B
Chapter 7 - Page 29
2ield to call00annual !ond Anser: ! Diff: M
*$
. A bond that matures in 11 years has an annual coupon rate of $ percent "ith interest paid
annually. !he bond-s face value is =1,000, and its yield to maturity is +.# percent. !he
bond can be called ) years from no" at a price of =1,010. %hat is the bond-s nominal
yield to call&
a. *.$2B
b. $./1B
c. $.#/B
d. $.)$B
e. +.$1B
2ield to call00semiannual !ond Anser: a Diff: M
**
. A corporate bond "ith 12 years to maturity has a * percent semiannual coupon and a face
value of =1,000. 9!hat is, the semiannual coupon payments are =/#.: !he bond has a
nominal yield to maturity of
+ percent. !he bond can be called in three years at a call price of =1,0/#. %hat is the
bond-s nominal yield to call&
a. /.12B
b. 10.)2B
c. 1+.22B
d. #.11B
e. 2.)1B
2ield to call04semiannual !ond Anser: ! Diff: M
100
. 6ood <orporation recently issued 20year bonds. !he bonds have a coupon rate of $
percent and pay interest semiannually. Also, the bonds are callable in 1 years at a call price
equal to 11# percent of par value. !he par value of the bonds is =1,000. 'f the yield to
maturity is
+ percent, "hat is the yield to call&
a. $.))B
b. +.+#B
c. *.$*B
d. 10.00B
e. +.00B
2ield to call00semiannual !ond Anser: d Diff: M
101
. A 12year bond "ith a 10 percent semiannual coupon and a =1,000 par value has a
nominal yield to maturity of * percent. !he bond can be called in five years at a call price
of =1,0#0. %hat is the bond-s nominal yield to call&
a. /.#0B
b. $.2#B
c. $.$$B
d. $.*$B
e. *.00B
Chapter 7 - Page 30
2ield to call00semiannual !ond Anser: c Diff: M
102
. A corporate bond "ith an 11 percent semiannual coupon has a yield to maturity of *
percent. !he bond matures in 20 years but is callable in 10 years. !he maturity value is
=1,000. !he call price is =1,0##.
%hat is the bond-s yield to call&
a. $./)B
b. $.#0B
c. $.#$B
d. $.1#B
e. *.00B
2ield to call00semiannual !ond Anser: ! Diff: M
10)
. 5cPriff 5otors has bonds outstanding that "ill mature in 12 years. !he bonds pay a 12
percent semiannual coupon and have a face value of =1,000 9that is, the bonds pay a =10
coupon every si( months:. !he bonds currently have a yield to maturity of 10 percent.
!he bonds are callable in $ years and have a call price of =1,0#0. %hat is the bonds- yield
to call&
a. $.$*B
b. *.$*B
c. *.*/B
d. 10.00B
e. 12.00B
10/
. A 12year bond has a 10 percent semiannual coupon and a face value of =1,000. !he bond
has a nominal yield to maturity of + percent. !he bond can be called in five years at a call
price of =1,0#0. %hat is the bond-s nominal yield to call&
a. #.2*B
b. #./0B
c. #.))B
d. #.+1B
e. /.#1B
10#
. A 12year, =1,000 face value bond has an $ percent semiannual coupon and a nominal
yield to maturity of 1 percent. !he bond is callable in
# years at a call price of =1,0/0. %hat is the bond-s nominal yield to call&
a. 1.+1B
b. $.2+B
c. /.$1B
d. ).#2B
e. #.22B
Chapter 7 - Page 31
2ield to call00semiannual !ond Anser: ! Diff: M (
101
. A 10year bond sells for =1,0+#. !he bond has a * percent semiannual coupon and a face
value of =1,000. 9!hat is, the bond pays a =/# coupon every si( months.: !he bond is
callable in # years and the call price is =1,0)#. %hat is the bond-s nominal yield to call&
a. +.1*B
b. +.+#B
c. +.*0B
d. $.00B
e. $.1)B
2ield to maturity Anser: c Diff: M (
10+
. A bond "ith a face value of =1,000 has a 10year maturity and an $.# percent annual
coupon. !he bond has a current yield of $ percent. %hat is the bond-s yield to maturity&
a. $.2#B
b. $.$1B
c. +.#*B
d. $.#0B
e. $.00B
2ield to maturity00semiannual !ond Anser: d Diff: M
10$
. A 1#year bond "ith a 10 percent semiannual coupon has a par value of =1,000. !he bond
may be called after 10 years at a call price of =1,0#0. !he bond has a nominal yield to call
of 1.# percent. %hat is the bond-s yield to maturity, stated on a nominal, or annual basis&
a. #.*+B
b. 1.)0B
c. 1.+#B
d. 1.*#B
e. +.10B
2ield to maturity00semiannual !ond Anser: d Diff: M
10*
. A 10year bond has a face value of =1,000. !he bond has a + percent semiannual coupon.
!he bond is callable in + years at a call price of =1,0/0. !he bond has a nominal yield to
call of 1.# percent. %hat is the bond-s nominal yield to maturity&
a. ).1/B
b. 1.0#B
c. +.12B
d. 1.2+B
e. 1.##B
2ield to maturity00semiannual !ond Anser: d Diff: M (
110
. A bond that matures in $ years has a *.# percent coupon rate, semiannual payments, a face
value of =1,000, and an $.2 percent current yield.
%hat is the bond-s nominal yield to maturity 94!5:&
Chapter 7 - Page 32
a. +.20B
b. +./#B
c. 1.##B
d. 1.$*B
e. $.20B
Annual interest payments remaining Anser: ! Diff: M
111
. 4ou have Gust been offered a =1,000 par value bond for =$/+.$$. !he coupon rate is $
percent, payable annually, and annual interest rates on ne" issues of the same degree of
ris, are 10 percent. 4ou "ant to ,no" ho" many more interest payments you "ill
receive, but the party selling the bond cannot remember. <an you determine ho" many
interest payments remain&
a. 1/
b. 1#
c. 12
d. 20
e. 10
Current yield and capital gains yield Anser: c Diff: M
112
. 5eade <orporation bonds mature in 1 years and have a yield to maturity of $.# percent.
!he par value of the bonds is =1,000. !he bonds have a 10 percent coupon rate and pay
interest on a semiannual basis. %hat are the current yield and capital gains yield on the
bonds for this year& 9Assume that interest rates do not change over the course of the year.:
a. <urrent yield A $.#0B; capital gains yield A 1.#0B
b. <urrent yield A *.)#B; capital gains yield A 0.1#B
c. <urrent yield A *.)#B; capital gains yield A 0.$#B
d. <urrent yield A 10.00B; capital gains yield A 0.00B
e. <urrent yield A 10.#0B; capital gains yield A 1.#0B
Current yield and 2TM Anser: c Diff: M
11)
. A 11year bond "ith a 10 percent annual coupon has a current yield of
$ percent. %hat is the bond-s yield to maturity 94!5:&
a. 1.*B
b. +.1B
c. +.)B
d. +.#B
e. +.+B
+ength of time until annual !onds called Anser: ! Diff: M (
11/
. 5atteo !oys has bonds outstanding that have a * percent annual coupon and a face value of
=1,000. !he bonds "ill mature in 10 years, although they can be called before maturity at a
call price of =1,0#0. !he bonds have a yield to call of 1.# percent and a yield to maturity of
+./ percent. 6o" long until these bonds may first be called&
a. 2.21 years
b. ).11 years
Chapter 7 - Page 33
c. ).1$ years
d. #.)+ years
e. 1.)2 years
Mar/et -alue of semiannual !onds Anser: a Diff: M
11#
. 'n order to accurately assess the capital structure of a firm, it is necessary to convert its
balance sheet figures to a mar,et value basis. O@5 <orporation-s balance sheet as of
today, @anuary 1, 200), is as follo"sJ
7ongterm debt 9bonds, at par: =10,000,000
Ireferred stoc, 2,000,000
<ommon stoc, 9=10 par: 10,000,000
2etained earnings /,000,000
!otal debt and equity =21,000,000
!he bonds have a / percent coupon rate, payable semiannually, and a par value of =1,000.
!hey mature on @anuary 1, 201). !he yield to maturity is 12 percent, so the bonds no"
sell belo" par. %hat is the current mar,et value of the firm-s debt&
a. =#,/12,000
b. =#,/$0,000
c. =2,#)1,000
d. =+,+01,000
e. =+,0#1,000
3uture !ond -alue00annual payment Anser: c Diff: M
111
. 4ou Gust purchased a 1#year bond "ith an 11 percent annual coupon. !he bond has a
face value of =1,000 and a current yield of 10 percent. Assuming that the yield to maturity
of *.+0+2 percent remains constant, "hat "ill be the price of the bond one year from no"&
a. =1,000
b. =1,01/
c. =1,0*+
d. =1,100
e. =1,1#0
Chapter 7 - Page 34
&ond coupon rate Anser: c Diff: M
11+
. <old 0o(es 7td. has 100 bonds outstanding 9maturity value A =1,000:. !he nominal
required rate of return on these bonds is currently 10 percent, and interest is paid
semiannually. !he bonds mature in # years, and their current mar,et value is =+1$ per bond.
%hat is the annual coupon interest rate&
a. $B
b. 1B
c. /B
d. 2B
e. 0B
&ond coupon rate Anser: d Diff: M
11$
. !he current price of a 10year, =1,000 par value bond is =1,1#$.*1. 'nterest on this bond
is paid every si( months, and the nominal annual yield is 1/ percent. Piven these facts,
"hat is the annual coupon rate on this bond&
a. 10B
b. 12B
c. 1/B
d. 1+B
e. 21B
Tough:
&ond -alue Anser: d Diff: T
11*
. Assume that 5cDonald-s and 0urger Oing have similar =1,000 par value bond issues
outstanding. !he bonds are equally ris,y. !he 0urger Oing bond has an annual coupon
rate of $ percent and matures 20 years from today. !he 5cDonald-s bond has a coupon
rate of $ percent, "ith interest paid semiannually, and it also matures in 20 years. 'f the
nominal required rate of return, ,d, is 12 percent, semiannual basis, for both bonds, "hat is
the difference in current mar,et prices of the t"o bonds&
a. = 0.#0
b. = 2.20
c. = ).++
d. =1+.#)
e. = 1.2$
Chapter 7 - Page 35
&ond -alue and effecti-e annual rate Anser: ! Diff: T
120
. 4ou are considering investing in a security that matures in 10 years "ith a par value of
=1,000. During the first five years, the security has an $ percent coupon "ith quarterly
payments 9that is, you receive =20 a quarter for the first 20 quarters:. During the
remaining five years the security has a 10 percent coupon "ith quarterly payments 9that is,
you receive =2# a quarter for the second 20 quarters:. After 10 years 9/0 quarters: you
receive the par value.
Another 10year bond has an $ percent semiannual coupon 9that is, the coupon payment is
=/0 every si( months:. !his bond is selling at its par value, =1,000. !his bond has the
same ris, as the security you are thin,ing of purchasing. Piven this information, "hat
should be the price of the security you are considering purchasing&
a. = $*$.1#
b. =1,010.+2
c. =1,0)+.11
d. = */).22
e. =1,1/#.$*
&ond -alue after reorgani5ation Anser: d Diff: T
121
. 2ecently, Ohio 6ospitals 'nc. filed for ban,ruptcy. !he firm "as reorgani3ed as American
6ospitals 'nc., and the court permitted a ne" indenture on an outstanding bond issue to be
put into effect. !he issue has 10 years to maturity and a coupon rate of 10 percent, paid
annually. !he ne" agreement allo"s the firm to pay no interest for # years. !hen, interest
payments "ill be resumed for the ne(t # years. Cinally, at maturity 94ear 10:, the principal
plus the interest that "as not paid during the first # years "ill be paid. 6o"ever, no
interest "ill be paid on the deferred interest. 'f the required annual return is 20 percent,
"hat should the bonds sell for in the mar,et today&
a. =2/2.21
b. =2$1.1*
c. =#+$.)1
d. =)12.//
e. =$1).1*
Chapter 7 - Page 36
&ond sin/ing fund payment Anser: d Diff: T
122
. PIQ7 sold =1,000,000 of 12 percent, )0year, semiannual payment bonds 1# years ago.
!he bonds are not callable, but they do have a sin,ing fund that requires PIQ7 to redeem
# percent of the original face value of the issue each year 9=#0,000:, beginning in 4ear 11.
!o date, 2# percent of the issue has been retired. !he company can either call bonds at
par for sin,ing fund purposes or purchase bonds on the open mar,et, spending sufficient
money to redeem # percent of the original face value each year. 'f the nominal yield to
maturity 91# years remaining: on the bonds is currently 1/ percent, "hat is the least
amount of money PIQ7 must put up to satisfy the sin,ing fund provision&
a. =/),$#1
b. =#0,000
c. =)+,#00
d. =/),+*1
e. =)*,/22
&ond coupon payment Anser: ! Diff: T
12)
. Cish Q <hips 'nc. has t"o bond issues outstanding, and both sell for =+01.22. !he first issue
has an annual coupon rate of $ percent and 20 years to maturity. !he second has an identical
yield to maturity as the first bond, but only # years remain until maturity. 0oth issues pay
interest

annually. %hat is the annual interest payment on the second issue&
a. =120.00
b. = )+.12
c. = #1./2
d. = 2*.1$
e. = 11.11
&onds ith differential payments Anser: c Diff: T
12/
. Semiannual payment bonds "ith the same ris, 9Aaa: and maturity 920 years: as your
company-s bonds have a nominal 9not 8A2: yield to maturity of * percent. 4our
company-s treasurer is thin,ing of issuing at par some =1,000 par value, 20year, quarterly
payment bonds. She has as,ed you to determine "hat quarterly interest payment, in
dollars, the company "ould have to set in order to provide the same effective annual rate
98A2: as those on the 20year, semiannual payment bonds. %hat "ould the quarterly,
dollar interest payment be&
a. =/#.00
b. =2#.00
c. =22.2#
d. =2+.#0
e. =2).00
Chapter 7 - Page 37
Multiple Part:
(The following information applies to the next three problems.)
A bond that matures in 10 years sells for =*2#. !he bond has a face value of =1,000 and an $
percent annual coupon.
Current yield00annual !ond Anser: a Diff: E (
12#
. %hat is the bond-s current yield&
a. $.1#B
b. $.00B
c. $.))B
d. +.$$B
e. $.*#B
2ield to maturity00annual !ond Anser: c Diff: M (
121
. %hat is the bond-s yield to maturity&
a. *.00B
b. *.##B
c. *.1$B
d. $.+#B
e. *.))B
3uture !ond -alue00annual payment Anser: e Diff: M (
12+
. Assume that the yield to maturity remains constant for the ne(t three years. %hat "ill be
the price of the bond three years from today&
a. = *2#
b. = *#1
c. =1,000
d. = *++
e. = */1
(The following information applies to the next two problems.)
A 12year bond has an $ percent annual coupon and a face value of =1,000.
!he bond has a yield to maturity of + percent.
&ond -alue00annual payment Anser: d Diff: E (
12$
. %hat is the price of the annual coupon bond today&
a. = *2/.1/
b. =1,000.00
c. =1,0+0.2/
d. =1,0+*./)
e. =1,0**.21
Chapter 7 - Page 38
Chapter 7 - Page 39
3uture !ond -alue00annual payment Anser: e Diff: E (
12*
. 'f the yield to maturity remains at + percent, "hat "ill be the price of the bond three years
from today&
a. = *)+.#)
b. = *1).*/
c. =1,021.2/
d. =1,0#2.1$
e. =1,01#.1#
A 1#year bond has a par value of =1,000 and a 10 percent semiannual coupon. 9!hat is, the bond
pays a coupon of =#0 every si( months.: !he bond has a price of =1,1*0 and it is callable in #
years at a call price of =1,0#0.
2ield to maturity00semiannual !ond Anser: d Diff: E (
1)0
. %hat is the semiannual coupon bond-s nominal yield to maturity 94!5:&
a. 1.)+B
b. 1.+)B
c. +.10B
d. +.$)B
e. $.2#B
2ield to call00semiannual !ond Anser: a Diff: E (
1)1
. %hat is the semiannual coupon bond-s nominal yield to call 94!<:&
a. 1.)+B
b. 1.+)B
c. +.10B
d. +.$)B
e. $.2#B
6astings 5otors has bonds outstanding "ith 12 years left until maturity. !he bonds have a
=1,000 par value and an $ percent annual coupon. <urrently, the bonds sell at a price of =1,02#.
2ield to maturity00annual !ond Anser: a Diff: E (
1)2
. %hat is the annual coupon bond-s yield to maturity&
a. +.1+B
b. +.$0B
c. $.00B
d. $.1)B
Chapter 7 - Page 40
e. $.))B
Chapter 7 - Page 41
#rice ris/00annual !ond Anser: e Diff: M (
1))
. %hat "ill be the percentage increase in the annual coupon bond-s price if the yield to
maturity "ere to immediately fall by one percentage point 9100 basis points:&
a. #.+B
b. 1.0B
c. 1.*B
d. +.+B
e. $.0B
6e! Appendi7 %A
Easy:
8ero coupon !ond concepts Anser: a Diff: E
+A
1)/
a. 'f interest rates increase, a 10year 3ero coupon bond "ill drop in price by a greater
percentage than "ill a 10year $ percent coupon bond.
b. One nice thing about 3ero coupon bonds is that individual investors do not have to
pay any ta(es on a 3ero coupon bond until it matures, even if they are not holding
the bonds as part of a ta(deferred account.
c. 'f a bond "ith a sin,ing fund provision has a yield to maturity greater than its
coupon rate, the issuing company "ould prefer to comply "ith the sin,ing fund by
calling the bonds in at par rather than buying the bonds bac, in the open mar,et.
Medium:
Coupon and 5ero coupon !ond concepts Anser: d Diff: M
+A
1)#
. <onsider each of the follo"ing bondsJ
0ond AJ $year maturity "ith a + percent annual coupon.
0ond 0J 10year maturity "ith a * percent annual coupon.
0ond <J 12year maturity "ith a 3ero coupon.
8ach bond has a face value of =1,000 and a yield to maturity of
$ percent. %hich of the follo"ing statements is most correct&
a. 0ond A sells at a discount, "hile 0ond 0 sells at a premium.
b. 'f the yield to maturity on each bond falls to + percent, 0ond < "ill have the largest
percentage increase in its price.
c. 0ond < has the most reinvestment rate ris,.
Chapter 7 - Page 42
Multiple Choice: #ro!lems
Easy:
)tripped ,.). Treasury !ond Anser: e Diff: E
+A
1)1
. 5cP"ire <ompany-s pension fund proGected that a significant number of its employees
"ould ta,e advantage of an early retirement program the company plans to offer in five
years. Anticipating the need to fund these pensions, the firm bought 3ero coupon ;.S.
!reasury !rust <ertificates maturing in five years. %hen these instruments "ere originally
issued, they "ere 12 percent coupon, )0year ;.S. !reasury bonds. !he stripped !reasuries
are currently priced to yield 10 percent. !heir total maturity value is =1,000,000. %hat is
their total cost 9price: to 5cP"ire today&
a. = ##),++1
b. =#,1/2,100
c. =),/0/,#11
d. =/,0/2,0/0
e. =),+2#,#2$
8ero coupon !ond Anser: ! Diff: E
+A
1)+
. At the beginning of the year, you purchased a +year, 3ero coupon bond "ith a yield to
maturity of 1.$ percent. !he bond has a face value of =1,000. 4our ta( rate is )0
percent. %hat is the total ta( that you "ill have to pay on the bond during the first year&
a. =20./0
b. =12.$+
c. =)0.0)
d. =1).+#
e. =11./#
Medium:
8ero coupon !ond Anser: d Diff: M
+A
1)$
. 4ou Gust purchased a 3ero coupon bond "ith a yield to maturity of
* percent. !he bond matures in 12 years, and has a face value of =1,000. Assume that
your ta( rate is 2# percent. %hat is the dollar amount of ta(es you "ill pay at the end of
the first year of holding the bond&
a. =#.00
b. =1.00
c. =+.00
d. =$.00
e. =*.00
Chapter 7 - Page 43
8ero coupon !ond Anser: ! Diff: M
+A
1)*
. S. <laus Q <ompany is planning a 3ero coupon bond issue. !he bond has a par value of
=1,000, matures in 2 years, and "ill be sold at a price of =$21./#. !he firm-s marginal
ta( rate is /0 percent. %hat is the annual afterta( cost of debt to the company on this
issue&
a. /.0B
b. 1.0B
c. $.0B
d. 10.0B
e. 12.0B
8ero coupon !ond Anser: a Diff: M
+A
1/0
. A 1#year 3ero coupon bond has a yield to maturity of $ percent and a maturity value of
=1,000. %hat is the amount of ta( an investor in the )0 percent ta( brac,et "ill pay the
first year of the bond&
a. = +.#+
b. =10./1
c. =1#.$*
d. =20.//
e. =2#.22
8ero coupon !ond Anser: d Diff: M
+A
1/1
. On @anuary 1st @ulie bought a +year, 3ero coupon bond "ith a face value of =1,000 and
a yield to maturity of 1 percent. Assume that @ulie-s ta( rate is 2# percent. 6o" much
ta( "ill @ulie have to pay on the bond the first year she o"ns it&
a.=1#.00
b.=2#.00
c.=+).+1
d. = *.*$
e.=$).+/
8ero coupon !ond and EA$ Anser: d Diff: M
+A
1/2
. ;.S. Delay <orporation, a subsidiary of the Iostal Service, must decide "hether to issue
3ero coupon bonds or quarterly payment bonds to fund construction of ne" facilities.
!he =1,000 par value quarterly payment bonds "ould sell at =+*#.#/, have a 10 percent
annual coupon rate, and mature in 10 years. At "hat price "ould the 3ero coupon
bonds "ith a maturity of 10 years have to sell to earn the same effective annual rate as
the quarterly payment bonds&
a. =2+/.#0
b. =2+1.**
c. =1*$.$*
d. =2#+.#2
e. =2#/.$/
Calla!le 5ero coupon !ond Anser: c Diff: M
Chapter 7 - Page 44
+A
1/)
. 2ecycler 0attery <orporation 920<: issued 3ero coupon bonds # years ago at a price of
=21/.#0 per bond. 20<-s 3eros had a 20year original maturity, "ith a =1,000 par
value. !he bonds "ere callable 10 years after the issue date at a price + percent over
their accrued value on the call date. 'f the bonds sell for =2)*.)* in the mar,et today,
"hat annual rate of return should an investor "ho buys the bonds today e(pect to earn
on them&
a. 1#.+B
b. 12./B
c. 10.0B
d. *.#B
e. $.0B
Ta7es on 5ero coupon !ond Anser: a Diff: M
+A
1//
. !oday is @anuary 1, 200) and you Gust purchased a +year, 3ero coupon bond "ith a face
value of =1,000 and a yield to maturity of 1 percent. 4our ta( rate is )0 percent. 6o"
much in ta(es "ill you have to pay on the bond the first year that you hold it&
a. = 11.*+
b. =211./*
c. = 12.1*
d. = )*.*0
e. =1**.#2
Ta7es on 5ero coupon !ond Anser: e Diff: M (
+A
1/#
. A 3ero coupon bond "ith a face value of =1,000 matures in 1# years. !he bond has a yield
to maturity of + percent. 'f an investor buys the bond at the beginning of the year, ho"
much money in ta(es "ill the investor have to pay on the 3ero coupon bond the first year.
Assume that the investor has a 2# percent marginal ta( rate.
a. =#.2#
b. =#.//
c. =#.**
d. =1.2#
e. =1.)/
Accrued -alue and interest e7pense Anser: a Diff: M
+A
1/1
. Nogril <ompany issued 20year, 3ero coupon bonds "ith an e(pected yield to maturity
of * percent. !he bonds have a par value of =1,000 and "ere sold for =1+$./) each.
%hat is the e(pected interest e(pense on these bonds for 4ear $&
a. =2*.)#
b. =)2.00
c. =*0.00
d. =21.12
e. =2#.+*
Tough:
8eros and e7pectations theory Anser: d Diff: T
Chapter 7 - Page 45
+A
1/+
. A 2year, 3ero coupon !reasury bond "ith a maturity value of =1,000 has a price of
=$+)./)$+. A 1year, 3ero coupon !reasury bond "ith a maturity value of =1,000 has a
price of =*)$.*1+1. 'f the pure e(pectations theory is correct, for "hat price should 1
year, 3ero coupon !reasury bonds sell one year from no"&
a. =+*$.$*
b. =$2/.11
c. =$#2.2$
d. =*)0.2)
e. =*$*.11
8eros and e7pectations theory Anser: a Diff: T
+A
1/$
. A /year, 3ero coupon !reasury bond sells at a price of =+12.$*#2. A )year, 3ero
coupon !reasury bond sells at a price of =$2+.$/*1. Assuming the e(pectations theory is
correct, "hat does the mar,et believe the price of 1year, 3ero coupon bonds "ill be in
three years&
a. =*21.11
b. =*)/.#$
c. =*)$.*+
d. =*/#.21
e. =*#0./+
8ero coupon !ond Anser: d Diff: T
+A
1/*
. Assume that the State of Clorida sold ta(e(empt, 3ero coupon bonds "ith a =1,000
maturity value # years ago. !he bonds had a 2#year maturity "hen they "ere issued,
and the interest rate built into the issue "as a nominal $ percent, compounded
semiannually. !he bonds are no" callable at a premium of / percent over the accrued
value. %hat effective annual rate of return "ould an investor "ho bought the bonds
"hen they "ere issued and "ho still o"ns them earn if they "ere called today&
a. /./1B
b. 1.+)B
c. $.2#B
d. *.01B
e. *.#2B
Chapter 7 - Page 46
8ero coupon !ond Anser: e Diff: T
+A
1#0
. Assume that the <ity of !ampa sold an issue of =1,000 maturity value, ta( e(empt
9muni:, 3ero coupon bonds # years ago. !he bonds had a 2#year maturity "hen they
"ere issued, and the interest rate built into the issue "as a nominal 10 percent, but "ith
semiannual compounding. !he bonds are no" callable at a premium of 10 percent over
the accrued value. %hat effective annual rate of return "ould an investor "ho bought
the bonds "hen they "ere issued and "ho still o"ns them earn if they "ere called
today&
a. 12.01B
b. 10.2#B
c. 10.00B
d. 11.1)B
e. 12.)+B
Ta7es on 5ero coupon !ond Anser: a Diff: T
+A
1#1
. Schiffauer 8lectronics plans to issue 10year, 3ero coupon bonds "ith a par value of
=1,000 and a yield to maturity of *.# percent. !he company has a ta( rate of )0 percent.
6o" much e(tra in ta(es "ould the company pay 9or save: the second year 9at t A 2: if
they go ahead and issue the bonds&
a. Save =12.#*
b. Save =1).+*
c. Save =/1.*+
d. .o savings
e. Iay =1).+*
Multiple Part:
(The information below applies to the next two problems.)
Pargoyle ;nlimited is planning to issue a 3ero coupon bond to fund a proGect that "ill yield its
first positive cash flo" in three years. !hat cash flo" "ill be sufficient to pay off the entire debt
issue. !he bond-s par value "ill be =1,000, it "ill mature in ) years, and it "ill sell in the mar,et
for =+2+.2#. !he firm-s marginal ta( rate is /0 percent.
8ero coupon interest ta7 shield Anser: ! Diff: T
+A
1#2
. %hat is the nominal dollar value of the interest ta( savings to the firm in the third year of
the issue&
a. = )2.#$
b. = /0.2*
c. =100.+2
d. = 10./)
e. =10*.10
Chapter 7 - Page 47
After0ta7 cost of de!t Anser: c Diff: M
+A
1#)
. %hat is the e(pected afterta( cost of this debt issue&
a. 11.20B
b. /./$B
c. 1.+2B
d. 1.10B
e. /.00B
6e! Appendi7 %&
Medium:
+i1uidation procedures Anser: e Diff: M
+0
1#/
. <hapter + of the 0an,ruptcy Act is designed to do "hich of the follo"ing&
a. Irovide safeguards against the "ithdra"al of assets by the o"ners of the ban,rupt
firm.
b. 8stablish the rules of reorgani3ation for firms "ith proGected cash flo"s that
eventually "ill be sufficient to meet debt payments.
c. Allo" insolvent debtors to discharge all of their obligations and to start over
unhampered by a burden of prior debt.
e. Statements a and c are correct.
&an/ruptcy la Anser: d Diff: M
+0
1##
a. Our ban,ruptcy la"s "ere enacted in the 1$00s, revised in the 1*)0s, and have
remained unaltered since that time.
b. Cederal ban,ruptcy la" deals only "ith corporate ban,ruptcies. 5unicipal and
personal ban,ruptcy are governed solely by state la"s.
c. All ban,ruptcy petitions are filed by creditors see,ing to protect their claims on firms
in financial distress. !hus, all ban,ruptcy petitions are involuntary as vie"ed from
the perspective of the firm-s management.
d. <hapters 11 and + are the most important ban,ruptcy chapters for financial
management purposes. 'f a reorgani3ation plan cannot be "or,ed out under <hapter
11, then the company "ill be liquidated as prescribed in <hapter + of the Act.
e. >2estructuring? a firm-s debt can involve forgiving a certain portion of the debt but
does not involve changing the debt-s maturity or its contractual interest rate.
&an/ruptcy issues Anser: e Diff: M
+0
1#1
a. !he primary test of feasibility in a reorgani3ation is "hether every claimant agrees
Chapter 7 - Page 48
"ith the reorgani3ation plan.
b. !he basic doctrine of fairness states that all debt holders must be treated equally.
c. Since the primary issue in ban,ruptcy is to determine the sharing of losses bet"een
o"ners and creditors, the >public interest? is not a relevant concern.
d. %hile the firm is in ban,ruptcy, the e(isting management is al"ays allo"ed to remain
in control of the firm, though the court monitors its actions closely.
e. !o a large e(tent, the decision to dissolve a firm through liquidation or to ,eep it
alive through reorgani3ation depends on a determination of the value of the firm if it
is rehabilitated versus the value of its assets if they are sold off individually.
Tough:
#riority of claims Anser: c Diff: T
+0
1#+
. %hat "ould be the priority of the claims as to the distribution of assets in a liquidation
under <hapter + of the 0an,ruptcy Act&
1. !rustees- costs to administer and operate the firm.
2. <ommon stoc,holders.
). Peneral, or unsecured, creditors.
/. Secured creditors "ho have claim to the proceeds from the sale of a specific
property pledged for a mortgage.
#. !a(es due to federal and state governments.
a. 1, /, ), #, 2
b. #, /, 1, ), 2
c. /, 1, #, ), 2
d. #, 1, /, 2, )
e. 1, #, /, ), 2
Chapter 7 - Page 49
C"A#TE$ %
A()6E$) A(D )'+,TI'()
1. Interest rates Answer: e Diff: E
2 . Interest rates and bond prices
Answer: c Diff: E
Statement a is false; just the reverse is true. Statement b is false; the 15-
year bond is selling at a discount because its coupon payment is less than the
YT. Statement c is true; longer-maturity and lo!er-coupon bonds have a larger
percentage price change than short-maturity" high-coupon bonds. Statement d is
false; just the reverse is true.
#. Interest rates and bond prices Answer: c Diff: E
$f the going mar%et interest rate &YT' is ( percent" but the coupon rate is )
percent" then investors are getting a better coupon payment from this bond than
they could from a ne! bond issued in the mar%et today. Therefore" this bond is
more valuable and must be selling at a premium. Therefore" statement a is
false. *henever interest rates fall" the price of a bond increases. Therefore"
statement b is false. $f interest rates remain un-changed" as the bond gets
closer to its maturity" its price !ill approach par value. Since the bond is
selling at a premium" its price must decline to its par value as it gets closer
to maturity. Therefore" statement c is true.
+. Interest rates and bond prices Answer: d Diff: E
,irst" both bonds !ill decrease in price. -onger-maturity" lo!er-coupon bonds
have greater price changes !ith rate movements than shorter-maturity" higher-
coupon bonds. So statement d must be correct.
5. Interest vs. reinvestment rate risk Answer: e Diff: E
Statements a" b" c" and d are all correct. Therefore" the correct choice is
statement e.
.. Interest vs. reinvestment rate risk Answer: c Diff: E
$nterest rate ris% means the ris% that the price of the bond !ill change due to
interest rate changes. The longer the maturity" the greater the interest rate
ris%. /einvestment rate ris% is the ris% that once the bond matures" you !on0t
be able to reinvest the principal at the same rate. The shorter the maturity"
the greater the reinvestment rate ris%. Statement a is false. -ong-term bonds
have more interest rate ris% and less reinvestment rate ris% than short-term
bonds. Statement b is false. -ong-term bonds have less reinvestment rate ris%
than short-term bonds. Statement c is true. 1eros have more interest rate ris%
because their one payment is subject to the ma2imum number of discounting
periods" so the 3ero0s price !ill fluctuate greatly !henever interest rates
change. There is less reinvestment rate ris% because there are no coupons that
need to be reinvested" just the par value at maturity. Statement d is false.
$f interest rates increase" the prices of all bonds !ill decrease. Statement e
is false. You have to pay ta2es on the difference in the accreted value of the
3eros each year" as though you had actually reali3ed the capital gain for the
year. You don0t actually reali3e your capital gain until maturity" or until
you sell the bond" but you still pay ta2es as though you had.
(. Price risk Answer: a Diff: E
The longer the maturity of a bond" the more of an effect a change in interest
rates !ill have on it. The reason for this is that the price change is
compounded into the bond price for more periods. Therefore" you can rule out
statements b and e. 4 bond that pays coupons !ill be less affected by interest
rate changes than one that doesn0t pay coupons. The bond price is the 567 of
all the future cash flo!s" both the coupon payments and the par value paid at
maturity. The first coupon payment is only discounted one period. The second
coupon is discounted t!o periods" and so on. The par value is discounted for
the full life of the bond. Thus" statements c and d can be eliminated. Since a
3ero coupon bond0s price today is determined just by the 567 of its par value"
all of its payment is discounted for the ma2imum amount of time" !hereas a
coupon bond has many payments discounted for less than the ma2imum amount of
time. Therefore" a 3ero coupon bond is most affected by interest rate changes.
So" the longest 3ero coupon bond is the correct ans!er" !hich is statement a.
8. Callable bond Answer: a Diff: E
Statement a is correct; the other statements are false. 4 bond do!n-grade
generally raises the cost of issuing ne! debt. Therefore" the callable bonds
!ould not be called. $f the call premium &the cost paid in e2cess of par'
increases" the cost of calling debt increases; therefore" callable bonds !ould
not be called.
)
. Call provision Answer: b Diff: E
19. Bond coupon rate Answer: c Diff: E
11
. Bond concepts Answer: a Diff: E
Statement a is correct; the other statements are false. 4 bond0s price and YT
are negatively related. $f a bond0s YT is greater than its coupon rate" it
!ill sell at a discount.
12. Bond concepts Answer: c Diff: E
Statement c is correct; the other statements are false. $f a bond0s YT :
annual coupon" then it !ill trade at a discount. $f interest rates increase"
the 19-year 3ero coupon bond0s price change is greater than the 19-year coupon
bond0s.
1# . Bond concepts Answer: e Diff: E
4ll the statements are true; therefore" the correct choice is statement e.
Since the bond is selling at par" its YT ; coupon rate. The current yield is
calculated as <)9=<1"999 ; )>. $f YT ; coupon rate" the bond !ill sell at
par. So" if the bond0s YT remains constant the bond0s price !ill remain at
par.
1+. Bond concepts Answer: a Diff: E
$f the bond is selling at a discount" the coupon rate must be less than the
re?uired yield on the bond. So statement a is correct. Statement b is false"
because the price !ill increase to!ards <1"999. Statement c can only be
correct if the bond is trading at par" and it isn0t.
15. Bond concepts Answer: d Diff: E
The bond has a coupon rate higher than the YT" so it must be trading at a
price above its par value. Statement a is incorrect; its current yield ;
@oupon=6rice" !hich !ill be less than 8 percent because the price is greater
than par. Statement b is correct. Statement c is also correct; the price of
the bond !ill decline over time because it is currently trading above par.
Therefore" statement d is the best ans!er.
1.. Bond concepts Answer: a Diff: E
Since Aond A sells at par" then the coupon rate on Aond A e?uals its YT.
Therefore" its YT is 19 percent. Since all the bonds have the same ris% and
the yield curve is steady" the YT for Aonds 4 and @ !ill also be 19 percent.
Aecause Aond 4 has an 8 percent coupon" it must be trading at a discount and
its price !ill increase over time to!ards the par value. Aecause Aond @ has
a coupon rate of 12 percent" it must be trading at a premium and its price
!ill decline over time to!ards the par value. The only correct ans!er is
statement a.
1(. Bond concepts Answer: d Diff: E
Statement a is false. $f the YT is 8 percent" and 40s coupon payment is
only ( percent" investors !ill find 4 to be less valuable than a ne! par
value bond !ith an 8 percent coupon. Therefore" 4 !ill be selling for less
than its par value &at a discount'. $f the YT is 8 percent and A0s coupon
payment is ) percent" investors !ill find A to be more valuable than a ne!
par value bond !ith an 8 percent coupon. Therefore" A !ill be selling for
more than its par value &at a premium'. There-fore" A0s price must be higher
than 40s. Statement b is false. The bonds !ill not have the same price
until e2piration" !hen the price of each !ill be its par value of <1"999.
Statement c is false. Aond A is selling at a higher price than Aond 4 from
the statements given in the problem. Statement d is correct. $f a bond is
selling at a discount" over time its price !ill increase until it reaches its
par value at e2piration. Since Aond 4 is selling at a discount this
statement is true. Statement e is false. The total yield on the bond !ill
be the sum of the capital gains yield and the current yield. $f it has a
positive capital gains yield" and it !ill since 4 is selling at a discount"
its current yield must be less than 8 percent because the sum of the t!o
yields must e?ual 8 percent.
18. Bond concepts Answer: c Diff: E
$f the YT is lo!er than the coupon rate" then this bond gives higher coupon
payments than the Bgoing rate.C Therefore" it is more valuable" and !ill
sell at a premium. So" statement a is false. The current yield is the
bond0s annual coupon payments divided by the bond0s price todayD @urrent
yield ; 4nnual coupon payment=@urrent price. Since !e %no! that the bond is
selling at a premium" it !ill be selling for a higher price than <1"999. $f
the bond !ere selling at par &<1"999'" then the current yield !ould be the
same as the coupon rate. Since it is selling at a premium" the denominator
of the current yield e?uation is larger" ma%ing the current yield smaller.
Therefore" statement b is false. Since the bond is selling at a premium" its
price !ill decrease through time until its price e?uals the par value" just
at maturity. /emember the follo!ing diagramD
<1"999
Selling at 6remium
Selling at Eiscount
aturity
Therefore" statement c is the correct choice.
1) . Bond concepts
Answer: a Diff: E N
Statement a is correct. Statement b is incorrect; just the opposite is true.
Aonds !ith higher coupons have less interest rate price ris% but more
reinvestment rate ris%. Statement c is incorrect; the price of a discount
bond !ill continue to change" based on years to maturity. 4s a discount bond
approaches maturity" its price !ill increase to its par value. @learly" then"
statements d and e are also incorrect.
29 .Bond concepts Answer: d Diff: E N
The correct ans!er is statement d. 4ll of the statements are correct. 4ll of
the statements directly follo! from the basics of bond pricing presented in the
te2t.
21. Bond yield Answer: a Diff: E
$f the bond sells at a premium" its price !ill decline as it approaches
maturity. &/emember that at maturity it has to be !orth its par value.'
Therefore" statement a is true. The current yield is defined as the coupon
payment divided by the price. $f the bond is selling at a premium" then its
price !ill have to decline over time. $f its price is declining" then there
is a negative capital gains yield. /emember that YT !ill e?ual the capital
gains yield plus the current yield. Therefore" for YT to be 8 percent !ith a
negative capital gains yield" the current yield must be higher than 8
percent. Therefore" statement b is false. $f the bond is trading at a
premium and the YT is constant" it !ill have to slo!ly decline in value
until" just at maturity" it is !orth its par value. Therefore" statement c
is false. $f the bond0s coupon rate !ere less than the YT" it !ould be less
valuable than ne! bonds issued at the YT and !ould" therefore" trade at a
discount" not a premium. Therefore" statement d is false. $f the YT
increases" then this bond0s cash flo!s &coupons' !ill be discounted at a
higher rate and !ill be !orth less. Therefore" the price !ill decrease" not
increase. Therefore" statement e is false.
22. Bond yields and prices Answer: d Diff: E
$f the YT is ( percent" this is the mar%et interest rate. Therefore" Aond
40s coupon rate is higher than the mar%et rate" so it must be selling above
par &at a premium'. Aond A0s coupon rate is lo!er than the mar%et rate" so
it must be selling belo! par &at a discount'.
Aond 7alue
<
<1"999
A
4
Years
aturity
Statement a is false. $f the YT remains the same" the price of Aond 4 !ill
fall" and the price of bond A !ill rise. The total yield of
( percent on both bonds !ill consist of a capital gains yield and a current
yield. The sum of these t!o yields !ill be ( percent. Statements b" c" and e
are false for the reason mentioned above. Therefore" the correct ans!er is
statement d.
2#. inkin! fund provision Answer: e Diff: E
Statement a is false; sin%ing funds re?uire companies to retire a certain
portion of their debt annually. Statement b is true; if interest rates have
declined" companies !ill call the bonds and investors !ill have to reinvest
at lo!er rates. Statement c is true; if interest rates have risen &causing
bond prices to fall' the company !ill buy bonds bac% in the open mar%et.
Statements b and c are true; therefore" statement e is the correct choice.
2+. inkin! fund provision Answer: d Diff: E
Statements a and c are correct; therefore" statement d is the correct choice.
Aonds !ill be purchased on the open mar%et !hen they are selling at a
discount and !ill be called for redemption !hen the price of the bonds
e2ceeds the redemption price.
25. "ypes of debt Answer: e Diff: E
Statement e is correct; the others are false. Fun% bonds have a higher yield
to maturity relative to investment grade bonds. 4 debenture is an unsecured
bond" !hile subordinated debt has greater default ris% than senior debt.
2.. Bond yield Answer: b Diff: #
2(. Bond yield Answer: c Diff: #
Statement c is correct; the other statements are false. Ay definition" if a
coupon bond is selling at par its current yield !ill e?ual its yield to
maturity. $f !e let Aond 4 be a 5-year" 12> coupon bond that sells at par" its
current yield e?uals its YT !hich e?uals 12>. $f !e let Aond A be a 5-year"
19> coupon bond &in a 12> interest rate environment' the bond !ill sell for
<)2(.)9. $ts current yield e?uals 19.(8> &<199=<)2(.)9'" but its yield to
maturity e?uals 12>. The YT@ is a better measure of return than the YT if the
bond is selling at a premium.
28. Price risk Answer: c Diff: #
Statement c is correct; the other statements are incorrect. -ong-term" lo!-
coupon bonds are most affected by changes in interest rates; therefore" of
the bonds listed" the 19-year 3ero coupon bond !ill have the largest
percentage increase in price.
2). Price risk Answer: c Diff: #
Statement c is correct; the other statements are false. 1ero coupon bonds have
greater price ris% than either of the coupon bonds or the annuity.
#9. Price risk Answer: c Diff: #
Statement c is correct; the other statements are false. 4ll other things
e?ual" a 3ero coupon bond !ill e2perience a larger percentage change in value
for a given change in interest rates than !ill a coupon-bearing bond.
,urther" bonds !ith long remaining lives e2perience greater percentage
changes in value than do bonds !ith short remaining lives. Thus" of the
bonds listed" the 19-year 3ero coupon bond has the largest percentage
increase in value.
#1. Price risk Answer: a Diff: #
Statement a is correct. 4ll other things e?ual" a 3ero coupon bond !ill
e2perience a larger percentage change in value for a given change in interest
rates than !ill a coupon-bearing bond. ,urther" bonds !ith long remaining
lives e2perience greater percentage changes in value than do bonds !ith short
remaining lives. Thus" of the bonds listed" the 19-year 3ero coupon bond has
the largest percentage increase in value.
#2. Price risk Answer: a Diff: #
Statement a is correct. The longer the maturity and the lo!er the coupon of
a bond" the more sensitive it is to interest rate &price' ris%. The bond in
ans!er a has a maturity greater than or e?ual to and a coupon less than or
e?ual to all the other bonds.
##. Price risk Answer: a Diff: #
Statement a is correct. The bond !ith the smallest coupon and longest
maturity !ill be most sensitive to changes in interest rates.
#+. Bond concepts Answer: e Diff: #
The correct ans!er is e; the other statements are false. 4 3ero coupon bond
!ill al!ays sell at a discount belo! par" provided interest rates are above
3ero" !hich they al!ays are.
#5
. Bond concepts Answer: d Diff: #
$f inflation !ere to increase" interest rates !ould rise" thus bond prices
!ould decline.
#.. Bond concepts Answer: b Diff: #
Statement b is correct; the other statements are false. $f a bond is selling
at a premium" the YT !ould be less than the coupon rate. $n addition" as
long as interest rates are greater than 3ero" 3eros should never trade above
par.
#(. Bond concepts Answer: b Diff: #
Statement b is correct; the other statements are false. $f a bond0s coupon
rate : than the re?uired rate" the bond !ill sell at a premium. 4 bond0s total
return includes both an interest yield and a capital gains component" !hich
represents the change in the price of the bond over a given year.
#8
. Bond concepts Answer: e Diff: #
#). Bond concepts Answer: d Diff: #
Statement a is correct. ,rom the information given" !e can solve for the
price of the bond ; <88(. @urrent yield ; <199=<88( ; 11.2(+>. Statement b
is incorrect; since the bond is selling at a discount its YT@ : YT. The YT@
; 1+.95>. Statement c is correct.
,rom the information given" since the coupon rate G YT !e %no! the bond is
selling at a discount. 7
A
; <88(.99.
+9. Bond concepts Answer: d Diff: # N
The correct ans!er is statement d. Aonds !ith a lo!er coupon have a lo!er
reinvestment rate ris%. Aonds !ith longer maturities have a lo!er reinvestment
rate ris%. Since all three bonds have the same maturity" the one !ith the
highest coupon !ill have the highest reinvestment rate ris%. Aond 1 has the
highest coupon" so statement a is false. $f mar%et interest rates remain
unchanged" discount bonds &@65 G YT' !ill go up in price" !hile premium bonds
&@65 : YT' !ill go do!n in price. Aond 1 is selling at a premium" so its
price !ill decline &if interest rates are unchanged'. Therefore" statement b is
false. $f mar%et interest rates increase" the prices of all bonds !ill
decrease" therefore" statement c is incorrect. Statement d is correct from the
information given above in response to statement b. $f mar%et interest rates
decline" all bonds !ill have an increase in price. The one !ith the largest
percentage increase !ill be the one !ith the most price ris%. 4s maturity
increases" price ris% increases. 4s coupon decreases" price ris% increases.
Since all three bonds have the same maturity" the one !ith the lo!est coupon
!ill have the greatest price ris%. Therefore" Aond H !ill have the largest
percentage increase in price" so statement e is false.
+1 .Bond concepts Answer: b Diff: # N
The correct ans!er is statement b. $f the YT remains constant" the price of
Aond 4 !ill still e2ceed par" the price of Aond A !ill e?ual par" and the
price of Aond @ !ill be belo! par. So" statement a is incorrect. 4s the YT
rises" the price of all bonds !ill decrease. So" statement b is correct. $f
the YT decreases" Aond @ !ill have the largest percentage increase in price
since its price is the lo!est of the three bonds. Aond A !ill follo!" and
Aond 4 !ill have the lo!est percentage increase in price. So" statement c is
incorrect.
+2. Interest rates and bond prices Answer: e Diff: # N
The correct ans!er is statement e. Statement a is incorrect; Aond 4 is a
premium bond" !hile Aond A is a discount bond. Statement b is incorrect;
because Aond 4 is at a premium its price !ill decline one year from no!" !hile
Aond A0s price !ill increase one year from no! because it is a discount bond.
Statement c is also incorrect; the t!o bonds have the same maturity" but Aond A
has the lo!er coupon so it !ill e2perience the greatest increase in value.
Therefore" statement e is the correct choice.
+#. Callable bond Answer: d Diff: #
++. Callable bond Answer: b Diff: #
Statement b is correct; the other statements are false. The bonds0 prices !ould
differ substantially only if investors thin% a call is li%ely" in !hich case
investors !ould have to give up a high coupon bond. @alls are most li%ely if the
current mar%et rate is !ell belo! the coupon rate. 5ote that if the current rate
is above the coupon rate" the bond !on0t be called.
+5. "ypes of debt and t$eir relative costs Answer: c Diff: #
+.. #iscellaneous concepts Answer: c Diff: #
Statement c is correct; the other statements are false. Aan%rupt firms often
are reorgani3ed rather than li?uidated. ,irms prefer the less e2pensive
option of calling the bonds--!hich in this case is the sin%ing fund call
price. $nterest e2pense accrues for ta2 purposes on 3ero coupon bonds" so
firms can reali3e the ta2 savings from issuing debt. @allable bonds !ill sell
for a higher yield than noncallable bonds" if all other things are held
constant.
+(. #iscellaneous concepts Answer: b Diff: #
+8. #iscellaneous concepts Answer: e Diff: #
Statements a and b are both correct; therefore statement e is the correct
choice. -o!-coupon bonds have less reinvestment rate ris% than high coupon
bonds. $f the bond is trading at a premium" then its coupon rate is high in
relation to current interest rates. The issuer !ould be li%ely to call the
bond and issue ne! bonds at the lo!er current interest rate. Thus" !e !ould
e2pect to earn the yield to call.
+). Current yield and yield to maturity Answer: e Diff: #
Statement e is the correct choice. $f a bond sells for less than par" then
its yield to maturity !ill e2ceed its coupon rate. $f a bond sells at par"
then its current yield" yield to maturity" and coupon rate are all the same.
The bond selling for more than par !ill have a lo!er current yield than a
bond selling at par. Io!ever" the bond selling for more than par !ill have a
negative capital gain &that is" a capital loss' !hile the bond selling at par
!ill have no capital gain.
59. Current yield and yield to maturity Answer: a Diff: #
Statement a is correct; the other statements are false. $f the bond sells
for a premium" this implies that the YT must be less than the coupon rate.
4s a bond approaches maturity" its price !ill move to!ards the par value.
51. Corporate bonds and default risk Answer: c Diff: #
Statement c is the correct choice; the other statements are false. The
e2pected return may be greater than" less than" or e?ual to the yield to
maturity. ,irms in financial distress may or may not eventually declare
ban%ruptcy; that is" they may recover.
52. Default risk and bankruptcy Answer: b Diff: #
Statement b is the appropriate choice. 4n indenture is not a bond. $t is a
legal contract that spells out in detail the rights of both investors and the
firm issuing debt.
5#. Default risk and bankruptcy Answer: b Diff: #
5+. Default risk and bankruptcy Answer: d Diff: #
Statements a and b are correct; therefore" statement d is the correct choice.
@hapter ( is li?uidation. @hapter 11 is reorgani3ation.
55. inkin! funds and bankruptcy Answer: d Diff: #
*hen the coupon rate is belo! the mar%et rate" then the price is belo! par" so
the firm !ill buy bac% its bonds on the open mar%et.
$f interest rates have declined after the issuance of a bond" then the bond has
a coupon rate higher than the going mar%et interest rate. Therefore" investors
are being paid a higher rate than current interest rates and they !ould prefer
to %eep the bonds to receive a higher return.
5.. Bond yields and prices Answer: b Diff: "
Statement b is correct. $f a bond0s YT e2ceeds its coupon rate" then" by
definition" the bond sells at a discount. Thus" the bond0s price is less
than its maturity value. Statement a is false. @onsider 3ero coupon bonds.
4 3ero coupon bondJs YT e2ceeds its coupon rate &!hich is e?ual to 3ero';
ho!ever" its current yield is e?ual to 3ero !hich is e?ual to its coupon
rate. Statement c is false; a bond0s value is determined by its cash flo!sD
coupon payments plus principal. $f the
2 bonds have different coupon payments" their prices !ould have to be
different in order for them to have the same YT.
5(. Bond concepts Answer: b Diff: "
58. Bond concepts Answer: e Diff: "
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 !ill have on the bond0s price. Statement b is false. To see
this" assume interest rates increase from ( percent to 19 percent. Kvaluate
the change in the prices of a 19-year" 5 percent coupon bond and a 19-year" 12
percent coupon bond. The 5 percent coupon bond0s price decreases by 1).+
percent" !hile the 12 percent coupon bond0s price decreases by only 1..)
percent. Statement c is correct. To see this" evaluate a 19-year" 3ero coupon
bond and a )-year" 19 percent annual coupon bond at 2 different interest rates"
say ( percent and 19 percent. The 3ero coupon bond0s price decreases by 2+.1.
percent" !hile the )-year" 19 percent coupon bond0s price decreases by only
1..#5 percent.
5). Interest vs. reinvestment rate risk Answer: c Diff: "
Statement c is correct. ,or e2ample" assume these coupon bonds have 19 years
until maturity and the current interest rate is 12 percent. The 5 percent
coupon bond0s value is <.9+.+8" !hile the 19 percent coupon bond0s value is
<88(.99. Thus" the lo!er-coupon bond has more interest rate ris% than the
higher-coupon bond. The lo!er the coupon" the greater the percentage of the
cash flo! that !ill come in the later years &from the maturity value'" hence"
the greater the impact of interest rate changes. Statement a is false--as !e
demonstrated above. Statement b is false--shorter-term bonds have more
reinvestment rate ris% than longer-term bonds because the principal payment
must be reinvested sooner on the shorter-term bond. Statement d is false--as
!e demonstrated earlier. Statement e is false because perpetuities have no
maturity date; therefore" they have more interest rate ris% than 3ero coupon
bonds. The longer a security0s maturity" the greater its interest rate ris%.
.9. Bond indenture Answer: d Diff: "
.1. "ypes of debt and t$eir relative costs Answer: e Diff: "
*4@E
9 59> 199>
ortgage
%d>
Eebentures
e.g. 6oint 4
represents 59>
debentures and
59> mortgage
bonds
6ercentage of total issue
as mortgage bonds.
4
1. @ompany can0t lo!er its total cost of the <199 million of debt very much"
if any" by the mi2 of debentures and mortgage bonds.
2. Eebentures0 ris% rises as mortgage debt rises.
#. ortgage bonds0 ris% rises as more mortgage bonds are issued.
+. So" the B*4@EC !ill li%ely remain fairly stable.
.2. Annual coupon rate Answer: d Diff: E N
*e must solve for the payment and infer the coupon rate from that value. Knter
the follo!ing data into your financial calculatorD
5 ; 19; $ ; ); 67 ; L)9#.(#51; ,7 ; 1999; and then solve for 6T ; <(5.
Ience" the coupon rate is <(5=<1"999 ; (.5>.
.#. Bond value%%annual payment Answer: d Diff: E
Knter the follo!ing input data in the calculatorD
5 ; 12; $ ; 8; 6T ; )9; ,7 ; 1999; and then solve for 67 ; -<1"9(5.#.. 7
A

<1"9(5.
.+. Bond value%%semiannual payment Answer: e Diff: E
Time -ineD
9
5>
1 2 29
.-month

M M M M 6eriods
67 ; N 6T ; .9 .9 .9
,7 ; 1"999
,inancial calculator solutionD
$nputsD 5 ; 29; $ ; 5; 6T ; .9; ,7 ; 1999.
OutputD 67 ; -<1"12+..2; 7
A
; <1"12+..2.
.5. Bond value%%semiannual payment Answer: d Diff: E
Time -ineD
9
5>
1 2 # + +9
.-month

M M M M M M 6eriods
+9 +9 +9 +9 +9
67 ; N ,7 ; 1"999

$nputsD 5 ; +9; $ ; 5; 6T ; +9; ,7 ; 1999.
OutputD 67 ; -<828.+1; 7
A
<828.
... Bond value%%semiannual payment Answer: e Diff: E N
This is a straight-for!ard bond valuation" just remember that the bond has
semiannual coupons. Knter the follo!ing data into your financial calculatorD
5 ; 12 2 ; 2+; $ ; 8 2 ; +; 6T ; )9 2 ; +5; ,7 ; 1999; and then solve
for 67 ; -<1"9(..2#. 7
A
; <1"9(..2#.
.( . Bond value%%semiannual payment
Answer: b Diff: E N
Psing your financial calculator" enter the follo!ing data as inputsD
5 ; 2 19 ; 29; $ ; )=2 ; +.5; 6T ; 9.98=2 1"999 ; +9; ,7 ; 1999; and
then solve for 67 ; -<)#+.).. 7
A
; <)#+.)..
.8. Bond value%%semiannual payment Answer: c Diff: E
5 ; 19 2 ; 29; $ ; )=2 ; +.5; 6T ; 59; ,7 ; 1999; and then solve for 67 ;
-<1"9.5.9+. 7
A
; <1"9.5.9+.
.)
. Bond value%%semiannual payment Answer: b Diff: E
5 ; 15 2 ; #9; $=Y/ ; 11=2 ; 5.5; 6T ; 1"999 9.98=2 ; +9; ,7 ; 1999; and
then solve for 67 ; -<(81.)). 7
A
; <(81.)).
(9. Bond value%%semiannual payment Answer: c Diff: E N
Knter the follo!ing data inputs into the calculatorD
5 ; 2+; $=Yr ; (=2 ; #.5; 6T ; +9; ,7 ; 1999; and then solve for 67 ;
-<1"989.2). 7
A
; <1"989.2).
(1. Bond value%%&uarterly payment Answer: c Diff: E
Time -ineD
9
#>
1 2 # + +9

Quarters

M M M M M M
6T ; #5 #5 #5 #5 #5
67 ; N ,7 ; 1"999

$nputsD 5 ; +9; $ ; #; 6T ; #5; ,7 ; 1999.
OutputD 67 ; -<1"115.5(; 7
A
; <1"115.5(.
(2. 'ield to maturity%%annual bond Answer: a Diff: E
Knter 5 ; 11; 67 ; -8.5; 6T ; 89; ,7 ; 1999; and then solve for $=Y/ ;
19.98.8> 19.9)>.
(#. 'ield to maturity%%semiannual bond Answer: c Diff: E
5 ; 12 2 ; 2+; 67 ; -1989; 6T ; 59; ,7 ; 1999; and then solve for $ ;
+.+598> 2 ; 8.)91.>.
(+
. 'ield to maturity%%semiannual bond Answer: b Diff: E
5 ; 18; 67 ; -)29; 6T ; #5; ,7 ; 1999; and then solve for $=Y/ ; +.1#)1>.
@onvert this semiannual periodic rate to a nominal annual rate" +.1#)1> 2 ;
8.2(82> 8.28>.
(5. '"# and '"C%%semiannual bond Answer: e Diff: E
To calculate YTD
5 ; 28; 67 ; -19(5; 6T ; +9; ,7 ; 1999; and then solve for $=Y/ ; #.5(> 2
; (.1+>.
To calculate YT@D
5 ; 19; 67 ; -19(5; 6T ; +9; ,7 ; 1959; and then solve for $=Y/ ; #.52> 2
; (.95>.
(.. 'ield to maturity and bond value(annual bond Answer: d Diff: E
Step 1D ,ind the YT. 5 ; 29; 67 ; -)25; 6T ; )9; ,7 ; 1999; and then solve
for $ ; YT ; ).8(##>.
Step 2D Solve for 6
5
. $n 5 years" there !ill be 15 years left until maturity"
so the price at t ; 5 isD 5 ; 15; $=Y/ ; ).8(##; 6T ; )9; ,7 ; 1999;
and then solve for 67 ; -<)##.9). 7
A
; <)##.9).
((. Current yield Answer: b Diff: E
@urrent yield ; 4nnual coupon payment=@urrent price.
Step 1D ,ind the price of the bondD
5 ; ); $=Y/ ; 19; 6T ; (9; ,7 ; 1999; and then solve for 67 ; -
<82(.2#. 7
A
; <82(.2#.
Step 2D @alculate the current yieldD @Y ; <(9=<82(.2# ; 8.+.>.
(8. Current yield Answer: d Diff: E
@urrent yield ; 4nnual coupon payment=@urrent price.
Step 1D ,ind the price of the bondD
5 ; 12; $=Y/ ; ).5; 6T ; 85; ,7 ; 1999; and then solve for 67 ; -
<)#9. 7
A
; <)#9.
Step 2D @alculate the current yieldD @Y ; <85=<)#9 ; ).1+>.
(). Current yield Answer: c Diff: E
The current yield is e?ual to the annual coupon divided by the price. The
annual coupon is givenD 9.98 <1"999 ; <89. You need to find the price
before calculating the current yield.
Step 1D Psing the T7 inputs of your calculator" find the bond0s priceD
5 ; 15; $ ; (; 6T ; 89; ,7 ; 1999; and then solve for 67 ;
-<1"9)1.98. 7
A
; <1"9)1.98.
Step 2D @alculate the bond0s current yieldD
@urrent yield ; 4nnual coupon=@urrent price
@urrent yield ; <89=<1"9)1.98
; (.##>.
89. Current yield and yield to maturity Answer: b Diff: E
@urrent yield is calculated asD <89=<)85 ; 8.12>.
5 ; 12; 67 ; -)85; 6T ; 89; ,7 ; 1999; and then solve for $=Y/ &YT' ; 8.29>.
81. )uture bond value%%annual payment Answer: b Diff: E N
T!o years from no!" there !ill be 8 years left to maturity. Pse your
financial calculator to determine its price by entering the follo!ing data as
inputsD
5 ; 8; $ ; 19; 6T ; 89; ,7 ; 1999; and then solve for 67 ; -<8)#.#9. 7
A
;
<8)#.#9.
82. *isk premium on bonds Answer: c Diff: E
@alculate the previous ris% premium" /6
AAA
" and ne! /6
AAA
D
/6
AAA
; 11.5> - 8.(> ; 2.8>.
5e! /6
AAA
; 2.8>=2 ; 1.+>.
@alculate ne! YT on AAA bondsD YT
AAA
; (.8> R 1.+> ; ).2>.
8#. Bond value%%annual payment Answer: e Diff: #
The semiannual bond selling at par has a nominal yield to maturity e?ual to
its annual coupon rate &you can chec% this'. Thus the nominal YT for the
semiannual bond is 8>. To convert this to an effective annual rate for the
annual bondD
5O> ; 8; 6=Y/ ; 2; and then solve for K,,> ; 8.1.>.
*e can no! value the annual bond using this rate" as the nominal rate is the
same as the effective rate !hen compounding occurs annually. Thus; 5 ; .; $
; 8.1.; 6T ; 89; ,7 ; 1999; and then solve for 67 ; -<))2..+. 7
A
; <))2..+.
8+. Bond value%%annual payment Answer: a Diff: #
Step 1D Eetermine the effective annual rate of return on the semiannual
bondD
The semiannual bond has a YT of ) percent because it is selling at
par. This is e?uivalent to an effective annual rate of ).2925> ;
S&1 R 9.9)=2'
2
- 1T.
Step 2D Eetermine the value of the annual bondD
5 ; 19; $ ; ).2925; 6T ; )9; ,7 ; 1999; and then solve for 67 ; -
<)8(.12. 7
A
; <)8(.12.
85. Bond value%%annual payment Answer: d Diff: #
Time -ineD
9 1 2 # + 5 . ( 8

Years
M M M M M M M M M
Eeferred 6Ts earn .> 89 89 89 89
89 89 89 89 .> 191.99
.> 19(.9.
7
A
; N .> 11#.+8
.> 129.2)
,7
Eeferred 6Ts R $nterest
;

++1.8#
,7
6ar
; 1"999.99
28>
5umerical solutionD
,ind the compounded value at Year 8 of the postponed interest payments
,7
Eeferred interest
; <89&1.9.'
(
R <89&1.9.'
.
R <89&1.9.'
5
R <89&1.9.'
+
; <++1.8# payable at t ; 8.
5o! find the value of the bond considering all cash flo!s
7
A
; <89&1=1.28'
5
R <89&1=1.28'
.
R <89&1=1.28'
(

R <89&1=1.28'
8
R <1"999&1=1.28'
8
R <++1.8#&1=1.28'
8
; <2...8..
@alculate ,7 of deferred interest in 2 stepsD
Step 1D $nputsD @,
9
; 9; @,
1
; 89; 5
j
; +; @,
2
; 9; 5
j
; +; $ ; ..
OutputD 5,7 ; <2((.298.
Step 2D $nputsD 5 ; 8; $ ; .; 67 ; -2((.298; 6T ; 9.
OutputD ,7 ; <++1.828.
@alculate 7
A
" !hich is the 67 of scheduled interest" deferred accrued
interest" and maturity valueD
$nputsD @,
9
; 9; @,
1
; 9; 5
j
; +; @,
2
; 89; 5
j
; #; @,
#
; 89 R ++1.8# R 1"999 ;
1521.8#; $ ; 28.
OutputD 67 ; <2...88; 7
A
; <2...88.
8.. Bond value%%annual payment Answer: a Diff: #
Time -ineD
1=1=9# 12=#1=9# 12=#1=2922
9
12>
1 2 29

Years
M M M M
2"999 2"999 2"999
7
A
; N ,7 ; 199"999
@alculate the 67 of the bonds
$nputsD 5 ; 29; $ ; 12; 6T ; 2999; ,7 ; 199999.
OutputD 67 ; -<25"#95.5..
@alculate e?ual annuity due payments
AKU$5 mode $nputsD 5 ; 2; $ ; 19; 67 ; -25#95.5.; ,7 ; 9.
OutputD 6T ; <1#"255.2) <1#"255.
8(. Bond value%%semiannual payment Answer: d Diff: #
Time -ineD
9
8>
1 2 #9 .-month
M M M M 6eriods
6T ; +9 +9 +9
7
A
; N ,7 ; 1"999
$nputsD 5 ; #9; $ ; 8; 6T ; +9; ,7 ; 1999.
OutputD 67 ; -<5+)..); 7
A
; <5+)..) <559.
88. Bond value%%semiannual payment Answer: b Diff: #
Time -ineD
9 1 2 29

.-month
M M M M 6eriods
6T ; .9 .9 .9
7
A-Old
; 1"999 ,7 ; 1"999
6T ; +9 +9 +9
7
A-5e!
; N ,7 ; 1"999

.>
$nputsD 5 ; 29; $ ; .; 6T ; +9; ,7 ; 1999.
OutputD 67 ; -<((9..9; 7
A
; <((9..9.
5umber of bondsD <2"999"999=<((9..9 2"5). bonds.V
V/ounded up to ne2t !hole bond.
8). Bond value%%semiannual payment Answer: d Diff: #
Time -ineD
9 1 2 19

.-month
T-
1
M M M M 6eriods
6T ; (9 (9 (9
7
A
; N ,7 ; 7
A
5
; 1"9(#..1

aturity
19 11 12 29

.-month
T-
2
M M M M 6eriods
(9 (9 (9
7
A
5
; N ,7 ; 1"999
%d=2 ; 8>
%d=2 ; .>
Solve for 7
A
at Time ; 5 &7
5
' !ith 5 years to maturity
$nputsD 5 ; 19; $ ; .; 6T ; (9; ,7 ; 1999.
OutputD 67 ; -<1"9(#..9. 7
A5
; <1"9(#..9.
Solve for 7
A
at Time ; 9" assuming sale at 7
A5
; <1"9(#..9.
$nputsD 5 ; 19; $ ; 8; 6T ; (9; ,7 ; 19(#..9.
OutputD 67 ; -<)...)); 7
A
; <)...)).
)9. Bond value%%semiannual payment Answer: d Diff: #
The 8> annual coupon bond0s YT is ).1>. The effective annual rate &K4/' is
).1> because the bond is an annual bond. 5o!" !e need to find the nominal
rate for the semiannual bond that has the same K4/" so !e can calculate its
price.
K,,> ; ).1; 6=Y/ ; 2; and then solve for 5O> ; 8.)91)>.
4n e?ually ris%y 8> semiannual coupon bond has the same K4/.
5o!" solve for the semiannual bond0s price. 5 ; 2 19 ; 29; $=Y/ ; 8.)91)=2
; +.+519; 6T ; 89=2 ; +9; ,7 ; 1999; and then solve for 67 ;
-<)+1.9). 7
A
; <)+1.9).
)1 . Bond value%%semiannual payment
Answer: a Diff: # N
On the first bond" since the bond is selling at par" its coupon rate is the
nominal annual rate charged in the mar%et. Io!ever" this is for semiannual
coupon bonds. So" this needs to be converted into an effective rate for
annual coupon bonds.
Step 1D Knter the follo!ing data as inputs in your calculatorD
5O> ; (; 6=Y/ ; 2; and then solve for K,,> ; (.1225>.
Step 2D Pse the effective rate calculated above to solve for the price of
the second bond" !hich is an annual coupon bondD
5 ; 12; $ ; (.1225; 6T ; 9.9( 1"999 ; (9; ,7 ; 1999; and then
solve for 67 ; -<))9.##. 7
A
; <))9.##.
)2. Bond value%%&uarterly payment Answer: b Diff: #
Time -ineD
9 1 2 # + .9

Quarters
M M M M M M
6T ; #(.5 #(.5 #(.5 #(.5 #(.5
7
A
; N ,7 ; 1"999
#>
$nputsD 5 ; .9; $ ; #; 6T ; #(.59; ,7 ; 1999.
OutputD 67 ; -<1"29(.5(; 7
A
; <1"29(.5(.
)#. Bond value%%&uarterly payment Answer: b Diff: #
Time -ineD
9 1 2 # + 29

Quarters
M M M M M M
6T ; 25 25 25 25 25
7
A
; N ,7 ; 1"999
#>
$nputsD 5 ; 29; $ ; #; 6T ; 25; ,7 ; 1999.
OutputD 67 ; -<)25..1; 7
A
<)2..
)+. Call price%%&uarterly payment Answer: c Diff: #
,irst" solve for the bond price today as follo!sD 5 ; 19 + ; +9; $ ; 8=+ ;
2; 6T ; 199=+ ; 25; ,7 ; 1999; and then solve for 67 ;
-<1"1#..(8. 7
A
; <1"1#..(8.
5o!" the call price can be solved for as follo!sD 5 ; 5 + ; 29; $ ; (.5=+
; 1.8(5; 67 ; -11#..(8; 6T ; 25; and then solve for ,7 ; <1"9+8.#+.
)5
. Call price%%semiannual payment Answer: e Diff: #
Step 1D ,ind the bond price using the YTD
5 ; #9; $ ; (.5=2 ; #.(5; 6T ; 9.19=2 1"999 ; 59; ,7 ; 1999; and
then solve for 67 ; -<1"222.8(. 7
A
; <1"222.8(.
Step 2D Solve for the call priceD
5 ; 19; $ ; 5.5+=2 ; 2.((; 67 ; -1222.8(; 6T ; 59; and then solve
for ,7 ; <1"9#).)#8 W <1"9+9.
).. 'ield to call Answer: a Diff: #
Step 1D ,ind the price of the semiannual bond today using the YT and other
information givenD
5 ; 12 2 ; 2+; $ ; (.5=2 ; #.(5; 6T ; +5; ,7 ; 1999; and then
solve for 67 ; -<1"11(.##.2. 7
A
; <1"11(.##.2.
Step 2D Uiven the bond0s price" calculate the yield to call by entering the
follo!ing data as inputsD
5 ; + 2 ; 8; 67 ; -111(.##.2; 6T ; +5; ,7 ; 19+5; and then solve
for $ ; %=2 ; #.#9(#> per . months
% ; #.#9(#> 2 ; ...1+.> W ...1>.
)(. 'ield to call%%annual bond Answer: a Diff: #
,irst get the price based on the YTD
5 ; 12; $ ; (.5; 6T ; )9; ,7 ; 1999; and then solve for 67 ;
-<1"11..9#. 7
A
; <1"11..9#.
5o! solve for the YT@D
5 ; +; 67 ; -111..9#; 6T ; )9; ,7 ; 1959; and then solve for $ ; ..(#>.
)8. 'ield to call%%annual bond Answer: b Diff: #
The bond price today is found as 5 ; 11; $ ; (.5; 6T ; 89; ,7 ; 1999; and
then solve for 67 ; -<1"9#..58. 7
A
; <1"9#..58.
Solve for the yield to call as follo!sD 5 ; #; 67 ; -19#..58; 6T ; 89; ,7 ;
19.9; and then solve for $ ; 8.+1>.
)). 'ield to call%%semiannual bond Answer: a Diff: #
Step 1D Eetermine the stoc%0s current priceD
Pse the YT to find the price today. Knter the follo!ing input data
in the calculatorD
5 ; 2+; $ ; (=2 ; #.5; 6T ; )9=2 ; +5; ,7 ; 1999; and then solve
for 67 ; -<1"1.9.58. 7
A
; <1"1.9.58.
Step 2D Eetermine the bond0s yield to callD
Pse the 67 found in Step 1 to find the YT@.
5 ; .; 67 ; -11.9.58; 6T ; )9=2 ; +5; ,7 ; 19+5; and then solve for $
; 2.#11> per . months or 2 2.#11> ; +..22> +..2>.
199
. 'ield to call%%semiannual bond Answer: b Diff: #
,irst" calculate the bond price as follo!sD 5 ; 29 2 ; +9; $ ; (=2 ; #.5;
6T ; 9.98=2 1"999 ; +9; ,7 ; 1999; and then solve for 67 ;
-<1"19..(8. 7
A
; <1"19..(8.
5o!" !e can calculate the YT@ as follo!s" recogni3ing that the bond can be
called in . years at a call price of 115> 1"999 ; 1"159D 5 ; . 2 ; 12;
67 ; -119..(8; 6T ; +9; ,7 ; 1159; and then solve for $ ; #.8(58> 2 ;
(.(5>.
191. 'ield to call%%semiannual bond Answer: d Diff: #
,ind the current bond price using the YTD
5 ; 12 2 ; 2+; $ ; )=2 ; +.5; 6T ; 199=2 ; 59; ,7 ; 1999; and then solve
for 67 ; -<1"9(2.+8. 7
A
; <1"9(2.+8.
Solve for the YT@D
5 ; 5 2 ; 19; 67 ; -19(2.+8; 6T ; 59; ,7 ; 1959; $ ; +.+)> 2 ; 8.)8>.
192. 'ield to call%%semiannual bond Answer: c Diff: #
,irst calculate the bond priceD
5 ; 2 29 ; +9; $=Y/ ; )=2 ; +.5; 6T ; 119=2 ; 55; ,7 ; 1999; and then
solve for 67 ; -<1"18+.92. 7
A
; <1"18+.92.
5o!" solve for the YT@D
5 ; 2 19 ; 29; 67 ; -118+.92; 6T ; 55; ,7 ; 1955; and then solve for $=Y/
; +.2)> 2 ; 8.58>.
19#. 'ield to call%%semiannual bond Answer: b Diff: #
,irst !e need to find the bond priceD
5 ; 12 2 ; 2+; $ ; 19=2 ; 5; 6T ; .9; ,7 ; 1999; and then solve for 67 ; -
<1"1#(.)). 7
A
; <1"1#(.)).
5o! use the bond price to figure the YT@D
5 ; 8 2 ; 1.; 67 ; -11#(.)); 6T ; .9; ,7 ; 1959; and then solve for
$ ; +.)++1> 2 ; ).888#> ).8)>.
19+. 'ield to call%%semiannual bond Answer: c Diff: #
Step 1D ,ind the bond price today" if held to maturityD
Knter the follo!ing input data into the calculatorD
5 ; 2+" $ ; (=2 ; #.5" 6T ; 59" ,7 ; 1999" and then solve for 67 ;
-<1"2+9.88. 7
A
; <1"2+9.88.
Step 2D @alculate the yield to callD
5 ; 19" 67 ; -12+9.88" 6T ; 59" ,7 ; 1959" and then solve for $ ;
2...(>.
Io!ever" this is a si2-month rate" not a one-year rate. To find the
nominal yield to call" just multiply this rate by 2D 2...(> 2 ;
5.##>.
195. 'ield to call%%semiannual bond Answer: c Diff: #
Step 1D ,ind the bond price today if it is not calledD
5 ; 2+; $ ; #; 6T ; +9; ,7 ; 1999; and then solve for 67 ;
-<1"1.).#.. 7
A
; <1"1.).#..
Step 2D ,ind the yield to callD
5 ; 19; 67 ; -11.).#.; 6T ; +9; ,7 ; 19+9; and then solve for $ ;
2.+#>.
This is the nominal rate for . months. The annual nominal rate is 2
2.+#> ; +.8.>.
19. . 'ield to call%%semiannual bond
Answer: b Diff: # N
Knter the follo!ing data as inputs in your calculatorD
5 ; 2 5 ; 19; 67 ; -19(5; 6T ; 9.9)=2 1"999 ; +5; ,7 ; 19#5; and then
solve for $ ; %
d
=2 ; #.8(+#>.
Since this is a .-month rate" just multiply by 2 to solve for the nominal
yield to call. $ ; %
d
; 2 #.8(+#> ; (.(+8.> (.(5>.
19(. 'ield to maturity Answer: c Diff: # N
Eata givenD 5 ; 19; $ ; N &This is !hat the problem is loo%ing for'; 6T ;
85; 67 ; N &Eon0t have directly" but you can calculate it from the current
yield'; ,7 ; 1"999.
Step 1D @alculate the bond0s current price from information given in the
current yield.
@urrent yield ; @oupon=6rice
9.98 ; <85=6rice
6rice ; N ; <1"9.2.59.
Step 2D Uiven the bond0s price" calculate the bond0s yield to maturity using
your financial calculator by entering the follo!ing data as inputsD
5 ; 19; 67 ; -19.2.59; 6T ; 85; ,7 ; 1999; and then solve for $ ;
(.585)> W (.5)>.
198. 'ield to maturity%%semiannual bond Answer: d Diff: #
Step 1D ,irst determine !hat the bond is selling for today based on the
information given about its call featureD
5 ; 19&2' ; 29; $ ; ..5=2 ; #.25; 6T ; 199=2 ; 59; ,7 ; 1959; and
then solve for 67 ; -<1"289.81. 7
A
; <1"289.81.
Step 2D Pse this current price solution to solve for the YTD
5 ; 15&2' ; #9; 67 ; -1289.81; 6T ; 199=2 ; 59; ,7 ; 1999; and
then solve for $ ; #.+((5>.
Step #D Since this is a semiannual rate" multiply it by 2 to solve for the
nominal" annual YTD
YT ; #.+((5>&2' ; ..)55> W ..)5>.
19). 'ield to maturity%%semiannual bond Answer: d Diff: #
*e %no! the YT@" so from that !e can find the current price. Once !e %no!
the current price" !e can find the YT.
Step 1D Psing the YT@ information solve for the bond0s current priceD
5 ; 1+; $ ; #.25; 6T ; #5; ,7 ; 19+9; and then solve for 67 ;
-<1"95#.##. 7
A
; <1"95#.##.
Step 2D 5o! use the bond0s current price to find the YTD
5 ; 29; 67 ; -195#.##; 6T ; #5; ,7 ; 1999; and then solve for $ ;
#.1#(>.
Step #D This rate is a semiannual rate. To find the nominal annual rate"
multiply by t!o to get #.1#(> 2 ; ..2(+> ..2(>.
119. 'ield to maturity%%semiannual bond Answer: d Diff: # N
5 ; 8 2 ; 1.; $ ; N; 67 ; N; 6T ; 9.9)5=2 1"999 ; +(.59; ,7 ; 1"999
Step 1D Eetermine the bond0s current price.
@urrent yield ; 4nnual interest=@urrent bond price
8.2> ; <)5.99=7
A
7
A
; <)5.99=9.982
7
A
; <1"158.5+.
Step 2D Eetermine the bond0s yield to maturity.
5 ; 1.; 67 ; -1158.5+; 6T ; +(.59; ,7 ; 1999; $ ; N Solve for $ ;
%
d
=2 ; #.++>; %
d
; #.++> 2 ; ..8)>.
111. Annual interest payments remainin! Answer: b Diff: #
Time -ineD
9 1 2 n ; N Years
M M M M
6T ; 89 89 89
7
A
; 8+(.88 ,7 ; 1"999
19>
$nputsD $ ; 19; 67 ; -8+(.88; 6T ; 89; ,7 ; 1999.
OutputD 5 ; 15 years.
112
. Current yield and capital !ains yield Answer: c Diff: #
,irst" calculate the bond price as follo!sD 5 ; . 2 ; 12; $ ; 8.5=2 ;
+.25; 6T ; 9.19=2 1"999 ; 59; ,7 ; 1999; and then solve for 67 ;
-<1"9.).#(89. 7
A
; <1"9.).#(8.
The current yield &@Y' is then <199=<1"9.).#(89 ; ).#5>. /ecogni3ing that
the @Y and capital gains yield &@U' constitute the total return &YT' on the
bond or @Y R @U ; YT" solve for @U in the follo!ing e?uation ).#5> R @U ;
8.5>" @U ; -9.85>.
11#. Current yield and '"# Answer: c Diff: #
Step 1D @alculate the price of the 1.-year bondD
@urrent yield ; @oupon=6rice
8> ; <199=6rice
6rice ; <199=9.98 ; <1"259.99.
This assumes a <1"999 face value. $t doesn0t matter !hat face value
you select as long as you are consistent throughout your calculations.
Step 2D @alculate the 1.-year bond0s YTD
5 ; 1.; 67 ; -1259; 6T ; 199; ,7 ; 1999; and then solve for $ ; (.#>.
11+. +en!t$ of time until annual bonds called Answer: b Diff: # N
,or these %inds of problems" set up the t!o valuations &!ithout call and !ith
call'. Pse the yield to maturity information to solve for the price of the
bond. Then" use the price of the bond to solve for the time until the call may
be e2ercised.
Step 1D Solve for the price of the bond. $nput the follo!ing data into your
calculatorD 5 ; 19; $ ; (.+; 6T ; )9; ,7 ; 1999; and solve for 67 ;
-<1"119.#285. 7
A
; <1"119.#285.
Step 2D Pse the price calculated in the first step to solve for the time
until the bond can be called. $nput the follo!ing data into your
calculatorD $ ; ..5; 67 ; -1119.#285; 6T ; )9; ,7 ; 1959; and solve
for 5 ; #.15.) or #.1. years.
115. #arket value of semiannual bonds Answer: a Diff: #
Time -ineD
1=1=299# 1=1=291#
9 1 2 29 .-month
M M M M 6eriods
6T ; 29 29 29
7
A
; N ,7 ; 1"999
.>
$nputsD 5 ; 29; $ ; .; 6T ; 29; ,7 ; 1999.
OutputD 67 ; -<5+1.29; 7
A
; <5+1.29.
Since there are 19"999 bonds outstanding the total value of debt is
<5+1.29&19"999' ; <5"+12"999.
11.. )uture bond value%%annual payment Answer: c Diff: #
The YT ; @urrent yield R @apital gain.
ThusD @apital gain ; YT - @urrent yield
; ).(9(2> - 19> ; -9.2)28>.
The price in 1 year ; 6rice no! &1 R @U>'.
6rice no!D
@urrent yield ; 4nnual coupon=6rice.
ThusD 6rice ; 4nnual coupon=@urrent yield
; <119=9.19 ; <1"199.
6rice in one year ; <1"199 &1 R @U>'
; <1"199 &1 - 9.992)28' &/emember to e2press the
; <1"9)..(8 <1"9)(. capital gain as a decimal.'
11(. Bond coupon rate Answer: c Diff: #
Time -ineD

9 1 2 # + 19 .-month

M M M M M M 6eriods

6T ; N 6T 6T 6T 6T
7
A
; (.8 ,7 ; 1"999
%d=2 ; 5>
$nputsD 5 ; 19; $ ; 5; 67 ; -(.8; ,7 ; 1999.
OutputD 6T ; <1).)55 &semiannual 6T'.
4nnual coupon rate ; &6T 2'= ; &<1).)55 2'=<1"999 ; #.))> +>.
118. Bond coupon rate Answer: d Diff: #
Time -ineD

9 1 2 29 .-month

M M M M 6eriods

6T ; N 6T 6T
7
A
; 1"158.)1 ,7 ; 1"999
%d=2 ; (>
$nputsD 5 ; 29; $ ; (; 67 ; -1158.)1; ,7 ; 1999.
OutputD 6T ; <85.99 &semiannual 6T'.
4nnual coupon rate ; <85&2'=<1"999 ; 1(.9>.
11). Bond value Answer: d Diff: "
Time -ineD
9
12.#.>
1 2 # 29 Years
T-
AX
M M M M M
6T ; 89 89 89 89
7
AX
; N ,7 ; 1"999

9
.>
1 2 # + #8 #) +9 .-month
T-
cE
M M M M M M M M 6eriods
6T ; +9 +9 +9 +9 +9 +9 +9

7
cE
; N ,7 ; 1"999
Aurger Xing 7
A
D
@alculate K4/ to apply to Aurger Xing bonds using interest rate conversion
feature" and calculate the value" 7
AX
" of Aurger Xing bondsD
$nputsD 6=Y/ ; 2; 5O> ; 12. OutputD K,,> ; K4/ ; 12.#.>. &/emember to
s!itch 6=Y/ bac% to 1.'
$nputsD 5 ; 29; $ ; 12.#.; 6T ; 89; ,7 ; 1999.
OutputD 67 ; -<.81.5+. 7
A
; <.81.5+.
cEonalds 7
A
D
$nputsD 5 ; +9; $ ; .; 6T ; +9; ,7 ; 1999.
OutputD 67 ; -<.)).9(. 7
A
; <.)).9(.
@alculate the difference bet!een the t!o bondsJ 67sD
EifferenceD 7
A&cE'
- 7
A&AX'
; <.)).9( - <.81.5+ ; <1(.5#.
129. Bond value and effective annual rate Answer: b Diff: "
Since the securities are of e?ual ris%" they must have the same effective
rate. Since the comparable 19-year bond is selling at par" its nominal yield
is 8 percent" the same as its coupon rate. Aecause it is a semiannual coupon
bond" its effective rate is 8.1. percent. Psing your calculator" enter 5O>
; 8; 6=Y/ ; 2; and solve for K,,>.
&/emember to change bac% to 6=Y/ ; 1.' So" since the bond you are
considering purchasing has ?uarterly payments" its nominal rate is calculated
as follo!sD K,,> ; 8.1.; 6=Y/ ; +; and solve for 5O>. 5O> ; (.)21.>.
&4gain" remember to change bac% to 6=Y/ ; 1.' To determine the ?uarterly
payment bond0s price you must use the cash flo! register because the payment
amount changes. @,
9
; 9" @,
1
; 29; 5
j
; 29; @,
2
; 25; 5
j
; 1); @,
#
; 1925; $ ;
(.)21.=+ ; 1.)89+; and then solve for 567 ; <1"9.9.(2.
121. Bond value after reor!ani,ation Answer: d Diff: "
Time -ineD

9 1 2 # + 5 . 19 Years

M M M M M M M M
199 199 199 199 199 199 199
599
7
A
; N ,7 ; 1"999
29>
i ; 9>
Eeferred payments accruing no interest
$nputsD @,
9
; 9; @,
1
; 9; 5
j
; 5; @,
2
; 199; 5
j
; +; @,
5
; 1.99; $ ; 29.
OutputD 567 ; <#.2.++. 7
A
; <#.2.++.
122. Bond sinkin! fund payment Answer: d Diff: "
The company must call 5 percent or <59"999 face value each year. $t could
call at par and spend <59"999 or buy on the open mar%et. Since the interest
rate is higher than the coupon rate &1+> vs. 12>'" the bonds !ill sell at a
discount" so open mar%et purchases should be used.
Time -ineD
9 1 2 #9 .-month
M M M M 6eriods
67 ; N 6T ; .9 .9 .9
,7 ; 1"999
(>
$nputsD 5 ; #9; $ ; (; 6T ; .9; ,7 ; 1999.
OutputD 67 ; -<8(5.)1. 7
A
; <8(5.)1.
The company !ould have to buy <59"999=<1"999 ; 59 bonds at <8(5.)1 each ;
<+#"()5.59 <+#"()..
12#. Bond coupon payment Answer: b Diff: "
Time -ineD
9
%
d
; N
1 2 29 Years
T-
1
M M M M
7
A1
; (91.22 6T ; 89 89 89
,7 ; 1"999

9
%
d
; 12>
1 2 # + 5 Years
T-
2
M M M M M M
7
A2
; (91.22 6T ; N 6T 6T 6T 6T
,7 ; 1"999
@alculate YT or %
d
for first issueD
$nputsD 5 ; 29; 67 ; -(91.22; 6T ; 89; ,7 ; 1999.
OutputD $ ; %
d
; YT ; 12>.
@alculate 6T on second issue using 12> ; %
d
; YTD
$nputsD 5 ; 5; $ ; 12; 67 ; -(91.22; ,7 ; 1999.
OutputD 6T ; <#(.11. W <#(.12.
12+. Bonds wit$ differential payments Answer: c Diff: "
Time -ineD
Semiannual
9
%d=2 ; +.5>
1 2 # + +9 .-month

M M M M M M 6eriods
@,s -1"999 6T ; N 6T 6T 6T 6T
,7 ; 1"999
Quarterly
9
%d=+ ; 2.225>
1 2 # + 5 . 89 Quarters
M M M M M M M M
@,s -1"999 6T ; N 6T 6T 6T 6T 6T 6T
,7 ; 1"999
Step 1D @alculate the K4/ of )> nominal yield bond compounded semi-annually.
Pse interest rate conversion feature.
$nputsD 6=Y/ ; 2; 5O> ; ). OutputD K,,> ; ).2925>. &/emember to
change bac% to 6=Y/ ; 1.'
Step 2D @alculate the nominal rate" %
5om
" of a ).2925> K4/ but !ith ?uarterly
compounding.
$nputsD 6=Y/ ; +; K,,> ; ).2925. OutputD 5O> ; 8.)9>. &/emember
to change bac% to 6=Y/ ; 1.'
Step #D @alculate the ?uarterly periodic rate from %
5om
of 8.)> and calculate
the ?uarterly payment.
%
6K/
; %
5om
=+ ; 8.)9>=+ ; 2.225>.
$nputsD 5 ; 89; $ ; 2.225; 67 ; -1999; ,7 ; 1999.
OutputD 6T ; <22.25.
125 . Current yield%%annual bond
Answer: a Diff: E N
@urrent yield ; 4nnual interest=@urrent bond price
@urrent yield ; <89=<)25
@urrent yield ; 8..5>.
12. . 'ield to maturity%%annual bond
Answer: c Diff: # N
Knter the follo!ing data as inputs in your calculator as follo!sD
5 ; 19; 67 ; -)25; 6T ; 89; ,7 ; 1999; $ ; N Solve for $ ; %
d
; YT ; ).18>.
12( )uture bond value%%annual payment Answer: e Diff: # N
Knter the follo!ing data as inputs in your calculator as follo!sD
5 ; (; $ ; ).18; 6T ; 89; ,7 ; 1999; 67 ; N Solve for 67 ; -<)+9.)(. 7
A
;
W <)+1.99.
128 . Bond value%%annual payment
Answer: d Diff: E N
Knter the follo!ing data as inputs in your calculatorD
5 ; 12; $ ; (; 6T ; 9.98 1"999 ; 89; ,7 ; 1999; and then solve for 67 ; -
<1"9().+#. 7
A
; <1"9().+#.
12) . )uture bond value%%annual payment
Answer: e Diff: E N
# years have passed so 5 no! is 12 L # ; ).
5 ; ); $ ; (; 6T ; 9.98 1"999 ; 89; ,7 ; 1999; and then solve for 67 ; -
<1"9.5.15. 7
A
; <1"9.5.15.
1#9 .'ield to maturity%%semiannual bond Answer: d Diff: E N
$nput the follo!ing data in your calculatorD 5 ; #9; 67 ; -11)9; 6T ; 59; ,7
; 1999; and then solve for $ ; #.)128>" but this interest rate is on a
semiannual basis. The nominal YT is #.)128> 2 ; (.825(> (.8#>.
1#1 .'ield to call%%semiannual bond Answer: a Diff: E N
$nput the follo!ing data in your calculatorD 5 ; 19; 67 ; -11)9; 6T ; 59; ,7
; 1959; and then solve for $ ; #.18+1>" but this interest rate is on a
semiannual basis. The nominal YT@ is #.18+1> 2 ; ..#.82> ..#(>.
1#2. 'ield to maturity%%annual bond Answer: a Diff: E N
Knter the follo!ing data as inputs in the financial calculatorD
5 ; 12; 67 ; -1925; 6T ; 89; ,7 ; 1999; and then solve for $ ; YT ; (..(#8>
(..(>.
1##. Price risk%%annual bond Answer: e Diff: # N
Old YT ; (..(#8>. 5e! YT ; (..(#8> - 1> ; ...(#8>.
Psing the ne! YT" first solve for the ne! bond price by entering the
follo!ing data in your financial calculatorD
5 ; 12; $ ; YT ; ...(#8; 6T ; 89; ,7 ; 1999; and then solve for 67 ;
-<1"19(.1). 7
A
; <1"19(.1).
5o!" you can calculate the change in priceD
99 . 925 " 1 <
99 . 925 " 1 < 1) . 19( " 1 <
; 8.92> 8>.
1#+-A%. .ero coupon bond concepts Answer: a Diff: E
The 19-year bond has payments that come sooner than the 3ero coupon bond0s
payments. Therefore" some of the 19-year bond0s cash flo!s !ill be discounted
6E& A##E(DI9 %A )'+,TI'()
for fe!er periods and !ill lose less of their value. Therefore" the value of
the 19-year 3ero coupon bond !ill drop by more than the 8 percent coupon bond.
Therefore" statement a is correct. Statement b used to be true" but the $/S
caught on that people !ere trying to avoid ta2es by buying 3ero coupon bonds"
and they changed the ta2 code. Therefore" statement b is false. $f the YT
is higher than the coupon rate" then the bond is selling at a discount. The
company pays less buying it on the open mar%et than purchasing it at par
value. So statement c is false.
1#5-A%. Coupon and ,ero coupon bond concepts Answer: d Diff: #
$f the YT is 8 percent" then the going interest rate is 8 percent. Aond 4 has
a lo!er coupon than the going coupon rate on ne! bonds" and investors !on0t
pay as much for it. Therefore" it is selling at a discount. The opposite is
true for Aond A. Therefore" statement a is true. $f the YT falls" then
interest rates are falling" and bond prices !ill increase. The bond that is
most affected by this change !ill be the one !hose payments are discounted the
most. The 12-year 3ero coupon bond has all of its payments discounted at the
ne! lo! rate for a period of 12 years &since it only ma%es one payment at the
end of the bond0s life'. Aond A !ill have its final par value discounted for
the entire 19 years of its life" but it has interest payments in the interim.
One !ill be discounted for just one year" one for just t!o years" etc.
Therefore" the 67 of these earlier cash flo!s !ill be less affected by the
drop in interest rates. ,or Aond 4" since its life is the shortest" it !ill
be the least affected by the change in interest rates. Therefore" statement b
is true. /einvestment rate ris% means that there is a chance that !hen the
bond matures interest rates !ill have fallen" and you !ill not be able to get
as high a coupon rate on a replacement bond. The 3ero coupon bond doesn0t
mature for 12 years" and there are no coupon payments to reinvest" so you are
assured of its return for 12 years. The 8-year bond has the most reinvestment
rate ris% because you can only be assured of that rate for 8 more years.
Therefore" statement c is false. Since statements a and b are true" the
correct choice is statement d.
1#.-A%. tripped /.. "reasury bond Answer: e Diff: E
9
i ; 19>
1 2 # + 5 Years

M M M M M M
7
A
; N ,7 ; ."999"999
$nputsD 5 ; 5; $ ; 19; 6T ; 9; ,7 ; .999999.
OutputD 67 ; -<#"(25"52(.)+. 7
A
; <#"(25"528.
1#(-A%. .ero coupon bond Answer: b Diff: E
Step 1D ,ind out !hat !as paid for the bondD
67 ; <1"999=&1.9.8'
(
; <.#9.)5).
Step 2D Eetermine the Year 1 accrued interestD
The accrued interest in the first year is <.#9.)5) 9.9.8 ;
<+2.)95.
Step #D @alculate the ta2 on the accrued interestD
Ta2 on the accrued interest is <+2.)95 9.# ; <12.8(.
1#8-A%. .ero coupon bond Answer: d Diff: #
,irst" find the value of the bond today as follo!sD 5 ; 12; $ ; ); 6T ;
9; ,7 ; 1999; and then solve for 67 ; -<#55.5#. 7
A
; <#55.5#.
Second" find the value of the bond at the end of the first year as follo!sD
5 ; 11; $ ; ); 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<#8(.5#. 7
A1
; <#8(.5#.
The ta2able income on the bond is the appreciation in value over the year or
<#8(.5# - <#55.5# ; <#2. Thus" the ta2 paid is 25> <#2 ; <8.
1#)-A%. .ero coupon bond Answer: b Diff: #
Time -ineD 1ero coupon bond
9
%d ; N
1 2 Years
M M M
67 ; 82..+5 ,7 ; 1"999
,irst" find the value of %
d
as the interest rate that !ill cause <82..+5 to
gro! to <1"999 in 2 years.
$nputsD 5 ; 2; 67 ; -82..+5; 6T ; 9; ,7 ; 1999. OutputD $ ; %
d
; 19>.
%
d
&4fter-ta2' ; %
d
&1 - T' ; 9.19&9..' ; 9.9. ; .>.
4nalysis of cash flo!s method using calculated %
d
; 19> and financial
calculatorD
Year
9 1 2
4ccrued value <82..+5 <)9).19 <1"999.99
$nterest &&7
t
1.19' - 7
t
' 82..5 )9.)9
Ta2 savings &$nterest 9.+9' ##.9. #..#.
@ash flo!s R82..+5 R##.9. R#..#.
-1"999.99
-< ).#..+
Time lineD
9
%d&4T' ; N
1 2 Years
M M M
67 ; 82..+5 R##.9. -).#..+

,in
ancial calculator solutionD &Psing @,s from !or%sheet analysis'
$nputsD @,
9
; 82..+5; @,
1
; ##.9.; @,
2
; -).#..+. OutputD $//> ; ..9>.
%
d
&4T' ; ..9>.
1+9-A%. .ero coupon bond Answer: a Diff: #
Step 1D ,ind 67 of bondD
5 ; 15; $ ; 8; 6T ; 9; ,7 ; 1999; and then solve for 67 ; -<#15.2+. 7
A
; <#15.2+.
Step 2D ,ind interest for the first yearD
7alue at t;9 <#15.2+
$nterest rate 9.98
$nterest income < 25.22
Step #D ,ind ta2 dueD
$nterest income <25.22
Ta2 rate 9.#9
Ta2 due < (.5(
1+1-A%. .ero coupon bond Answer: d Diff: #
Step 1D ,ind the price of the bond todayD
5 ; (; $ ; .; 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<..5.95(1. 7
A
; <..5.95(1.
Step 2D ,ind the price of the bond in 1 yearD
5 ; .; $ ; .; 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<(9+.).95. 7
A
; <(9+.).95.
Step #D @alculate the ta2es due on the gainD
The difference is <(9+.).95 - <..5.95(1 ; <#).)9#+.
The ta2es due are 9.25 <#).)9#+ ; <).)(5) <).)8.
1+2-A%. .ero coupon bond and EA* Answer: d Diff: #
Time lineD &Quarterly payment bonds'
9 1 2 # + 5 . ( 8 +9 Quarters

M M M M M M M M M M
6T ; 25 25 25 25 25 25 25 25 25
67 ; -()5.5+ ,7 ; 1"999
@alculate nominal periodic and annual interest ratesD
$nputsD 5 ; +9; 67 ; -()5.5+; 6T ; 25; ,7 ; 1999.
OutputD $ ; %
d
=+ ; #.+5> per period.
%
5om
; + #.+5> ; 1#.89>.
@alculate K4/ using interest rate conversion featureD
$nputsD 6=Y/ ; +; 5O> ; 1#.89. OutputD K,,> ; 1+.5#>. &/emember to
change bac% to 6=Y/ ; 1.'
Time lineD &1ero coupon bond'
9
1+.5#>
1 2 19 Years

M M M M

67 ; N 6T ; 9 9 ,7 ; 1"999
@alculate 67 of 3ero coupon bond using K4/D
$nputsD 5 ; 19; $ ; 1+.5#; 6T ; 9; ,7 ; 1999.
OutputD 67 ; -<25(.518 W -<25(.52. 7
A
; <25(.52.
1+#-A%. Callable ,ero coupon bond Answer: c Diff: #
Time -ineD
9 5 19 15 29 Years

M M M M M
21+.59 today 1st call

,7 ; 1"999
issue M date
price mar%et price
; 2#).#)
$nputsD 5 ; 29; 67 ; -21+.59; 6T ; 9; ,7 ; 1999. OutputD $ ; 8.9>. The
bonds !ere issued at 8>.
$nputsD 5 ; 15; 67 ; -2#).#); 6T ; 9; ,7 ; 1999. OutputD $ ; 19.9>. 4t a
current mar%et price of <2#).#)" mar%et rates are 19.9>. Thus" the bond !ill
not li%ely be called" so today at Year 5" YT of 19> is the most li%ely annual
rate an investor !ill earn.
1++-A%. .ero coupon bond and ta0es Answer: a Diff: #
You need to figure out ho! much you !ould pay for the bond today" and !hat
its price !ill be ne2t year to find the capital gain.
Step 1D Eetermine the price of the 3ero coupon bond todayD
5 ; (; $ ; .; 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<..5.95(1. 7
A
; <..5.95(1.
Step 2D Eetermine the price of the 3ero coupon bond one year laterD
5 ; .; $ ; .; 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<(9+.).95. 7
A1
; <(9+.).95.
Step #D Eetermine the ta2es due on the gainD
The difference bet!een the t!o prices is the capital gainD
@apital gain ; <(9+.).95 - <..5.95(1 ; <#).)9.
This gain is ta2ed at the rate of #9>D
Ta2es ; 9.# <#).)9 ; <11.)(.
1+5 -A%. "a0es on ,ero coupon bond
Answer: e Diff: # N
Step 1D Eetermine the price of the bond todayD
5 ; 15; $ ; (; 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<#.2.++.. 7
A
; <#.2.++..
Step 2D Eetermine the price of the bond one year from no!D
5 ; 1+; $ ; (; 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<#8(.81(. 7
A1
; <#8(.81(.
Step #D Eetermine the capital gain on the bondD
@apital gain ; <#8(.81( L <#.2.++. ; <25.#(1.
Step +D @alculate the first year0s ta2esD
Ta2es due ; <25.#(1 9.25 ; <..#+.
1+.-A%. Accrued value and interest e0pense Answer: a Diff: #
9
i ; )>
1 2 . ( 8 29 Years

M M M M M M M
7
A
; 1(8.+# 7
(
; N 7
8
; N ,7 ; 1"999
$nputsD 5 ; 8; $ ; ); 67 ; -1(8.+#; 6T ; 9. OutputD ,7 ; <#55.5# ; 7
8
.
$nputsD 5 ; (; $ ; ); 67 ; -1(8.+#; 6T ; 9. OutputD ,7 ; <#2..18 ; 7
(
.
EifferenceD <#55.5# - <#2..18 ; <2).#5.
Solution chec%D <2).#5=<#2..18 ; ).9>.
1+(-A%. .eros and e0pectations t$eory Answer: d Diff: "
,irst find the yields on one-year and t!o-year 3ero-coupon bonds" so you
can find the implied rate on a one-year bond" one year from no!. Then use
this implied rate to find its price.
1-YearD
5 ; 1; 67 ; -)#8.).(1; 6T ; 9; ,7 ; 1999; and then solve for $ ; ..5>.
2-YearD
5 ; 2; 67 ; -8(#.+#8(; 6T ; 9; ,7 ; 1999; and then solve for $ ; (.9>.
Therefore" if the implied rate ; H
(.5>. ; H
(.9> ;
2
H R ..5>
5o! find the price of a 1-year 3ero" 1 year from no!D
5 ; 1; $ ; (.5; 6T ; 9; ,7 ; 1999; and then solve for 67 ; -<)#9.2#.
7
A1
; <)#9.2#.
1+8-A%. .eros and e0pectations t$eory Answer: a Diff: "
9 1 2 # +

M M M M M

#-year 3ero; 6rice ; 82(.8+)1

+-year 3ero; 6rice ; (.2.8)52
Step 1D @alculate the YT for the #-year 3eroD
5 ; #; 67 ; -82(.8+)1; 6T ; 9; ,7 ; 1999; then solve for $ ; ..5>.
Step 2D @alculate the YT for the +-year 3eroD
5 ; +; 67 ; -(.2.8)52; 6T ; 9; ,7 ; 1999; then solve for $ ; (>.
Step #D @alculate the interest rate on a 1-year 3ero" # years from no!D
(> ;
+
H R ..5>&#'
H ; 8.5>.
Step +D @alculate the price of a 1-year 3ero # years from no!D
5 ; 1; $ ; 8.5; 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<)21.... 7
A
; <)21....
1+)-A%. .ero coupon bond Answer: d Diff: "
9 2 + . 8 19
M M M M M M
4ccrued value 1+9.(1 152.1) 1.+..1 1(8.9+ 1)2.5( 298.2)
@all value 21...2
i ; +>

Step 1D @alculate 67 of 3ero coupon bond at Time 9D
5 ; 59; $ ; +; 6T ; 9; ,7 ; 1999; and then solve for 67 ;
-<1+9.(1. 7
A
; <1+9.(1.
Step 2D @alculate accrued value at Year 5D
<1+9.(1&1.9+'
2&5'
; <298.2).
Step #D @all value at Year 5D
<298.2)&1.9+' ; <21...2.
Step +D @alculate K4/ as follo!sD
5 ; 19; 67 ; -1+9.(1; 6T ; 9; ,7 ; 21...2; and then solve for $ ;
+.+1>; ho!ever" this is a semiannual rate.
K4/ ; &1.9++1'
2
- 1 ; ).91>.
159-A%. .ero coupon bond Answer: e Diff: "
Time -ineD
9 19 59 .-month
M M M 6eriods
67 ; N ; 8(.29 67
5
; 1+2.95 ,7 ; 1"999
R 6remium 1+.29
15..25
YT@ ; N

,in
ancial calculator solutionD
Step 1D Eetermine K4/ for discounting. Psing interest rate conversion
featureD
$nputsD 6=Y/ ; 2; 5O> ; 19>. OutputD K,,> ; 19.25>.
,ormula methodD K4/ ;
2
%
R 1
2
- 1 ; &1.95'
2
- 1 ; 9.1925.
Step 2D Eetermine price of bond !hen issued.
$nputsD 5 ; 25; $ ; 19.25; 6T ; 9; ,7 ; 1999. OutputD 67 ; -
<8(.29. 7
A
; <8(.29.
Step #D Eetermine accrued value of bond today" and calculate call price.
$nputsD 5 ; 5; $ ; 19.25; 67 ; -8(.29; 6T ; 9.
OutputD ,7 ; <1+2.9+. 6remium is 19> over accrued value. @all
price ; <1+2.9+ 1.19 ; <15..2+.
Step +D Eetermine the periodic rate &semiannual compounding'.
$nputsD 5 ; 19; 67 ; -8(.29; 6T ; 9; ,7 ; 15..2+.
OutputD $ ; ..995>.
5ominal annual rate ; 2 ..995> ; 12.91>.
Step 5D Eetermine effective annual rate earned on bond using interest rate
conversion featureD
$nputsD 6=Y/ ; 2; 5O> ; 12.91. OutputD K,,> ; 12.#(>.
151-A%. "a0es on ,ero coupon bond Answer: a Diff: "
Since 3ero coupon bonds do not ma%e annual interest payments" the ta2
deduction is determined by the accumulated &but unpaid' interest on the
bond over the year. To determine this !e !ill calculate the value of the
bond at t ; 1 and at t ; 2.
t ; 1D 5 ; ); $=Y/ ; ).5; 6T ; 9; ,7 ; 1999; 67 ; -<++1.85. 7
A1
; <++1.85.
t ; 2D 5 ; 8; $=Y/ ; ).5; 6T ; 9; ,7 ; 1999; 67 ; -<+8#.82. 7
A2
; <+8#.82.
So the accumulated interest isD <+8#.82 - <++1.85 ; <+1.)(.
Ta2 savings ; #9>&<+1.)(' ; <12.5).
152-A%. .ero coupon interest ta0 s$ield Answer: b Diff: "
Time -ineD
9 1 2 # Years
M M M M
67 ; R(2(.25 6T ; 9 9 9
Ta2 savings1 Ta2 savings2 Ta2 savings#
,7 ; 1"999
$nputsD 5 ; #; 67 ; (2(.25; 6T ; 9; ,7 ; -1999. OutputD $ ; 11.29>.
9 1 2 #
1' 4ccrued value (2(.25 898.(9 8)).28 1"999.99
2' $nterest e2pense 81.+5 )9.58 199.(2
#' Ta2 savings &line 2 9.+9' #2.58 #..2# +9.2)
R+9.2)
-1"999.99
+' @ash flo!s R(2(.25 R#2.58 R#..2# -)5).(1
15#-A%. After%ta0 cost of debt Answer: c Diff: #
Solve for the YT using the information from the previous ?uestion
$nputsD 5 ; #; 67 ; (2(.25; 6T ; 9; ,7 ; -1999.
OutputD $ ; 11.29. Aefore-ta2 cost debt of this issue ; 11.29>.
%
d
&4fter-ta2' ; 11.29>&1 - T' ; 11.2>&9..' ; ..(2>.
4lternate solution using cash flo!sD
$nputsD @,
9
; (2(.25; @,
1
; #2.58; @,
2
; #..2#; @,
#
; -)5).(1.
OutputD $//> ; ..(2>.
15+
-B%. +i&uidation procedures Answer: e Diff: #
155-B%. Bankruptcy law Answer: d Diff: #
15.-B%. Bankruptcy issues Answer: e Diff: #
15(-B%. Priority of claims Answer: c Diff: "
6E& A##E(DI9 %& )'+,TI'()

Chuong 2

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Chuong 2

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(Difficulty: E = Easy, M = Medium, and T = Tough)

Multiple Choice: Conceptual

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