Finman Chap7

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

Easy:
Interest rates Answer: 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 bond prices Answer: 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 bond prices Answer: 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.
Chapter 7 - Page 1
CHAPTE !
"#$D% A$D THE& 'A()AT&#$
Interest rates and bond prices Answer: d Diff: E
/
. 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 vs. reinvestment rate risk Answer: 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 vs. reinvestment rate risk Answer: 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.
Price risk Answer: 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.
Chapter 7 - Page 2
e. 1year, 10 percent coupon bond.
Callable bond Answer: a Diff: E
$
. %hich of the follo"ing events "ould ma,e it more li,ely that a company
"ould choose to 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 provision Answer: b 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.
Bond coupon rate Answer: 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.:
Bond concepts Answer: 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
Bond concepts Answer: 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 10
year 3ero coupon bond.
c. 'f a coupon bond is selling at par, its current yield equals its
yield to maturity.
Bond concepts Answer: 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.
Bond concepts Answer: 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.
Bond concepts Answer: 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.
Bond concepts Answer: 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
Bond concepts Answer: a Diff: E N
1*
a. 7ongterm bonds have more interest rate price ris,, but less reinvestment
rate ris, than shortterm 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.
Bond concepts Answer: d Diff: E N
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.
Bond yield Answer: 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
Bond yields and prices Answer: 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.
inkin! fund provision Answer: 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.
inkin! fund provision Answer: 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.
Chapter 7 - Page 7
"ypes of debt Answer: 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.
Medium:
Bond yield Answer: b Diff: #
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.
Bond yield Answer: c Diff: #
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.
Price risk Answer: c Diff: #
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.
Chapter 7 - Page 8
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.
)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.
Price risk Answer: a Diff: #
)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.
Bond concepts Answer: e Diff: #
)/
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.
Bond concepts Answer: d Diff: #
)#
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
Bond concepts Answer: b Diff: #
)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.
Bond concepts Answer: b Diff: #
)+
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.
Bond concepts Answer: e Diff: #
)$
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.
Bond concepts Answer: d Diff: #
)*
. 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. %hich of the follo"ing statements
is most correct&
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
Bond concepts Answer: d Diff: # N
/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.
Bond concepts Answer: b Diff: # N
/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 bond prices Answer: e Diff: # N
/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. %hich of the follo"ing statements is
most correct&
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.
Chapter 7 - Page 12
Callable bond Answer: d Diff: #
/)
a. Distant cash flo"s are generally ris,ier than nearterm cash flo"s.
Curther, a 20year 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.
Callable bond Answer: b Diff: #
//
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
"ypes of debt and t$eir relative costs Answer: c Diff: #
/#
. 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.
#iscellaneous concepts Answer: c Diff: #
/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
#iscellaneous concepts Answer: b Diff: #
/+
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.
#iscellaneous concepts Answer: e Diff: #
/$
a. All else equal, a 1year bond "ill have a higher 9that is, better:
bond rating than a 20year 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 10
year, 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 Answer: e Diff: #
/*
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 Answer: a Diff: #
#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 bonds and default risk Answer: c Diff: #
#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 risk and bankruptcy Answer: b Diff: #
#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 risk and bankruptcy Answer: b Diff: #
#)
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 risk and bankruptcy Answer: d Diff: #
#/
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.
inkin! funds and bankruptcy Answer: d Diff: #
##
. %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:
Bond yields and prices Answer: b Diff: "
#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
Bond concepts Answer: b Diff: "
#+
. %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 20
year coupon bond.
Bond concepts Answer: e Diff: "
#$
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 vs. reinvestment rate risk Answer: c Diff: "
#*
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 10year 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
Bond indenture Answer: d Diff: "
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
"ypes of debt and t$eir relative costs Answer: e Diff: "
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: P*o+lems
Easy:
Annual coupon rate Answer: d Diff: E N
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
Bond value%%annual payment Answer: 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,*#+
Bond value%%semiannual payment Answer: 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
Bond value%%semiannual payment Answer: 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
Bond value%%semiannual payment Answer: e Diff: E N
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)
Bond value%%semiannual payment Answer: b Diff: E N
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. =*)#.$2
d. =*#2.)+
e. =*10.//
Bond value%%semiannual payment Answer: c Diff: E
1$
. 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
Bond value%%semiannual payment Answer: b 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
Bond value%%semiannual payment Answer: c Diff: E N
+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+*./)
Bond value%%&uarterly payment Answer: c Diff: E
+1
. A =1,000 par value bond pays interest of =)# each quarter 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#./*
'ield to maturity%%annual bond Answer: 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
'ield to maturity%%semiannual bond Answer: 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
'ield to maturity%%semiannual bond Answer: b 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
'"# and '"C%%semiannual bond Answer: 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
'ield to maturity and bond value%%annual bond Answer: 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 Answer: b 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. $.)+B
Chapter 7 - Page 23
Current yield Answer: d Diff: E
+$
. 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&
a. 1.)1B
b. 2.1#B
c. $.*#B
d. *.1/B
e. 10.21B
Current yield Answer: 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 Answer: b 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
(uture bond value%%annual payment Answer: b Diff: E N
$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
)isk premium on bonds Answer: 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:
Bond value%%annual payment Answer: e Diff: #
$)
. A 1year bond that pays $ percent interest semiannually sells at par
9=1,000:. Another 1year 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/
Bond value%%annual payment Answer: a Diff: #
$/
. A 10year bond "ith a * percent semiannual coupon is currently selling
at par. A 10year bond "ith a * percent annual coupon has the same
ris,, and therefore, the same effective annual return as the semiannual
bond. 'f the annual coupon bond has a face value of =1,000, "hat "ill
be its price&
a. = *$+.12
b. =1,000.00
c. = /+1.$+
d. =1,0$*.$/
e. = *1+.)/
Chapter 7 - Page 25
Bond value%%annual payment Answer: d Diff: #
$#
. 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.$$
e. =2/*.*$
Bond value%%annual payment Answer: a Diff: #
$1
. 5arie Snell recently inherited some bonds 9face value =100,000: from her
father, and soon thereafter she became engaged to Sam Spade, a
;niversity of Clorida mar,eting graduate. Sam "ants 5arie to cash in
the bonds so the t"o of them can use the money to >live li,e royalty?
for t"o years in 5onte <arlo. !he 2 percent annual coupon bonds mature
on December )1, 2022, and it is no" @anuary 1, 200). 'nterest on these
bonds is paid annually on December )1 of each year, and ne" annual
coupon bonds "ith similar ris, and maturity are currently yielding 12
percent. 'f 5arie sells her bonds no" and puts the proceeds into an
account that pays 10 percent compounded annually, "hat "ould be the
largest equal annual amounts she could "ithdra" for t"o years, beginning
today 9that is, t"o payments, the first payment today and the second
payment one year from today:&
a. =1),2##
b. =2*,+0$
c. =12,1#/
d. =2#,)0#
e. =1/,#$0
Chapter 7 - Page 26
Bond value%%semiannual payment Answer: d Diff: #
$+
. Due to a number of la"suits related to to(ic "astes, a maGor chemical
manufacturer has recently e(perienced a mar,et reevaluation. !he firm
has a bond issue outstanding "ith 1# years to maturity and a coupon rate
of $ percent, "ith interest paid semiannually. !he required nominal
rate on this debt has no" risen to 11 percent. %hat is the current
value of this bond&
a. =1,2+)
b. =1,000
c. =+,+$)
d. = ##0
e. = /#0
Bond value%%semiannual payment Answer: b Diff: #
$$
. @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)
Bond value%%semiannual payment Answer: a Diff: # N
*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
Bond value%%&uarterly payment Answer: b Diff: #
*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 IK'CA and IK'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/
Bond value%%&uarterly payment Answer: b Diff: #
*)
. 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 price%%&uarterly payment Answer: c Diff: #
*/
. Lennedy Mas %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 price%%semiannual payment Answer: e Diff: #
*#
. 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
'ield to call Answer: a Diff: # N
*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
'ield to call%%annual bond Answer: a Diff: #
*+
. 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.$1B
e. 1)./#B
Chapter 7 - Page 29
'ield to call%%annual bond Answer: b Diff: #
*$
. 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
'ield to call%%semiannual bond Answer: a Diff: #
**
. 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
'ield to call%*semiannual bond Answer: b Diff: #
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
'ield to call%%semiannual bond Answer: d Diff: #
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
'ield to call%%semiannual bond Answer: c Diff: #
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
'ield to call%%semiannual bond Answer: b Diff: #
10)
. 5cMriff 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
'ield to call%%semiannual bond Answer: b Diff: # N
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
'ield to maturity Answer: c Diff: # N
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
'ield to maturity%%semiannual bond Answer: d Diff: #
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
'ield to maturity%%semiannual bond Answer: d Diff: #
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
Chapter 7 - Page 32
'ield to maturity%%semiannual bond Answer: d Diff: # N
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:&
a. +.20B
b. +./#B
c. 1.##B
d. 1.$*B
e. $.20B
Annual interest payments remainin! Answer: b Diff: #
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 !ains yield Answer: c Diff: #
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 '"# Answer: c Diff: #
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
Chapter 7 - Page 33
+en!t$ of time until annual bonds called Answer: b Diff: # N
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
c. ).1$ years
d. #.)+ years
e. 1.)2 years
#arket value of semiannual bonds Answer: a Diff: #
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.
L@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. =#,/$0,000
c. =2,#)1,000
d. =+,+01,000
e. =+,0#1,000
(uture bond value%%annual payment Answer: c Diff: #
111
. 4ou Gust purchased a 1#year bond "ith an 11 percent annual coupon. !he
bond has a face value of =1,000 and a current yield of 10 percent.
Assuming that the yield to maturity of *.+0+2 percent remains constant,
"hat "ill be the price of the bond one year from no"&
a. =1,000
b. =1,01/
c. =1,0*+
d. =1,100
e. =1,1#0
Chapter 7 - Page 34
Bond coupon rate Answer: c Diff: #
11+
. <old 0o(es 7td. has 100 bonds outstanding 9maturity value A =1,000:. !he
nominal required rate of return on these bonds is currently 10 percent,
and interest is paid semiannually. !he bonds mature in # years, and
their current mar,et value is =+1$ per bond. %hat is the annual coupon
interest rate&
a. $B
b. 1B
c. /B
d. 2B
e. 0B
Bond coupon rate Answer: d Diff: #
11$
. !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. Miven these facts, "hat is the annual coupon rate
on this bond&
a. 10B
b. 12B
c. 1/B
d. 1+B
e. 21B
Tough:
Bond value Answer: d Diff: "
11*
. Assume that 5cDonald-s and 0urger Ling have similar =1,000 par value
bond issues outstanding. !he bonds are equally ris,y. !he 0urger Ling
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
Bond value and effective annual rate Answer: b Diff: "
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. Miven 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/#.$*
Bond value after reor!ani,ation Answer: d Diff: "
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. =$1).1*
Chapter 7 - Page 36
Bond sinkin! fund payment Answer: d Diff: "
122
. MIN7 sold =1,000,000 of 12 percent, )0year, semiannual payment bonds 1#
years ago. !he bonds are not callable, but they do have a sin,ing fund
that requires MIN7 to redeem # percent of the original face value of the
issue each year 9=#0,000:, beginning in 4ear 11. !o date, 2# percent of
the issue has been retired. !he company can either call bonds at par
for sin,ing fund purposes or purchase bonds on the open mar,et, spending
sufficient money to redeem # percent of the original face value each
year. 'f the nominal yield to maturity 91# years remaining: on the
bonds is currently 1/ percent, "hat is the least amount of money MIN7
must put up to satisfy the sin,ing fund provision&
a. =/),$#1
b. =#0,000
c. =)+,#00
d. =/),+*1
e. =)*,/22
Bond coupon payment Answer: b Diff: "
12)
. Cish N <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
Bonds wit$ differential payments Answer: c Diff: "
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 yield%%annual bond Answer: a Diff: E N
12#
. %hat is the bond-s current yield&
a. $.1#B
b. $.00B
c. $.))B
d. +.$$B
e. $.*#B
'ield to maturity%%annual bond Answer: c Diff: # N
121
. %hat is the bond-s yield to maturity&
a. *.00B
b. *.##B
c. *.1$B
d. $.+#B
e. *.))B
(uture bond value%%annual payment Answer: e Diff: # N
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.
Bond value%%annual payment Answer: d Diff: E N
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
(uture bond value%%annual payment Answer: e Diff: E N
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.
'ield to maturity%%semiannual bond Answer: d Diff: E N
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
'ield to call%%semiannual bond Answer: a Diff: E N
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#.
'ield to maturity%%annual bond Answer: a Diff: E N
1)2
. %hat is the annual coupon bond-s yield to maturity&
a. +.1+B
b. +.$0B
c. $.00B
d. $.1)B
e. $.))B
Chapter 7 - Page 39
Price risk%%annual bond Answer: e Diff: # N
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
,e+ Appendi- !A
Easy:
-ero coupon bond concepts Answer: 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 ,ero coupon bond concepts Answer: d Diff: #
+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 40
Multiple Choice: P*o+lems
Easy:
tripped ... "reasury bond Answer: e Diff: E
+A
1)1
. 5cM"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 5cM"ire today&
a. = ##),++1
b. =#,1/2,100
c. =),/0/,#11
d. =/,0/2,0/0
e. =),+2#,#2$
-ero coupon bond Answer: b 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:
-ero coupon bond Answer: d Diff: #
+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 41
-ero coupon bond Answer: b Diff: #
+A
1)*
. S. <laus N <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
-ero coupon bond Answer: a Diff: #
+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
-ero coupon bond Answer: d Diff: #
+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. =$).+/
-ero coupon bond and EA) Answer: d Diff: #
+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#/.$/
Chapter 7 - Page 42
Callable ,ero coupon bond Answer: c Diff: #
+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
"a/es on ,ero coupon bond Answer: a Diff: #
+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
"a/es on ,ero coupon bond Answer: e Diff: # N
+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 value and interest e/pense Answer: a Diff: #
+A
1/1
. Kogril <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
Chapter 7 - Page 43
e. =2#.+*
Tough:
-eros and e/pectations t$eory Answer: d Diff: "
+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 1year, 3ero
coupon !reasury bonds sell one year from no"&
a. =+*$.$*
b. =$2/.11
c. =$#2.2$
d. =*)0.2)
e. =*$*.11
-eros and e/pectations t$eory Answer: a Diff: "
+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./+
-ero coupon bond Answer: d Diff: "
+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 44
-ero coupon bond Answer: e Diff: "
+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
"a/es on ,ero coupon bond Answer: a Diff: "
+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.)
Margoyle ;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.
-ero coupon interest ta/ s$ield Answer: b Diff: "
+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 45
After%ta/ cost of debt Answer: c Diff: #
+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
,e+ Appendi- !"
Medium:
+i&uidation procedures Answer: e Diff: #
+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.
Bankruptcy law Answer: d Diff: #
+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.
Chapter 7 - Page 46
Bankruptcy issues Answer: e Diff: #
+0
1#1
a. !he primary test of feasibility in a reorgani3ation is "hether
every claimant agrees "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:
Priority of claims Answer: c Diff: "
+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.
). Meneral, 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 47
CHAPTE !
A$%,E% A$D %#()T&#$%
1. Interest rates Answer: e Diff: E
2 . Interest rates and bond prices
Answer: c Diff: E
Statement a is false; Gust the reverse is true. Statement b is false; the
1#year bond is selling at a discount because its coupon payment is less
than the 4!5. Statement c is true; longermaturity and lo"ercoupon bonds
have a larger percentage price change than shortmaturity, highcoupon
bonds. Statement d is false; Gust the reverse is true.
). Interest rates and bond prices Answer: c Diff: E
'f the going mar,et interest rate 94!5: 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. !herefore, this
bond is more valuable and must be selling at a premium. !herefore, statement
a is false. %henever interest rates fall, the price of a bond increases.
!herefore, statement b is false. 'f interest rates remain unchanged, 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. !herefore, statement c is true.
/. Interest rates and bond prices Answer: d Diff: E
Cirst, both bonds "ill decrease in price. 7ongermaturity, lo"ercoupon
bonds have greater price changes "ith rate movements than shortermaturity,
highercoupon bonds. So statement d must be correct.
#. Interest vs. reinvestment rate risk Answer: e Diff: E
Statements a, b, c, and d are all correct. !herefore, the correct choice is
statement e.
1. 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. !he longer the maturity, the greater the interest
rate ris,. 2einvestment rate ris, is the ris, that once the bond matures,
you "on-t be able to reinvest the principal at the same rate. !he shorter
the maturity, the greater the reinvestment rate ris,. Statement a is false.
7ongterm bonds have more interest rate ris, and less reinvestment rate ris,
than shortterm bonds. Statement b is false. 7ongterm bonds have less
reinvestment rate ris, than shortterm bonds. Statement c is true. Feros
have more interest rate ris, because their one payment is subGect to the
ma(imum number of discounting periods, so the 3ero-s price "ill fluctuate
greatly "henever interest rates change. !here is less reinvestment rate
ris, because there are no coupons that need to be reinvested, Gust the par
value at maturity. Statement d is false. 'f interest rates increase, the
prices of all bonds "ill decrease. Statement e is false. 4ou have to pay
ta(es on the difference in the accreted value of the 3eros each year, as
though you had actually reali3ed the capital gain for the year. 4ou don-t
actually reali3e your capital gain until maturity, or until you sell the
bond, but you still pay ta(es as though you had.
+. Price risk Answer: a Diff: E
!he longer the maturity of a bond, the more of an effect a change in
interest rates "ill have on it. !he reason for this is that the price
change is compounded into the bond price for more periods. !herefore, you
can rule out statements b and e. A bond that pays coupons "ill be less
affected by interest rate changes than one that doesn-t pay coupons. !he
bond price is the .IK of all the future cash flo"s, both the coupon payments
and the par value paid at maturity. !he first coupon payment is only
discounted one period. !he second coupon is discounted t"o periods, and so
on. !he par value is discounted for the full life of the bond. !hus,
statements c and d can be eliminated. Since a 3ero coupon bond-s price
today is determined Gust by the .IK of its par value, all of its payment is
discounted for the ma(imum amount of time, "hereas a coupon bond has many
payments discounted for less than the ma(imum amount of time. !herefore, 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.
$. Callable bond Answer: a Diff: E
Statement a is correct; the other statements are false. A bond do"ngrade
generally raises the cost of issuing ne" debt. !herefore, the callable
bonds "ould not be called. 'f the call premium 9the cost paid in e(cess of
par: increases, the cost of calling debt increases; therefore, callable
bonds "ould not be called.
*
. Call provision Answer: b Diff: E
10. Bond coupon rate Answer: c Diff: E
11
. Bond concepts Answer: a Diff: E
Statement a is correct; the other statements are false. A bond-s price and
4!5 are negatively related. 'f a bond-s 4!5 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 bond-s 4!5 O
annual coupon, then it "ill trade at a discount. 'f interest rates
increase, the 10year 3ero coupon bond-s price change is greater than the
10year coupon bond-s.
1) . Bond concepts Answer: e Diff: E
All the statements are true; therefore, the correct choice is statement e.
Since the bond is selling at par, its 4!5 A coupon rate. !he current yield
is calculated as =*0H=1,000 A *B. 'f 4!5 A coupon rate, the bond "ill sell
at par. So, if the bond-s 4!5 remains constant the bond-s 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
required yield on the bond. So statement a is correct. Statement b is
false, because the price "ill increase to"ards =1,000. Statement c can only
be correct if the bond is trading at par, and it isn-t.
1#. Bond concepts Answer: d Diff: E
!he bond has a coupon rate higher than the 4!5, so it must be trading at a
price above its par value. Statement a is incorrect; its current yield A
<ouponHIrice, "hich "ill be less than $ 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. !herefore, statement d is the best ans"er.
11. Bond concepts Answer: a Diff: E
Since 0ond 0 sells at par, then the coupon rate on 0ond 0 equals its 4!5.
!herefore, its 4!5 is 10 percent. Since all the bonds have the same ris,
and the yield curve is steady, the 4!5 for 0onds A and < "ill also be 10
percent. 0ecause 0ond A has an $ percent coupon, it must be trading at a
discount and its price "ill increase over time to"ards the par value.
0ecause 0ond < 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. !he
only correct ans"er is statement a.
1+. Bond concepts Answer: d Diff: E
Statement a is false. 'f the 4!5 is $ percent, and A-s coupon payment is
only + percent, investors "ill find A to be less valuable than a ne" par
value bond "ith an $ percent coupon. !herefore, A "ill be selling for
less than its par value 9at a discount:. 'f the 4!5 is $ percent and 0-s
coupon payment is * percent, investors "ill find 0 to be more valuable
than a ne" par value bond "ith an $ percent coupon. !herefore, 0 "ill be
selling for more than its par value 9at a premium:. !herefore, 0-s price
must be higher than A-s. Statement b is false. !he bonds "ill not have
the same price until e(piration, "hen the price of each "ill be its par
value of =1,000. Statement c is false. 0ond 0 is selling at a higher
price than 0ond A 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 e(piration. Since 0ond A is
selling at a discount this statement is true. Statement e is false. !he
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 A is selling at a discount, its current yield must be less than $
percent because the sum of the t"o yields must equal $ percent.
1$. Bond concepts Answer: c Diff: E
'f the 4!5 is lo"er than the coupon rate, then this bond gives higher
coupon payments than the >going rate.? !herefore, it is more valuable,
and "ill sell at a premium. So, statement a is false. !he current yield
is the bond-s annual coupon payments divided by the bond-s price todayJ
<urrent yield A Annual coupon paymentH<urrent price. Since "e ,no" that
the bond is selling at a premium, it "ill be selling for a higher price
than =1,000. 'f the bond "ere selling at par 9=1,000:, 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 equation is larger, ma,ing
the current yield smaller. !herefore, statement b is false. Since the
bond is selling at a premium, its price "ill decrease through time until
its price equals the par value, Gust at maturity. 2emember the follo"ing
diagramJ
=1,000
Selling at Iremium
Selling at Discount
5aturity
!herefore, statement c is the correct choice.
1* . Bond concepts
Answer: a Diff: E N
Statement a is correct. Statement b is incorrect; Gust the opposite is
true. 0onds "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. As a
discount bond approaches maturity, its price "ill increase to its par
value. <learly, then, statements d and e are also incorrect.
20 .Bond concepts Answer: d Diff: E N
!he correct ans"er is statement d. All of the statements are correct. All
of the statements directly follo" from the basics of bond pricing presented
in the te(t.
21. Bond yield Answer: a Diff: E
'f the bond sells at a premium, its price "ill decline as it approaches
maturity. 92emember that at maturity it has to be "orth its par value.:
!herefore, statement a is true. !he 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. 2emember that 4!5 "ill
equal the capital gains yield plus the current yield. !herefore, for 4!5
to be $ percent "ith a negative capital gains yield, the current yield
must be higher than $ percent. !herefore, statement b is false. 'f the
bond is trading at a premium and the 4!5 is constant, it "ill have to
slo"ly decline in value until, Gust at maturity, it is "orth its par
value. !herefore, statement c is false. 'f the bond-s coupon rate "ere
less than the 4!5, it "ould be less valuable than ne" bonds issued at the
4!5 and "ould, therefore, trade at a discount, not a premium. !herefore,
statement d is false. 'f the 4!5 increases, then this bond-s cash flo"s
9coupons: "ill be discounted at a higher rate and "ill be "orth less.
!herefore, the price "ill decrease, not increase. !herefore, statement e
is false.
22. Bond yields and prices Answer: d Diff: E
'f the 4!5 is + percent, this is the mar,et interest rate. !herefore,
0ond A-s coupon rate is higher than the mar,et rate, so it must be selling
above par 9at a premium:. 0ond 0-s coupon rate is lo"er than the mar,et
rate, so it must be selling belo" par 9at a discount:.
0ond Kalue
=
=1,000
0
A
4ears
5aturity
Statement a is false. 'f the 4!5 remains the same, the price of 0ond A
"ill fall, and the price of bond 0 "ill rise. !he total yield of
+ percent on both bonds "ill consist of a capital gains yield and a
current yield. !he sum of these t"o yields "ill be + percent. Statements
b, c, and e are false for the reason mentioned above. !herefore, the
correct ans"er is statement d.
2). inkin! fund provision Answer: e Diff: E
Statement a is false; sin,ing funds require 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 9causing 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. 0onds "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 e(ceeds the redemption price.
2#. "ypes of debt Answer: e Diff: E
Statement e is correct; the others are false. @un, bonds have a higher
yield to maturity relative to investment grade bonds. A debenture is an
unsecured bond, "hile subordinated debt has greater default ris, than
senior debt.
21. Bond yield Answer: b Diff: #
2+. Bond yield Answer: c Diff: #
Statement c is correct; the other statements are false. 0y definition, if a
coupon bond is selling at par its current yield "ill equal its yield to
maturity. 'f "e let 0ond A be a #year, 12B coupon bond that sells at par,
its current yield equals its 4!5 "hich equals 12B. 'f "e let 0ond 0 be a #
year, 10B coupon bond 9in a 12B interest rate environment: the bond "ill
sell for =*2+.*0. 'ts current yield equals 10.+$B 9=100H=*2+.*0:, but its
yield to maturity equals 12B. !he 4!< is a better measure of return than
the 4!5 if the bond is selling at a premium.
2$. Price risk Answer: c Diff: #
Statement c is correct; the other statements are incorrect. 7ongterm,
lo"coupon bonds are most affected by changes in interest rates;
therefore, of the bonds listed, the 10year 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. Fero coupon bonds
have greater price ris, than either of the coupon bonds or the annuity.
)0. Price risk Answer: c Diff: #
Statement c is correct; the other statements are false. All other things
equal, a 3ero coupon bond "ill e(perience a larger percentage change in
value for a given change in interest rates than "ill a couponbearing
bond. Curther, bonds "ith long remaining lives e(perience greater
percentage changes in value than do bonds "ith short remaining lives.
!hus, of the bonds listed, the 10year 3ero coupon bond has the largest
percentage increase in value.
)1. Price risk Answer: a Diff: #
Statement a is correct. All other things equal, a 3ero coupon bond "ill
e(perience a larger percentage change in value for a given change in
interest rates than "ill a couponbearing bond. Curther, bonds "ith long
remaining lives e(perience greater percentage changes in value than do
bonds "ith short remaining lives. !hus, of the bonds listed, the 10year
3ero coupon bond has the largest percentage increase in value.
)2. Price risk Answer: a Diff: #
Statement a is correct. !he longer the maturity and the lo"er the coupon
of a bond, the more sensitive it is to interest rate 9price: ris,. !he
bond in ans"er a has a maturity greater than or equal to and a coupon less
than or equal to all the other bonds.
)). Price risk Answer: a Diff: #
Statement a is correct. !he bond "ith the smallest coupon and longest
maturity "ill be most sensitive to changes in interest rates.
)/. Bond concepts Answer: e Diff: #
!he correct ans"er is e; the other statements are false. A 3ero coupon
bond "ill al"ays sell at a discount belo" par, provided interest rates are
above 3ero, "hich they al"ays are.
)#
. Bond concepts Answer: d Diff: #
choice. 'f inflation "ere to increase, interest rates "ould rise, thus
bond prices "ould decline.
)1. Bond concepts Answer: b Diff: #
Statement b is correct; the other statements are false. 'f a bond is
selling at a premium, the 4!5 "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 bond-s coupon
rate O than the required rate, the bond "ill sell at a premium. A bond-s
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.
)$
. Bond concepts Answer: e Diff: #
)*. Bond concepts Answer: d Diff: #
choice. Statement a is correct. Crom the information given, "e can solve
for the price of the bond A =$$+. <urrent yield A =100H=$$+ A 11.2+/B.
Statement b is incorrect; since the bond is selling at a discount its 4!<
O 4!5. !he 4!< A 1/.0#B. Statement c is correct.
Crom the information given, since the coupon rate P 4!5 "e ,no" the bond
is selling at a discount. K
0
A =$$+.00.
/0. Bond concepts Answer: d Diff: # N
!he correct ans"er is statement d. 0onds "ith a lo"er coupon have a lo"er
reinvestment rate ris,. 0onds "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,.
0ond F has the highest coupon, so statement a is false. 'f mar,et interest
rates remain unchanged, discount bonds 9<I. P 4!5: "ill go up in price,
"hile premium bonds 9<I. O 4!5: "ill go do"n in price. 0ond F is selling at
a premium, so its price "ill decline 9if interest rates are unchanged:.
!herefore, 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. !he one "ith the largest percentage increase "ill be the
one "ith the most price ris,. As maturity increases, price ris, increases.
As 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,. !herefore, 0ond E "ill have the largest percentage increase in price,
so statement e is false.
/1 .Bond concepts Answer: b Diff: # N
!he correct ans"er is statement b. 'f the 4!5 remains constant, the price
of 0ond A "ill still e(ceed par, the price of 0ond 0 "ill equal par, and
the price of 0ond < "ill be belo" par. So, statement a is incorrect. As
the 4!5 rises, the price of all bonds "ill decrease. So, statement b is
correct. 'f the 4!5 decreases, 0ond < "ill have the largest percentage
increase in price since its price is the lo"est of the three bonds. 0ond 0
"ill follo", and 0ond A "ill have the lo"est percentage increase in price.
So, statement c is incorrect.
/2. Interest rates and bond prices Answer: e Diff: # N
!he correct ans"er is statement e. Statement a is incorrect; 0ond A is a
premium bond, "hile 0ond 0 is a discount bond. Statement b is incorrect;
because 0ond A is at a premium its price "ill decline one year from no",
"hile 0ond 0-s 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 0ond 0 has the lo"er coupon so it "ill e(perience the greatest
increase in value. !herefore, 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. !he bonds- 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. .ote that if
the current rate is above the coupon rate, the bond "on-t be called.
/#. "ypes of debt and t$eir relative costs Answer: c Diff: #
/1. #iscellaneous concepts Answer: c Diff: #
Statement c is correct; the other statements are false. 0an,rupt firms
often are reorgani3ed rather than liquidated. Cirms prefer the less
e(pensive option of calling the bonds"hich in this case is the sin,ing
fund call price. 'nterest e(pense accrues for ta( purposes on 3ero coupon
bonds, so firms can reali3e the ta( savings from issuing debt. <allable
bonds "ill sell for a higher yield than noncallable bonds, if all other
things are held constant.
/+. #iscellaneous concepts Answer: b Diff: #
/$. #iscellaneous concepts Answer: e Diff: #
Statements a and b are both correct; therefore statement e is the correct
choice. 7o"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. !he issuer "ould be li,ely
to call the bond and issue ne" bonds at the lo"er current interest rate.
!hus, "e "ould e(pect 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 e(ceed its coupon rate. 'f a bond sells
at par, then its current yield, yield to maturity, and coupon rate are all
the same. !he bond selling for more than par "ill have a lo"er current
yield than a bond selling at par. 6o"ever, the bond selling for more than
par "ill have a negative capital gain 9that is, a capital loss: "hile the
bond selling at par "ill have no capital gain.
#0. 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 4!5 must be less than the coupon
rate. As a bond approaches maturity, its price "ill move to"ards the par
value.
#1. Corporate bonds and default risk Answer: c Diff: #
Statement c is the correct choice; the other statements are false. !he
e(pected return may be greater than, less than, or equal to the yield to
maturity. Cirms in financial distress may or may not eventually declare
ban,ruptcy; that is, they may recover.
#2. Default risk and bankruptcy Answer: b Diff: #
Statement b is the appropriate choice. An 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.
#). Default risk and bankruptcy Answer: b Diff: #
#/. Default risk and bankruptcy Answer: d Diff: #
Statements a and b are correct; therefore, statement d is the correct
choice. <hapter + is liquidation. <hapter 11 is reorgani3ation.
##. inkin! funds and bankruptcy Answer: d Diff: #
choice. %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. !herefore,
investors are being paid a higher rate than current interest rates and they
"ould prefer to ,eep the bonds to receive a higher return.
#1. Bond yields and prices Answer: b Diff: "
Statement b is correct. 'f a bond-s 4!5 e(ceeds its coupon rate, then, by
definition, the bond sells at a discount. !hus, the bond-s price is less
than its maturity value. Statement a is false. <onsider 3ero coupon
bonds. A 3ero coupon bondQs 4!5 e(ceeds its coupon rate 9"hich is equal
to 3ero:; ho"ever, its current yield is equal to 3ero "hich is equal to
its coupon rate. Statement c is false; a bond-s value is determined by
its cash flo"sJ 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 4!5.
#+. Bond concepts Answer: b Diff: "
#$. Bond concepts Answer: e Diff: "
Statements a and c are correct; therefore, Statement e is the correct
choice. !he longer the maturity of a bond, the greater the impact an
increase in interest rates "ill have on the bond-s price. Statement b is
false. !o see this, assume interest rates increase from + percent to 10
percent. 8valuate the change in the prices of a 10year, # percent coupon
bond and a 10year, 12 percent coupon bond. !he # percent coupon bond-s
price decreases by 1*./ percent, "hile the 12 percent coupon bond-s price
decreases by only 11.* percent. Statement c is correct. !o see this,
evaluate a 10year, 3ero coupon bond and a *year, 10 percent annual coupon
bond at 2 different interest rates, say + percent and 10 percent. !he 3ero
coupon bond-s price decreases by 2/.11 percent, "hile the *year, 10 percent
coupon bond-s price decreases by only 11.)# percent.
#*. Interest vs. reinvestment rate risk Answer: c Diff: "
Statement c is correct. Cor e(ample, assume these coupon bonds have 10
years until maturity and the current interest rate is 12 percent. !he #
percent coupon bond-s value is =10/./$, "hile the 10 percent coupon bond-s
value is =$$+.00. !hus, the lo"ercoupon bond has more interest rate ris,
than the highercoupon bond. !he lo"er the coupon, the greater the
percentage of the cash flo" that "ill come in the later years 9from the
maturity value:, hence, the greater the impact of interest rate changes.
Statement a is falseas "e demonstrated above. Statement b is false
shorterterm bonds have more reinvestment rate ris, than longerterm bonds
because the principal payment must be reinvested sooner on the shorterterm
bond. Statement d is falseas "e demonstrated earlier. Statement e is
false because perpetuities have no maturity date; therefore, they have more
interest rate ris, than 3ero coupon bonds. !he longer a security-s
maturity, the greater its interest rate ris,.
10. Bond indenture Answer: d Diff: "
11. "ypes of debt and t$eir relative costs Answer: e Diff: "
%A<D
0 #0B 100B
5ortgage
,dB
Debentures
e.g. Ioint A
represents #0B
debentures and
#0B mortgage
bonds
Iercentage of total issue
as mortgage bonds.
A
1. <ompany can-t lo"er its total cost of the =100 million of debt very
much, if any, by the mi( of debentures and mortgage bonds.
2. Debentures- ris, rises as mortgage debt rises.
). 5ortgage bonds- ris, rises as more mortgage bonds are issued.
/. So, the >%A<D? "ill li,ely remain fairly stable.
12. Annual coupon rate Answer: d Diff: E N
%e must solve for the payment and infer the coupon rate from that value.
8nter the follo"ing data into your financial calculatorJ
. A 10; ' A *; IK A R*0).+)#1; CK A 1000; and then solve for I5! A =+#.
6ence, the coupon rate is =+#H=1,000 A +.#B.
1). Bond value%%annual payment Answer: d Diff: E
8nter the follo"ing input data in the calculatorJ
. A 12; ' A $; I5! A *0; CK A 1000; and then solve for IK A =1,0+#.)1. K
0
=1,0+#.
1/. Bond value%%semiannual payment Answer: e Diff: E
!ime 7ineJ
0
#B
1 2 20
1month

S S S S Ieriods
IK A & I5! A 10 10 10
CK A 1,000
Cinancial calculator solutionJ
'nputsJ . A 20; ' A #; I5! A 10; CK A 1000.
OutputJ IK A =1,12/.12; K
0
A =1,12/.12.
1#. Bond value%%semiannual payment Answer: d Diff: E
!ime 7ineJ
0
#B
1 2 ) / /0
1month

S S S S S S Ieriods
/0 /0 /0 /0 /0
IK A & CK A 1,000

'nputsJ . A /0; ' A #; I5! A /0; CK A 1000.
OutputJ IK A =$2$./1; K
0
=$2$.
11. Bond value%%semiannual payment Answer: e Diff: E N
!his is a straightfor"ard bond valuation, Gust remember that the bond has
semiannual coupons. 8nter the follo"ing data into your financial
calculatorJ
. A 12 2 A 2/; ' A $ 2 A /; I5! A *0 2 A /#; CK A 1000; and then
solve for IK A =1,0+1.2). K
0
A =1,0+1.2).
1+ . Bond value%%semiannual payment
Answer: b Diff: E N
;sing your financial calculator, enter the follo"ing data as inputsJ
. A 2 10 A 20; ' A *H2 A /.#; I5! A 0.0$H2 1,000 A /0; CK A 1000; and
then solve for IK A =*)/.*1. K
0
A =*)/.*1.
1$. Bond value%%semiannual payment Answer: c Diff: E
. A 10 2 A 20; ' A *H2 A /.#; I5! A #0; CK A 1000; and then solve for IK
A =1,01#.0/. K
0
A =1,01#.0/.
1*
. Bond value%%semiannual payment Answer: b Diff: E
. A 1# 2 A )0; 'H42 A 11H2 A #.#; I5! A 1,000 0.0$H2 A /0; CK A 1000;
and then solve for IK A =+$1.**. K
0
A =+$1.**.
+0. Bond value%%semiannual payment Answer: c Diff: E N
8nter the follo"ing data inputs into the calculatorJ
. A 2/; 'H4r A +H2 A ).#; I5! A /0; CK A 1000; and then solve for IK A
=1,0$0.2*. K
0
A =1,0$0.2*.
+1. Bond value%%&uarterly payment Answer: c Diff: E
!ime 7ineJ
0
)B
1 2 ) / /0

Tuarters

S S S S S S
I5! A )# )# )# )# )#
IK A & CK A 1,000

'nputsJ . A /0; ' A ); I5! A )#; CK A 1000.
OutputJ IK A =1,11#.#+; K
0
A =1,11#.#+.
+2. 'ield to maturity%%annual bond Answer: a Diff: E
8nter . A 11; IK A $1#; I5! A $0; CK A 1000; and then solve for 'H42 A
10.0$1$B 10.0*B.
+). 'ield to maturity%%semiannual bond Answer: c Diff: E
. A 12 2 A 2/; IK A 10$0; I5! A #0; CK A 1000; and then solve for ' A
/./#0$B 2 A $.*011B.
+/
. 'ield to maturity%%semiannual bond Answer: b Diff: E
. A 1$; IK A *20; I5! A )#; CK A 1000; and then solve for 'H42 A /.1)*1B.
<onvert this semiannual periodic rate to a nominal annual rate, /.1)*1B
2 A $.2+$2B $.2$B.
+#. '"# and '"C%%semiannual bond Answer: e Diff: E
!o calculate 4!5J
. A 2$; IK A 10+#; I5! A /0; CK A 1000; and then solve for 'H42 A ).#+B
2 A +.1/B.
!o calculate 4!<J
. A 10; IK A 10+#; I5! A /0; CK A 10#0; and then solve for 'H42 A ).#2B
2 A +.0#B.
+1. 'ield to maturity and bond value0annual bond Answer: d Diff: E
Step 1J Cind the 4!5. . A 20; IK A *2#; I5! A *0; CK A 1000; and then
solve for ' A 4!5 A *.$+))B.
Step 2J Solve for I
#
. 'n # years, there "ill be 1# years left until
maturity, so the price at t A # isJ . A 1#; 'H42 A *.$+)); I5! A
*0; CK A 1000; and then solve for IK A =*)).0*. K
0
A =*)).0*.
++. Current yield Answer: b Diff: E
<urrent yield A Annual coupon paymentH<urrent price.
Step 1J Cind the price of the bondJ
. A *; 'H42 A 10; I5! A +0; CK A 1000; and then solve for IK A
=$2+.2). K
0
A =$2+.2).
Step 2J <alculate the current yieldJ <4 A =+0H=$2+.2) A $./1B.
+$. Current yield Answer: d Diff: E
<urrent yield A Annual coupon paymentH<urrent price.
Step 1J Cind the price of the bondJ
. A 12; 'H42 A *.#; I5! A $#; CK A 1000; and then solve for IK A
=*)0. K
0
A =*)0.
Step 2J <alculate the current yieldJ <4 A =$#H=*)0 A *.1/B.
+*. Current yield Answer: c Diff: E
!he current yield is equal to the annual coupon divided by the price. !he
annual coupon is givenJ 0.0$ =1,000 A =$0. 4ou need to find the price
before calculating the current yield.
Step 1J ;sing the !K5 inputs of your calculator, find the bond-s priceJ
. A 1#; ' A +; I5! A $0; CK A 1000; and then solve for IK A
=1,0*1.0$. K
0
A =1,0*1.0$.
Step 2J <alculate the bond-s current yieldJ
<urrent yield A Annual couponH<urrent price
<urrent yield A =$0H=1,0*1.0$
A +.))B.
$0. Current yield and yield to maturity Answer: b Diff: E
<urrent yield is calculated asJ =$0H=*$# A $.12B.
. A 12; IK A *$#; I5! A $0; CK A 1000; and then solve for 'H42 94!5: A
$.20B.
$1. (uture bond value%%annual payment Answer: b Diff: E N
!"o years from no", there "ill be $ years left to maturity. ;se your
financial calculator to determine its price by entering the follo"ing data
as inputsJ
. A $; ' A 10; I5! A $0; CK A 1000; and then solve for IK A =$*).)0. K
0
A =$*).)0.
$2. )isk premium on bonds Answer: c Diff: E
<alculate the previous ris, premium, 2I
000
, and ne" 2I
000
J
2I
000
A 11.#B $.+B A 2.$B.
.e" 2I
000
A 2.$BH2 A 1./B.
<alculate ne" 4!5 on 000 bondsJ 4!5
000
A +.$B U 1./B A *.2B.
$). Bond value%%annual payment Answer: e Diff: #
!he semiannual bond selling at par has a nominal yield to maturity equal
to its annual coupon rate 9you can chec, this:. !hus the nominal 4!5 for
the semiannual bond is $B. !o convert this to an effective annual rate
for the annual bondJ
.O5B A $; IH42 A 2; and then solve for 8CCB A $.11B.
%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. !hus; .
A 1; ' A $.11; I5! A $0; CK A 1000; and then solve for IK A =**2.1/. K
0
A
=**2.1/.
$/. Bond value%%annual payment Answer: a Diff: #
Step 1J Determine the effective annual rate of return on the semiannual
bondJ
!he semiannual bond has a 4!5 of * percent because it is selling
at par. !his is equivalent to an effective annual rate of
*.202#B A V91 U 0.0*H2:
2
1W.
Step 2J Determine the value of the annual bondJ
. A 10; ' A *.202#; I5! A *0; CK A 1000; and then solve for IK A
=*$+.12. K
0
A =*$+.12.
$#. Bond value%%annual payment Answer: d Diff: #
!ime 7ineJ
0 1 2 ) / # 1 + $

4ears
S S S S S S S S S
Deferred I5!s earn 1B $0 $0 $0 $0
$0 $0 $0 $0 1B 101.00
1B 10+.01
K
0
A & 1B 11)./$
1B 120.2*
CK
Deferred I5!s U 'nterest
A

//1.$)
CK
Iar
A 1,000.00
2$B
.umerical solutionJ
Cind the compounded value at 4ear $ of the postponed interest payments
CK
Deferred interest
A =$091.01:
+
U =$091.01:
1
U =$091.01:
#
U =$091.01:
/
A =//1.$) payable at t A $.
.o" find the value of the bond considering all cash flo"s
K
0
A =$091H1.2$:
#
U =$091H1.2$:
1
U =$091H1.2$:
+

U =$091H1.2$:
$
U =1,00091H1.2$:
$
U =//1.$)91H1.2$:
$
A =211.$1.
<alculate CK of deferred interest in 2 stepsJ
Step 1J 'nputsJ <C
0
A 0; <C
1
A $0; .
G
A /; <C
2
A 0; .
G
A /; ' A 1.
OutputJ .CK A =2++.20$.
Step 2J 'nputsJ . A $; ' A 1; IK A 2++.20$; I5! A 0.
OutputJ CK A =//1.$2$.
<alculate K
0
, "hich is the IK of scheduled interest, deferred accrued
interest, and maturity valueJ
'nputsJ <C
0
A 0; <C
1
A 0; .
G
A /; <C
2
A $0; .
G
A ); <C
)
A $0 U //1.$) U 1,000
A 1#21.$); ' A 2$.
OutputJ IK A =211.$$; K
0
A =211.$$.
$1. Bond value%%annual payment Answer: a Diff: #
!ime 7ineJ
1H1H0) 12H)1H0) 12H)1H2022
0
12B
1 2 20

4ears
S S S S
2,000 2,000 2,000
K
0
A & CK A 100,000
<alculate the IK of the bonds
'nputsJ . A 20; ' A 12; I5! A 2000; CK A 100000.
OutputJ IK A =2#,)0#.#1.
<alculate equal annuity due payments
08M'. mode 'nputsJ . A 2; ' A 10; IK A 2#)0#.#1; CK A 0.
OutputJ I5! A =1),2##.2* =1),2##.
$+. Bond value%%semiannual payment Answer: d Diff: #
!ime 7ineJ
0
$B
1 2 )0 1month
S S S S Ieriods
I5! A /0 /0 /0
K
0
A & CK A 1,000
'nputsJ . A )0; ' A $; I5! A /0; CK A 1000.
OutputJ IK A =#/*.1*; K
0
A =#/*.1* =##0.
$$. Bond value%%semiannual payment Answer: b Diff: #
!ime 7ineJ
0 1 2 20

1month
S S S S Ieriods
I5! A 10 10 10
K
0Old
A 1,000 CK A 1,000
I5! A /0 /0 /0
K
0.e"
A & CK A 1,000

1B
'nputsJ . A 20; ' A 1; I5! A /0; CK A 1000.
OutputJ IK A =++0.10; K
0
A =++0.10.
.umber of bondsJ =2,000,000H=++0.10 2,#*1 bonds.X
X2ounded up to ne(t "hole bond.
$*. Bond value%%semiannual payment Answer: d Diff: #
!ime 7ineJ
0 1 2 10

1month
!7
1
S S S S Ieriods
I5! A +0 +0 +0
K
0
A & CK A K
0
#
A 1,0+).11

5aturity
10 11 12 20

1month
!7
2
S S S S Ieriods
+0 +0 +0
K
0
#
A & CK A 1,000
,dH2 A $B
,dH2 A 1B
Solve for K
0
at !ime A # 9K
#
: "ith # years to maturity
'nputsJ . A 10; ' A 1; I5! A +0; CK A 1000.
OutputJ IK A =1,0+).10. K
0#
A =1,0+).10.
Solve for K
0
at !ime A 0, assuming sale at K
0#
A =1,0+).10.
'nputsJ . A 10; ' A $; I5! A +0; CK A 10+).10.
OutputJ IK A =*11.**; K
0
A =*11.**.
*0. Bond value%%semiannual payment Answer: d Diff: #
!he $B annual coupon bond-s 4!5 is *.1B. !he effective annual rate 98A2:
is *.1B because the bond is an annual bond. .o", "e need to find the
nominal rate for the semiannual bond that has the same 8A2, so "e can
calculate its price.
8CCB A *.1; IH42 A 2; and then solve for .O5B A $.*01*B.
An equally ris,y $B semiannual coupon bond has the same 8A2.
.o", solve for the semiannual bond-s price. . A 2 10 A 20; 'H42 A
$.*01*H2 A /./#10; I5! A $0H2 A /0; CK A 1000; and then solve for IK A
=*/1.0*. K
0
A =*/1.0*.
*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. 6o"ever, this is for
semiannual coupon bonds. So, this needs to be converted into an effective
rate for annual coupon bonds.
Step 1J 8nter the follo"ing data as inputs in your calculatorJ
.O5B A +; IH42 A 2; and then solve for 8CCB A +.122#B.
Step 2J ;se the effective rate calculated above to solve for the price of
the second bond, "hich is an annual coupon bondJ
. A 12; ' A +.122#; I5! A 0.0+ 1,000 A +0; CK A 1000; and then
solve for IK A =**0.)). K
0
A =**0.)).
*2. Bond value%%&uarterly payment Answer: b Diff: #
!ime 7ineJ
0 1 2 ) / 10

Tuarters
S S S S S S
I5! A )+.# )+.# )+.# )+.# )+.#
K
0
A & CK A 1,000
)B
'nputsJ . A 10; ' A ); I5! A )+.#0; CK A 1000.
OutputJ IK A =1,20+.#+; K
0
A =1,20+.#+.
*). Bond value%%&uarterly payment Answer: b Diff: #
!ime 7ineJ
0 1 2 ) / 20

Tuarters
S S S S S S
I5! A 2# 2# 2# 2# 2#
K
0
A & CK A 1,000
)B
'nputsJ . A 20; ' A ); I5! A 2#; CK A 1000.
OutputJ IK A =*2#.11; K
0
=*21.
*/. Call price%%&uarterly payment Answer: c Diff: #
Cirst, solve for the bond price today as follo"sJ . A 10 / A /0; ' A
$H/ A 2; I5! A 100H/ A 2#; CK A 1000; and then solve for IK A
=1,1)1.+$. K
0
A =1,1)1.+$.
.o", the call price can be solved for as follo"sJ . A # / A 20; ' A
+.#H/ A 1.$+#; IK A 11)1.+$; I5! A 2#; and then solve for CK A =1,0/$.)/.
*#
. Call price%%semiannual payment Answer: e Diff: #
Step 1J Cind the bond price using the 4!5J
. A )0; ' A +.#H2 A ).+#; I5! A 0.10H2 1,000 A #0; CK A 1000;
and then solve for IK A =1,222.$+. K
0
A =1,222.$+.
Step 2J Solve for the call priceJ
. A 10; ' A #.#/H2 A 2.++; IK A 1222.$+; I5! A #0; and then
solve for CK A =1,0)*.*)$ Y =1,0/0.
*1. 'ield to call Answer: a Diff: #
Step 1J Cind the price of the semiannual bond today using the 4!5 and
other information givenJ
. A 12 2 A 2/; ' A +.#H2 A ).+#; I5! A /#; CK A 1000; and then
solve for IK A =1,11+.))12. K
0
A =1,11+.))12.
Step 2J Miven the bond-s price, calculate the yield to call by entering
the follo"ing data as inputsJ
. A / 2 A $; IK A 111+.))12; I5! A /#; CK A 10/#; and then
solve for ' A ,H2 A ).)0+)B per 1 months
, A ).)0+)B 2 A 1.11/1B Y 1.11B.
*+. 'ield to call%%annual bond Answer: a Diff: #
Cirst get the price based on the 4!5J
. A 12; ' A +.#; I5! A *0; CK A 1000; and then solve for IK A
=1,111.0). K
0
A =1,111.0).
.o" solve for the 4!<J
. A /; IK A 1111.0); I5! A *0; CK A 10#0; and then solve for ' A 1.+)B.
*$. 'ield to call%%annual bond Answer: b Diff: #
!he bond price today is found as . A 11; ' A +.#; I5! A $0; CK A 1000; and
then solve for IK A =1,0)1.#$. K
0
A =1,0)1.#$.
Solve for the yield to call as follo"sJ . A ); IK A 10)1.#$; I5! A $0;
CK A 1010; and then solve for ' A $./1B.
**. 'ield to call%%semiannual bond Answer: a Diff: #
Step 1J Determine the stoc,-s current priceJ
;se the 4!5 to find the price today. 8nter the follo"ing input
data in the calculatorJ
. A 2/; ' A +H2 A ).#; I5! A *0H2 A /#; CK A 1000; and then solve
for IK A =1,110.#$. K
0
A =1,110.#$.
Step 2J Determine the bond-s yield to callJ
;se the IK found in Step 1 to find the 4!<.
. A 1; IK A 1110.#$; I5! A *0H2 A /#; CK A 10/#; and then solve
for ' A 2.)11B per 1 months or 2 2.)11B A /.122B /.12B.
100
. 'ield to call%%semiannual bond Answer: b Diff: #
Cirst, calculate the bond price as follo"sJ . A 20 2 A /0; ' A +H2 A
).#; I5! A 0.0$H2 1,000 A /0; CK A 1000; and then solve for IK A
=1,101.+$. K
0
A =1,101.+$.
.o", "e can calculate the 4!< as follo"s, recogni3ing that the bond can be
called in 1 years at a call price of 11#B 1,000 A 1,1#0J . A 1 2 A
12; IK A 1101.+$; I5! A /0; CK A 11#0; and then solve for ' A ).$+#$B 2
A +.+#B.
101. 'ield to call%%semiannual bond Answer: d Diff: #
Cind the current bond price using the 4!5J
. A 12 2 A 2/; ' A *H2 A /.#; I5! A 100H2 A #0; CK A 1000; and then
solve for IK A =1,0+2./$. K
0
A =1,0+2./$.
Solve for the 4!<J
. A # 2 A 10; IK A 10+2./$; I5! A #0; CK A 10#0; ' A /./*B 2 A $.*$B.
102. 'ield to call%%semiannual bond Answer: c Diff: #
Cirst calculate the bond priceJ
. A 2 20 A /0; 'H42 A *H2 A /.#; I5! A 110H2 A ##; CK A 1000; and then
solve for IK A =1,1$/.02. K
0
A =1,1$/.02.
.o", solve for the 4!<J
. A 2 10 A 20; IK A 11$/.02; I5! A ##; CK A 10##; and then solve for
'H42 A /.2*B 2 A $.#$B.
10). 'ield to call%%semiannual bond Answer: b Diff: #
Cirst "e need to find the bond priceJ
. A 12 2 A 2/; ' A 10H2 A #; I5! A 10; CK A 1000; and then solve for IK
A =1,1)+.**. K
0
A =1,1)+.**.
.o" use the bond price to figure the 4!<J
. A $ 2 A 11; IK A 11)+.**; I5! A 10; CK A 10#0; and then solve for
' A /.*//1B 2 A *.$$$)B *.$*B.
10/. 'ield to call%%semiannual bond Answer: c Diff: #
Step 1J Cind the bond price today, if held to maturityJ
8nter the follo"ing input data into the calculatorJ
. A 2/, ' A +H2 A ).#, I5! A #0, CK A 1000, and then solve for IK
A =1,2/0.$$. K
0
A =1,2/0.$$.
Step 2J <alculate the yield to callJ
. A 10, IK A 12/0.$$, I5! A #0, CK A 10#0, and then solve for '
A 2.11+B.
6o"ever, this is a si(month rate, not a oneyear rate. !o find
the nominal yield to call, Gust multiply this rate by 2J 2.11+B
2 A #.))B.
10#. 'ield to call%%semiannual bond Answer: c Diff: #
Step 1J Cind the bond price today if it is not calledJ
. A 2/; ' A ); I5! A /0; CK A 1000; and then solve for IK A
=1,11*.)1. K
0
A =1,11*.)1.
Step 2J Cind the yield to callJ
. A 10; IK A 111*.)1; I5! A /0; CK A 10/0; and then solve for '
A 2./)B.
!his is the nominal rate for 1 months. !he annual nominal rate
is 2 2./)B A /.$1B.
101 . 'ield to call%%semiannual bond
Answer: b Diff: # N
8nter the follo"ing data as inputs in your calculatorJ
. A 2 # A 10; IK A 10+#; I5! A 0.0*H2 1,000 A /#; CK A 10)#; and then
solve for ' A ,
d
H2 A ).$+/)B.
Since this is a 1month rate, Gust multiply by 2 to solve for the nominal
yield to call. ' A ,
d
A 2 ).$+/)B A +.+/$1B +.+#B.
10+. 'ield to maturity Answer: c Diff: # N
Data givenJ . A 10; ' A & 9!his is "hat the problem is loo,ing for:; I5!
A $#; IK A & 9Don-t have directly, but you can calculate it from the current
yield:; CK A 1,000.
Step 1J <alculate the bond-s current price from information given in the
current yield.
<urrent yield A <ouponHIrice
0.0$ A =$#HIrice
Irice A & A =1,012.#0.
Step 2J Miven the bond-s price, calculate the bond-s yield to maturity
using your financial calculator by entering the follo"ing data as
inputsJ
. A 10; IK A 1012.#0; I5! A $#; CK A 1000; and then solve for '
A +.#$#*B Y +.#*B.
10$. 'ield to maturity%%semiannual bond Answer: d Diff: #
Step 1J Cirst determine "hat the bond is selling for today based on the
information given about its call featureJ
. A 1092: A 20; ' A 1.#H2 A ).2#; I5! A 100H2 A #0; CK A 10#0;
and then solve for IK A =1,2$0.$1. K
0
A =1,2$0.$1.
Step 2J ;se this current price solution to solve for the 4!5J
. A 1#92: A )0; IK A 12$0.$1; I5! A 100H2 A #0; CK A 1000; and
then solve for ' A )./++#B.
Step )J Since this is a semiannual rate, multiply it by 2 to solve for
the nominal, annual 4!5J
4!5 A )./++#B92: A 1.*##B Y 1.*#B.
10*. 'ield to maturity%%semiannual bond Answer: d Diff: #
%e ,no" the 4!<, so from that "e can find the current price. Once "e ,no"
the current price, "e can find the 4!5.
Step 1J ;sing the 4!< information solve for the bond-s current priceJ
. A 1/; ' A ).2#; I5! A )#; CK A 10/0; and then solve for IK A
=1,0#).)). K
0
A =1,0#).)).
Step 2J .o" use the bond-s current price to find the 4!5J
. A 20; IK A 10#).)); I5! A )#; CK A 1000; and then solve for '
A ).1)+B.
Step )J !his rate is a semiannual rate. !o find the nominal annual rate,
multiply by t"o to get ).1)+B 2 A 1.2+/B 1.2+B.
110. 'ield to maturity%%semiannual bond Answer: d Diff: # N
. A $ 2 A 11; ' A &; IK A &; I5! A 0.0*#H2 1,000 A /+.#0; CK A 1,000
Step 1J Determine the bond-s current price.
<urrent yield A Annual interestH<urrent bond price
$.2B A =*#.00HK
0
K
0
A =*#.00H0.0$2
K
0
A =1,1#$.#/.
Step 2J Determine the bond-s yield to maturity.
. A 11; IK A 11#$.#/; I5! A /+.#0; CK A 1000; ' A & Solve for '
A ,
d
H2 A ).//B; ,
d
A ).//B 2 A 1.$*B.
111. Annual interest payments remainin! Answer: b Diff: #
!ime 7ineJ
0 1 2 n A & 4ears
S S S S
I5! A $0 $0 $0
K
0
A $/+.$$ CK A 1,000
10B
'nputsJ ' A 10; IK A $/+.$$; I5! A $0; CK A 1000.
OutputJ . A 1# years.
112
. Current yield and capital !ains yield Answer: c Diff: #
Cirst, calculate the bond price as follo"sJ . A 1 2 A 12; ' A $.#H2 A
/.2#; I5! A 0.10H2 1,000 A #0; CK A 1000; and then solve for IK A
=1,01*.)+$0. K
0
A =1,01*.)+$.
!he current yield 9<4: is then =100H=1,01*.)+$0 A *.)#B. 2ecogni3ing that
the <4 and capital gains yield 9<M: constitute the total return 94!5: on
the bond or <4 U <M A 4!5, solve for <M in the follo"ing equation *.)#B U
<M A $.#B, <M A 0.$#B.
11). Current yield and '"# Answer: c Diff: #
Step 1J <alculate the price of the 11year bondJ
<urrent yield A <ouponHIrice
$B A =100HIrice
Irice A =100H0.0$ A =1,2#0.00.
!his assumes a =1,000 face value. 't doesn-t matter "hat face
value you select as long as you are consistent throughout your
calculations.
Step 2J <alculate the 11year bond-s 4!5J
. A 11; IK A 12#0; I5! A 100; CK A 1000; and then solve for ' A +.)B.
11/. +en!t$ of time until annual bonds called Answer: b Diff: # N
Cor these ,inds of problems, set up the t"o valuations 9"ithout call and
"ith call:. ;se the yield to maturity information to solve for the price of
the bond. !hen, use the price of the bond to solve for the time until the
call may be e(ercised.
Step 1J Solve for the price of the bond. 'nput the follo"ing data into
your calculatorJ . A 10; ' A +./; I5! A *0; CK A 1000; and solve
for IK A =1,110.)2$#. K
0
A =1,110.)2$#.
Step 2J ;se 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
calculatorJ ' A 1.#; IK A 1110.)2$#; I5! A *0; CK A 10#0; and
solve for . A ).1#1* or ).11 years.
11#. #arket value of semiannual bonds Answer: a Diff: #
!ime 7ineJ
1H1H200) 1H1H201)
0 1 2 20 1month
S S S S Ieriods
I5! A 20 20 20
K
0
A & CK A 1,000
1B
'nputsJ . A 20; ' A 1; I5! A 20; CK A 1000.
OutputJ IK A =#/1.20; K
0
A =#/1.20.
Since there are 10,000 bonds outstanding the total value of debt is
=#/1.20910,000: A =#,/12,000.
111. (uture bond value%%annual payment Answer: c Diff: #
!he 4!5 A <urrent yield U <apital gain.
!husJ <apital gain A 4!5 <urrent yield
A *.+0+2B 10B A 0.2*2$B.
!he price in 1 year A Irice no" 91 U <MB:.
Irice no"J
<urrent yield A Annual couponHIrice.
!husJ Irice A Annual couponH<urrent yield
A =110H0.10 A =1,100.
Irice in one year A =1,100 91 U <MB:
A =1,100 91 0.002*2$: 92emember to e(press the
A =1,0*1.+$ =1,0*+. capital gain as a decimal.:
11+. Bond coupon rate Answer: c Diff: #
!ime 7ineJ

0 1 2 ) / 10 1month

S S S S S S Ieriods

I5! A & I5! I5! I5! I5!
K
0
A +1$ CK A 1,000
,
d
H2 A #B
'nputsJ . A 10; ' A #; IK A +1$; CK A 1000.
OutputJ I5! A =1*.*## 9semiannual I5!:.
Annual coupon rate A 9I5! 2:H5 A 9=1*.*## 2:H=1,000 A ).**B /B.
11$. Bond coupon rate Answer: d Diff: #
!ime 7ineJ

0 1 2 20 1month

S S S S Ieriods

I5! A & I5! I5!
K
0
A 1,1#$.*1 CK A 1,000
,dH2 A +B
'nputsJ . A 20; ' A +; IK A 11#$.*1; CK A 1000.
OutputJ I5! A =$#.00 9semiannual I5!:.
Annual coupon rate A =$#92:H=1,000 A 1+.0B.
11*. Bond value Answer: d Diff: "
!ime 7ineJ
0
12.)1B
1 2 ) 20 4ears
!7
0L
S S S S S
I5! A $0 $0 $0 $0
K
0L
A & CK A 1,000

0
1B
1 2 ) / )$ )* /0 1month
!7
5cD
S S S S S S S S Ieriods
I5! A /0 /0 /0 /0 /0 /0 /0

K
5cD
A & CK A 1,000
0urger Ling K
0
J
<alculate 8A2 to apply to 0urger Ling bonds using interest rate conversion
feature, and calculate the value, K
0L
, of 0urger Ling bondsJ
'nputsJ IH42 A 2; .O5B A 12. OutputJ 8CCB A 8A2 A 12.)1B. 92emember to
s"itch IH42 bac, to 1.:
'nputsJ . A 20; ' A 12.)1; I5! A $0; CK A 1000.
OutputJ IK A =1$1.#/. K
0
A =1$1.#/.
5cDonalds K
0
J
'nputsJ . A /0; ' A 1; I5! A /0; CK A 1000.
OutputJ IK A =1**.0+. K
0
A =1**.0+.
<alculate the difference bet"een the t"o bondsQ IKsJ
DifferenceJ K
095cD:
K
090L:
A =1**.0+ =1$1.#/ A =1+.#).
120. Bond value and effective annual rate Answer: b Diff: "
Since the securities are of equal ris,, they must have the same effective
rate. Since the comparable 10year bond is selling at par, its nominal
yield is $ percent, the same as its coupon rate. 0ecause it is a
semiannual coupon bond, its effective rate is $.11 percent. ;sing your
calculator, enter .O5B A $; IH42 A 2; and solve for 8CCB.
92emember to change bac, to IH42 A 1.: So, since the bond you are
considering purchasing has quarterly payments, its nominal rate is
calculated as follo"sJ 8CCB A $.11; IH42 A /; and solve for .O5B. .O5B A
+.*211B. 9Again, remember to change bac, to IH42 A 1.: !o determine the
quarterly payment bond-s price you must use the cash flo" register because
the payment amount changes. <C
0
A 0, <C
1
A 20; .
G
A 20; <C
2
A 2#; .
G
A 1*;
<C
)
A 102#; ' A +.*211H/ A 1.*$0/; and then solve for .IK A =1,010.+2.
121. Bond value after reor!ani,ation Answer: d Diff: "
!ime 7ineJ

0 1 2 ) / # 1 10 4ears

S S S S S S S S
100 100 100 100 100 100 100
#00
K
0
A & CK A 1,000
20B
i A 0B
Deferred payments accruing no interest
'nputsJ <C
0
A 0; <C
1
A 0; .
G
A #; <C
2
A 100; .
G
A /; <C
#
A 1100; ' A 20.
OutputJ .IK A =)12.//. K
0
A =)12.//.
122. Bond sinkin! fund payment Answer: d Diff: "
!he company must call # percent or =#0,000 face value each year. 't could
call at par and spend =#0,000 or buy on the open mar,et. Since the
interest rate is higher than the coupon rate 91/B vs. 12B:, the bonds "ill
sell at a discount, so open mar,et purchases should be used.
!ime 7ineJ
0 1 2 )0 1month
S S S S Ieriods
IK A & I5! A 10 10 10
CK A 1,000
+B
'nputsJ . A )0; ' A +; I5! A 10; CK A 1000.
OutputJ IK A =$+#.*1. K
0
A =$+#.*1.
!he company "ould have to buy =#0,000H=1,000 A #0 bonds at =$+#.*1 each A
=/),+*#.#0 =/),+*1.
12). Bond coupon payment Answer: b Diff: "
!ime 7ineJ
0
,
d
A &
1 2 20 4ears
!7
1
S S S S
K
01
A +01.22 I5! A $0 $0 $0
CK A 1,000

0
,
d
A 12B
1 2 ) / # 4ears
!7
2
S S S S S S
K
02
A +01.22 I5! A & I5! I5! I5! I5!
CK A 1,000
<alculate 4!5 or ,
d
for first issueJ
'nputsJ . A 20; IK A +01.22; I5! A $0; CK A 1000.
OutputJ ' A ,
d
A 4!5 A 12B.
<alculate I5! on second issue using 12B A ,
d
A 4!5J
'nputsJ . A #; ' A 12; IK A +01.22; CK A 1000.
OutputJ I5! A =)+.111 Y =)+.12.
12/. Bonds wit$ differential payments Answer: c Diff: "
!ime 7ineJ
Semiannual
0
,
d
H2 A /.#B
1 2 ) / /0 1month

S S S S S S Ieriods
<Cs 1,000 I5! A & I5! I5! I5! I5!
CK A 1,000
Tuarterly
0
,
d
H/ A 2.22#B
1 2 ) / # 1 $0 Tuarters
S S S S S S S S
<Cs 1,000 I5! A & I5! I5! I5! I5! I5! I5!
CK A 1,000
Step 1J <alculate the 8A2 of *B nominal yield bond compounded semi
annually. ;se interest rate conversion feature.
'nputsJ IH42 A 2; .O5B A *. OutputJ 8CCB A *.202#B. 92emember
to change bac, to IH42 A 1.:
Step 2J <alculate the nominal rate, ,
.om
, of a *.202#B 8A2 but "ith
quarterly compounding.
'nputsJ IH42 A /; 8CCB A *.202#. OutputJ .O5B A $.*0B.
92emember to change bac, to IH42 A 1.:
Step )J <alculate the quarterly periodic rate from ,
.om
of $.*B and
calculate the quarterly payment.
,
I82
A ,
.om
H/ A $.*0BH/ A 2.22#B.
'nputsJ . A $0; ' A 2.22#; IK A 1000; CK A 1000.
OutputJ I5! A =22.2#.
12# . Current yield%%annual bond
Answer: a Diff: E N
<urrent yield A Annual interestH<urrent bond price
<urrent yield A =$0H=*2#
<urrent yield A $.1#B.
121 . 'ield to maturity%%annual bond
Answer: c Diff: # N
8nter the follo"ing data as inputs in your calculator as follo"sJ
. A 10; IK A *2#; I5! A $0; CK A 1000; ' A & Solve for ' A ,
d
A 4!5 A *.1$B.
12+ (uture bond value%%annual payment Answer: e Diff: # N
8nter the follo"ing data as inputs in your calculator as follo"sJ
. A +; ' A *.1$; I5! A $0; CK A 1000; IK A & Solve for IK A =*/0.*+. K
0
A Y =*/1.00.
12$ . Bond value%%annual payment
Answer: d Diff: E N
8nter the follo"ing data as inputs in your calculatorJ
. A 12; ' A +; I5! A 0.0$ 1,000 A $0; CK A 1000; and then solve for IK A
=1,0+*./). K
0
A =1,0+*./).
12* . (uture bond value%%annual payment
Answer: e Diff: E N
) years have passed so . no" is 12 R ) A *.
. A *; ' A +; I5! A 0.0$ 1,000 A $0; CK A 1000; and then solve for IK A
=1,01#.1#. K
0
A =1,01#.1#.
1)0 .'ield to maturity%%semiannual bond Answer: d Diff: E N
'nput the follo"ing data in your calculatorJ . A )0; IK A 11*0; I5! A #0;
CK A 1000; and then solve for ' A ).*12$B, but this interest rate is on a
semiannual basis. !he nominal 4!5 is ).*12$B 2 A +.$2#+B +.$)B.
1)1 .'ield to call%%semiannual bond Answer: a Diff: E N
'nput the follo"ing data in your calculatorJ . A 10; IK A 11*0; I5! A #0;
CK A 10#0; and then solve for ' A ).1$/1B, but this interest rate is on a
semiannual basis. !he nominal 4!< is ).1$/1B 2 A 1.)1$2B 1.)+B.
1)2. 'ield to maturity%%annual bond Answer: a Diff: E N
8nter the follo"ing data as inputs in the financial calculatorJ
. A 12; IK A 102#; I5! A $0; CK A 1000; and then solve for ' A 4!5 A
+.1+)$B +.1+B.
1)). Price risk%%annual bond Answer: e Diff: # N
Old 4!5 A +.1+)$B. .e" 4!5 A +.1+)$B 1B A 1.1+)$B.
;sing the ne" 4!5, first solve for the ne" bond price by entering the
follo"ing data in your financial calculatorJ
. A 12; ' A 4!5 A 1.1+)$; I5! A $0; CK A 1000; and then solve for IK A
=1,10+.1*. K
0
A =1,10+.1*.
.o", you can calculate the change in priceJ
00 . 02# , 1 =
00 . 02# , 1 = 1* . 10+ , 1 =
A $.02B
$B.
1)/1A%. -ero coupon bond concepts Answer: a Diff: E
!he 10year bond has payments that come sooner than the 3ero coupon bond-s
payments. !herefore, some of the 10year bond-s cash flo"s "ill be
discounted for fe"er periods and "ill lose less of their value. !herefore,
the value of the 10year 3ero coupon bond "ill drop by more than the $
percent coupon bond. !herefore, statement a is correct. Statement b used
to be true, but the '2S caught on that people "ere trying to avoid ta(es by
buying 3ero coupon bonds, and they changed the ta( code. !herefore,
statement b is false. 'f the 4!5 is higher than the coupon rate, then the
bond is selling at a discount. !he company pays less buying it on the open
mar,et than purchasing it at par value. So statement c is false.
1)#1A%. Coupon and ,ero coupon bond concepts Answer: d Diff: #
'f the 4!5 is $ percent, then the going interest rate is $ percent. 0ond A
has a lo"er coupon than the going coupon rate on ne" bonds, and investors
"on-t pay as much for it. !herefore, it is selling at a discount. !he
opposite is true for 0ond 0. !herefore, statement a is true. 'f the 4!5
falls, then interest rates are falling, and bond prices "ill increase. !he
bond that is most affected by this change "ill be the one "hose payments
are discounted the most. !he 12year 3ero coupon bond has all of its
payments discounted at the ne" lo" rate for a period of 12 years 9since it
only ma,es one payment at the end of the bond-s life:. 0ond 0 "ill have
its final par value discounted for the entire 10 years of its life, but it
has interest payments in the interim. One "ill be discounted for Gust one
year, one for Gust t"o years, etc. !herefore, the IK of these earlier cash
flo"s "ill be less affected by the drop in interest rates. Cor 0ond A,
since its life is the shortest, it "ill be the least affected by the change
in interest rates. !herefore, statement b is true. 2einvestment 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. !he 3ero coupon bond doesn-t mature for 12 years, and
there are no coupon payments to reinvest, so you are assured of its return
for 12 years. !he $year bond has the most reinvestment rate ris, because
you can only be assured of that rate for $ more years. !herefore,
statement c is false. Since statements a and b are true, the correct
choice is statement d.
1)11A%. tripped ... "reasury bond Answer: e Diff: E
0
i A 10B
1 2 ) / # 4ears

S S S S S S
K
0
A & CK A 1,000,000
,E" APPE$D&. !A %#()T&#$%
'nputsJ . A #; ' A 10; I5! A 0; CK A 1000000.
OutputJ IK A =),+2#,#2+.*/. K
0
A =),+2#,#2$.
1)+1A%. -ero coupon bond Answer: b Diff: E
Step 1J Cind out "hat "as paid for the bondJ
IK A =1,000H91.01$:
+
A =1)0.*#*.
Step 2J Determine the 4ear 1 accrued interestJ
!he accrued interest in the first year is =1)0.*#* 0.01$ A
=/2.*0#.
Step )J <alculate the ta( on the accrued interestJ
!a( on the accrued interest is =/2.*0# 0.) A =12.$+.
1)$1A%. -ero coupon bond Answer: d Diff: #
Cirst, find the value of the bond today as follo"sJ . A 12; ' A *; I5!
A 0; CK A 1000; and then solve for IK A =)##.#). K
0
A =)##.#).
Second, find the value of the bond at the end of the first year as
follo"sJ . A 11; ' A *; I5! A 0; CK A 1000; and then solve for IK A
=)$+.#). K
01
A =)$+.#).
!he ta(able income on the bond is the appreciation in value over the year
or =)$+.#) =)##.#) A =)2. !hus, the ta( paid is 2#B =)2 A =$.
1)*1A%. -ero coupon bond Answer: b Diff: #
!ime 7ineJ Fero coupon bond
0
,
d
A &
1 2 4ears
S S S
IK A $21./# CK A 1,000
Cirst, find the value of ,
d
as the interest rate that "ill cause =$21./#
to gro" to =1,000 in 2 years.
'nputsJ . A 2; IK A $21./#; I5! A 0; CK A 1000. OutputJ ' A ,
d
A 10B.
,
d
9Afterta(: A ,
d
91 !: A 0.1090.1: A 0.01 A 1B.
Analysis of cash flo"s method using calculated ,
d
A 10B and financial
calculatorJ
4ear
0 1 2
Accrued value =$21./# =*0*.10 =1,000.00
'nterest 99K
t
1.10: K
t
: $2.1# *0.*0
!a( savings 9'nterest 0./0: )).01 )1.)1
<ash flo"s U$21./# U)).01 U)1.)1
1,000.00
= *1).1/
!ime lineJ
0
,
d
9A!: A &
1 2 4ears
S S S
IK A $21./# U)).01 *1).1/

Cinancial calculator solutionJ 9;sing <Cs from "or,sheet analysis:
'nputsJ <C
0
A $21./#; <C
1
A )).01; <C
2
A *1).1/. OutputJ '22B A 1.0B.
,
d
9A!: A 1.0B.
1/01A%. -ero coupon bond Answer: a Diff: #
Step 1J Cind IK of bondJ
. A 1#; ' A $; I5! A 0; CK A 1000; and then solve for IK A =)1#.2/.
K
0
A =)1#.2/.
Step 2J Cind interest for the first yearJ
Kalue at tA0 =)1#.2/
'nterest rate 0.0$
'nterest income = 2#.22
Step )J Cind ta( dueJ
'nterest income =2#.22
!a( rate 0.)0
!a( due = +.#+
1/11A%. -ero coupon bond Answer: d Diff: #
Step 1J Cind the price of the bond todayJ
. A +; ' A 1; I5! A 0; CK A 1000; and then solve for IK A
=11#.0#+1. K
0
A =11#.0#+1.
Step 2J Cind the price of the bond in 1 yearJ
. A 1; ' A 1; I5! A 0; CK A 1000; and then solve for IK A
=+0/.*10#. K
0
A =+0/.*10#.
Step )J <alculate the ta(es due on the gainJ
!he difference is =+0/.*10# =11#.0#+1 A =)*.*0)/.
!he ta(es due are 0.2# =)*.*0)/ A =*.*+#* =*.*$.
1/21A%. -ero coupon bond and EA) Answer: d Diff: #
!ime lineJ 9Tuarterly payment bonds:
0 1 2 ) / # 1 + $ /0 Tuarters

S S S S S S S S S S
I5! A 2# 2# 2# 2# 2# 2# 2# 2# 2#
IK A +*#.#/ CK A 1,000
<alculate nominal periodic and annual interest ratesJ
'nputsJ . A /0; IK A +*#.#/; I5! A 2#; CK A 1000.
OutputJ ' A ,
d
H/ A )./#B per period.
,
.om
A / )./#B A 1).$0B.
<alculate 8A2 using interest rate conversion featureJ
'nputsJ IH42 A /; .O5B A 1).$0. OutputJ 8CCB A 1/.#)B. 92emember to
change bac, to IH42 A 1.:
!ime lineJ 9Fero coupon bond:
0
1/.#)B
1 2 10 4ears

S S S S

IK A & I5! A 0 0 CK A 1,000
<alculate IK of 3ero coupon bond using 8A2J
'nputsJ . A 10; ' A 1/.#); I5! A 0; CK A 1000.
OutputJ IK A =2#+.#1$ Y =2#+.#2. K
0
A =2#+.#2.
1/)1A%. Callable ,ero coupon bond Answer: c Diff: #
!ime 7ineJ
0 # 10 1# 20 4ears

S S S S S
21/.#0 today 1st call

CK A 1,000
issue S date
price mar,et price
A 2)*.)*
'nputsJ . A 20; IK A 21/.#0; I5! A 0; CK A 1000. OutputJ ' A $.0B. !he
bonds "ere issued at $B.
'nputsJ . A 1#; IK A 2)*.)*; I5! A 0; CK A 1000. OutputJ ' A 10.0B. At
a current mar,et price of =2)*.)*, mar,et rates are 10.0B. !hus, the bond
"ill not li,ely be called, so today at 4ear #, 4!5 of 10B is the most
li,ely annual rate an investor "ill earn.
1//1A%. -ero coupon bond and ta/es Answer: a Diff: #
4ou need to figure out ho" much you "ould pay for the bond today, and
"hat its price "ill be ne(t year to find the capital gain.
Step 1J Determine the price of the 3ero coupon bond todayJ
. A +; ' A 1; I5! A 0; CK A 1000; and then solve for IK A
=11#.0#+1. K
0
A =11#.0#+1.
Step 2J Determine the price of the 3ero coupon bond one year laterJ
. A 1; ' A 1; I5! A 0; CK A 1000; and then solve for IK A
=+0/.*10#. K
01
A =+0/.*10#.
Step )J Determine the ta(es due on the gainJ
!he difference bet"een the t"o prices is the capital gainJ
<apital gain A =+0/.*10# =11#.0#+1 A =)*.*0.
!his gain is ta(ed at the rate of )0BJ
!a(es A 0.) =)*.*0 A =11.*+.
1/# 1A%. "a/es on ,ero coupon bond
Answer: e Diff: # N
Step 1J Determine the price of the bond todayJ
. A 1#; ' A +; I5! A 0; CK A 1000; and then solve for IK A
=)12.//1. K
0
A =)12.//1.
Step 2J Determine the price of the bond one year from no"J
. A 1/; ' A +; I5! A 0; CK A 1000; and then solve for IK A
=)$+.$1+. K
01
A =)$+.$1+.
Step )J Determine the capital gain on the bondJ
<apital gain A =)$+.$1+ R =)12.//1 A =2#.)+1.
Step /J <alculate the first year-s ta(esJ
!a(es due A =2#.)+1 0.2# A =1.)/.
1/11A%. Accrued value and interest e/pense Answer: a Diff: #
0
i A *B
1 2 1 + $ 20 4ears

S S S S S S S
K
0
A 1+$./) K
+
A & K
$
A & CK A 1,000
'nputsJ . A $; ' A *; IK A 1+$./); I5! A 0. OutputJ CK A =)##.#) A K
$
.
'nputsJ . A +; ' A *; IK A 1+$./); I5! A 0. OutputJ CK A =)21.1$ A K
+
.
DifferenceJ =)##.#) =)21.1$ A =2*.)#.
Solution chec,J =2*.)#H=)21.1$ A *.0B.
1/+1A%. -eros and e/pectations t$eory Answer: d Diff: "
Cirst find the yields on oneyear and t"oyear 3erocoupon bonds, so you
can find the implied rate on a oneyear bond, one year from no". !hen
use this implied rate to find its price.
14earJ
. A 1; IK A *)$.*1+1; I5! A 0; CK A 1000; and then solve for ' A 1.#B.
24earJ
. A 2; IK A $+)./)$+; I5! A 0; CK A 1000; and then solve for ' A +.0B.
!herefore, if the implied rate A E
+.#B. A E
+.0B A
2
E U 1.#B
.o" find the price of a 1year 3ero, 1 year from no"J
. A 1; ' A +.#; I5! A 0; CK A 1000; and then solve for IK A =*)0.2).
K
01
A =*)0.2).
1/$1A%. -eros and e/pectations t$eory Answer: a Diff: "
0 1 2 ) /

S S S S S

)year 3ero; Irice A $2+.$/*1

/year 3ero; Irice A +12.$*#2
Step 1J <alculate the 4!5 for the )year 3eroJ
. A ); IK A $2+.$/*1; I5! A 0; CK A 1000; then solve for ' A 1.#B.
Step 2J <alculate the 4!5 for the /year 3eroJ
. A /; IK A +12.$*#2; I5! A 0; CK A 1000; then solve for ' A +B.
Step )J <alculate the interest rate on a 1year 3ero, ) years from no"J
+B A
/
E U 1.#B9):
E A $.#B.
Step /J <alculate the price of a 1year 3ero ) years from no"J
. A 1; ' A $.#; I5! A 0; CK A 1000; and then solve for IK A
=*21.11. K
0
A =*21.11.
1/*1A%. -ero coupon bond Answer: d Diff: "
0 2 / 1 $ 10
S S S S S S
Accrued value 1/0.+1 1#2.1* 11/.11 1+$.0/ 1*2.#+ 20$.2*
<all value 211.12
i A /B

Step 1J <alculate IK of 3ero coupon bond at !ime 0J
. A #0; ' A /; I5! A 0; CK A 1000; and then solve for IK A
=1/0.+1. K
0
A =1/0.+1.
Step 2J <alculate accrued value at 4ear #J
=1/0.+191.0/:
29#:
A =20$.2*.
Step )J <all value at 4ear #J
=20$.2*91.0/: A =211.12.
Step /J <alculate 8A2 as follo"sJ
. A 10; IK A 1/0.+1; I5! A 0; CK A 211.12; and then solve for '
A /./1B; ho"ever, this is a semiannual rate.
8A2 A 91.0//1:
2
1 A *.01B.
1#01A%. -ero coupon bond Answer: e Diff: "
!ime 7ineJ
0 10 #0 1month
S S S Ieriods
IK A & A $+.20 IK
#
A 1/2.0# CK A 1,000
U Iremium 1/.20
1#1.2#
4!< A &

Step 1J Determine 8A2 for discounting. ;sing interest rate conversion
featureJ
'nputsJ IH42 A 2; .O5B A 10B. OutputJ 8CCB A 10.2#B.
Cormula methodJ 8A2 A
2
,
U 1
2
1 A 91.0#:
2
1 A 0.102#.
Step 2J Determine price of bond "hen issued.
'nputsJ . A 2#; ' A 10.2#; I5! A 0; CK A 1000. OutputJ IK A
=$+.20. K
0
A =$+.20.
Step )J Determine accrued value of bond today, and calculate call price.
'nputsJ . A #; ' A 10.2#; IK A $+.20; I5! A 0.
OutputJ CK A =1/2.0/. Iremium is 10B over accrued value. <all
price A =1/2.0/ 1.10 A =1#1.2/.
Step /J Determine the periodic rate 9semiannual compounding:.
'nputsJ . A 10; IK A $+.20; I5! A 0; CK A 1#1.2/.
OutputJ ' A 1.00#B.
.ominal annual rate A 2 1.00#B A 12.01B.
Step #J Determine effective annual rate earned on bond using interest
rate conversion featureJ
'nputsJ IH42 A 2; .O5B A 12.01. OutputJ 8CCB A 12.)+B.
1#11A%. "a/es on ,ero coupon bond Answer: a Diff: "
Since 3ero coupon bonds do not ma,e annual interest payments, the ta(
deduction is determined by the accumulated 9but unpaid: interest on the
bond over the year. !o determine this "e "ill calculate the value of
the bond at t A 1 and at t A 2.
t A 1J . A *; 'H42 A *.#; I5! A 0; CK A 1000; IK A =//1.$#. K
01
A =//1.$#.
t A 2J . A $; 'H42 A *.#; I5! A 0; CK A 1000; IK A =/$).$2. K
02
A =/$).$2.
So the accumulated interest isJ =/$).$2 =//1.$# A =/1.*+.
!a( savings A )0B9=/1.*+: A =12.#*.
1#21A%. -ero coupon interest ta/ s$ield Answer: b Diff: "
!ime 7ineJ
0 1 2 ) 4ears
S S S S
IK A U+2+.2# I5! A 0 0 0
!a( savings
1
!a( savings
2
!a( savings
)

CK A 1,000
'nputsJ . A ); IK A +2+.2#; I5! A 0; CK A 1000. OutputJ ' A 11.20B.
0 1 2 )
1: Accrued value +2+.2# $0$.+0 $**.2$ 1,000.00
2: 'nterest e(pense $1./# *0.#$ 100.+2
): !a( savings 9line 2 0./0: )2.#$ )1.2) /0.2*
U/0.2*
1,000.00
/: <ash flo"s U+2+.2# U)2.#$ U)1.2) *#*.+1
1#)1A%. After%ta/ cost of debt Answer: c Diff: #
Solve for the 4!5 using the information from the previous question
'nputsJ . A ); IK A +2+.2#; I5! A 0; CK A 1000.
OutputJ ' A 11.20. 0eforeta( cost debt of this issue A 11.20B.
,
d
9Afterta(: A 11.20B91 !: A 11.2B90.1: A 1.+2B.
Alternate solution using cash flo"sJ
'nputsJ <C
0
A +2+.2#; <C
1
A )2.#$; <C
2
A )1.2); <C
)
A *#*.+1.
OutputJ '22B A 1.+2B.
1#/
1B%. +i&uidation procedures Answer: e Diff: #
1##1B%. Bankruptcy law Answer: d Diff: #
1#11B%. Bankruptcy issues Answer: e Diff: #
1#+1B%. Priority of claims Answer: c Diff: "
,E" APPE$D&. !" %#()T&#$%

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

Multiple Choice: Conceptual

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