Bonds and Their Valuation Exercise

(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is some overlap between the T/F and the multiple choice questions, as some T/F
statements are used in the MC questions. See the preface for information on the AACS letter
indicators !F, M, etc." on the sub#ect lines.
Multiple Choice: True/alse
(9-2) Coupon rate F G Answer: a EASY
1
. If a firm raises capital by selling new bonds, it could be called the
issuing firm, and the coupon rate is generally set equal to the
required rate on bonds of equal risk.
a. True
b. False
(9-2) Call provision F G Answer: b EASY
. ! call pro"ision gi"es bondholders the right to demand, or call for,

repayment of a bond. Typically, companies call bonds if interest rates
rise and do not call them if interest rates decline.
a. True
b. False
(9-2) Sinking fun F G Answer: a EASY
#
. $inking funds are pro"isions included in bond indentures that require
companies to retire bonds on a scheduled basis prior to their final
maturity. %any indentures allow the company to acquire bonds for
sinking fund purposes by either &1' purchasing bonds on the open market
at the going market price or &' selecting the bonds to be called by a
lottery administered by the trustee, in which case the price paid is the
bond(s face "alue.
a. True
b. False
(9-2) !ero "oupon bon F G Answer: b EASY
)
. ! *ero coupon bond is a bond that pays no interest and is offered &and
initially sells' at par. These bonds pro"ide compensation to in"estors
in the form of capital appreciation.
a. True
b. False
Chapter 9: Bonds True/False Page 227
2013 Cengage Learning. ll !ights !eser"ed. #a$ not %e &opied' s&anned' or dupli&ated' in (hole or in part' e)&ept *or use as per+itted in
a li&ense distri%uted (ith a &ertain produ&t or ser"i&e or other(ise on a pass(ord,prote&ted (e%site *or &lassroo+ use.
CH!"TE# $
%&'D( !'D THE)# *!L+!T)&'
(9-2) Floating-rate ebt F G Answer: a EASY
+
. The desire for floating,rate bonds, and consequently their increased
usage, arose out of the e-perience of the early 1./0s, when inflation
pushed interest rates up to "ery high le"els and thus caused sharp
declines in the prices of outstanding bonds.
a. True
b. False
(9-#) $is"ounte "as% flows F G Answer: a EASY
1
. The market "alue of any real or financial asset, including stocks,
bonds, or art work purchased in hope of selling it at a profit, may be
estimated by determining future cash flows and then discounting them
back to the present.
a. True
b. False
(9-&) 'on pri"es an int( rates F G Answer: a EASY
2
. The price sensiti"ity of a bond to a gi"en change in interest rates is
generally greater the longer the bond(s remaining maturity.
a. True
b. False
(9-)) *ri"e risk F G Answer: b EASY
/
. ! bond that had a 0,year original maturity with 1 year left to maturity
has more price risk than a 10,year original maturity bond with 1 year
left to maturity. &!ssume that the bonds ha"e equal default risk and
equal coupon rates, and they cannot be called.'
a. True
b. False
(9-)) *ri"e risk F G Answer: b EASY
.
. 3ecause short,term interest rates are much more "olatile than long,term
rates, you would, in the real world, generally be sub4ect to much more
price risk if you purchased a #0,day bond than if you bought a #0,year
bond.
a. True
b. False
(9-+) 'ons an ebentures F G Answer: a EASY
10
. !s a general rule, a company(s debentures ha"e higher required interest
rates than its mortgage bonds because mortgage bonds are backed by
specific assets while debentures are unsecured.
a. True
b. False
Page 22- True/False Chapter 9: Bonds
(9-+) ,unk bon F G Answer: a EASY
11
. 5unk bonds are high,risk, high,yield debt instruments. They are often
used to finance le"eraged buyouts and mergers, and to pro"ide financing
to companies of questionable financial strength.
a. True
b. False
(9-+) 'on ratings - re.( returns F G Answer: a EASY
1
. There is an in"erse relationship between bonds( quality ratings and
their required rates of return. Thus, the required return is lowest for
!!!,rated bonds, and required returns increase as the ratings get lower.
a. True
b. False
(9-2) /n"o0e bon F G Answer: b 1E$/21
1#
. Income bonds pay interest only if the issuing company actually earns the
indicated interest. Thus, these securities cannot bankrupt a company,
and this makes them safer from an in"estor(s perspecti"e than regular
bonds.
a. True
b. False
(9-2) Sinking fun F G Answer: b 1E$/21
1)
. 6ou are considering bonds that will be issued tomorrow. 3oth are
rated triple 3 &333, the lowest in"estment,grade rating', both mature in
0 years, both ha"e a 107 coupon, neither can be called e-cept for
sinking fund purposes, and both are offered to you at their 81,000 par
"alues. 9owe"er, 3ond $F has a sinking fund while 3ond :$F does not.
;nder the sinking fund, the company must call and pay off +7 of the
bonds at par each year. The yield cur"e at the time is upward sloping.
The bond(s prices, being equal, are probably not in equilibrium, as 3ond
$F, which has the sinking fund, would generally be e-pected to ha"e a
higher yield than 3ond :$F.
a. True
b. False
(9-2) Floating-rate ebt F G Answer: b 1E$/21
1+
. Floating,rate debt is ad"antageous to in"estors because the interest
rate mo"es up if market rates rise. $ince floating,rate debt shifts
price risk to companies, it offers no ad"antages to corporate issuers.
a. True
b. False
(9-#) 'on pre0iu0s an is"ounts F G Answer: a 1E$/21
11
. ! bond has a 81,000 par "alue, makes annual interest payments of 8100,
has + years to maturity, cannot be called, and is not e-pected to
default. The bond should sell at a premium if market interest rates are
below 107 and at a discount if interest rates are greater than 107.
Chapter 9: Bonds True/False Page 229
a. True
b. False
Page 230 True/False Chapter 9: Bonds
(9-#) 'on value--annual pa30ent F G Answer: a 1E$/21
12
. 6ou ha"e funds that you want to in"est in bonds, and you 4ust noticed in
the financial pages of the local newspaper that you can buy a 81,000 par
"alue bond for 8/00. The coupon rate is 107 &with annual payments', and
there are 10 years before the bond will mature and pay off its 81,000
par "alue. 6ou should buy the bond if your required return on bonds
with this risk is 17.
a. True
b. False
(9-&) 'on pri"es an returns F G Answer: a 1E$/21
1/
. If the required rate of return on a bond &r
d
' is greater than its coupon
interest rate and will remain abo"e that rate, then the market "alue of
the bond will always be below its par "alue until the bond matures, at
which time its market "alue will equal its par "alue. &!ccrued interest
between interest payment dates should not be considered when answering
this question.'
a. True
b. False
(9-&) *ri"es an interest rates F G Answer: a 1E$/21
1.
. The prices of high,coupon bonds tend to be less sensiti"e to a gi"en
change in interest rates than low,coupon bonds, other things held
constant.
a. True
b. False
&9-+) 4estri"tive "ovenants F G Answer: a 1E$/21
0
. <estricti"e co"enants are designed primarily to protect bondholders by
constraining the actions of managers. $uch co"enants are spelled out in
bond indentures.
a. True
b. False
(9-+) 'ons an ebentures F G Answer: a 1E$/21
1
. =ther things equal, a firm will ha"e to pay a higher coupon rate on its
subordinated debentures than on its second mortgage bonds.
a. True
b. False
(9-5) Callable bons F G Answer: b 6A4$
. ! bond that is callable has a chance of being retired earlier than its
stated term to maturity. Therefore, if the yield cur"e is upward
sloping, an outstanding callable bond should ha"e a lower yield to
maturity than an otherwise identical noncallable bond.
a. True
b. False
Chapter 9: Bonds Con&eptual #/C Page 231
Multiple Choice: Conceptual
Most of these questions can be answered b$ thin%in& about relationships and reasonin& out
which answer is correct, but some require students to do a few calculations. 'ven if lo&ical
answers can be determined, it ma$ be useful to confirm them b$ wor%in& out some numbers.
Sometimes data are provided in the question, but sometimes students must ma%e up their own
e(amples to ta%e the numerical approach.
Most students will have to thin% carefull$ to answer the M')*+M and ,A-) questions,
and that will ta%e some time. Therefore, the more time the$ have to do the test or qui., the better
their scores should be.
Some of the questions are focused on a particular section, but others have statements
that are covered in various sections. *n the latter case, we indicate /Comprehensive0 rather
than &ive a section number.
Finall$, note that we provide answers onl$ to selected questions. 1e see no need to
answer relativel$ eas$, obvious questions, so we limit answers to questions where students mi&ht
have trouble understandin& wh$ their answer is wron&.
(9-&) /nterest rates C G Answer: a EASY
#
. >hich of the following statements is ?=<<@?TA
a. 6ou hold two bonds, a 10,year, *ero coupon, issue and a 10,year bond
that pays a 17 annual coupon. The same market rate, 17, applies to
both bonds. If the market rate rises from its current le"el, the
*ero coupon bond will e-perience the larger percentage decline.
b. The time to maturity does not affect the change in the "alue of a
bond in response to a gi"en change in interest rates.
c. 6ou hold two bonds. =ne is a 10,year, *ero coupon, bond and the
other is a 10,year bond that pays a 17 annual coupon. The same
market rate, 17, applies to both bonds. If the market rate rises
from the current le"el, the *ero coupon bond will e-perience the
smaller percentage decline.
d. The shorter the time to maturity, the greater the change in the "alue
of a bond in response to a gi"en change in interest rates, other
things held constant.
e. The longer the time to maturity, the smaller the change in the "alue
of a bond in response to a gi"en change in interest rates.
(9-)) Calling bons C G Answer: " EASY
)
. >hich of the following e"ents would make it more likely that a company
would call its outstanding callable bondsA
a. The companyBs bonds are downgraded.
b. %arket interest rates rise sharply.
c. %arket interest rates decline sharply.
d. The company(s financial situation deteriorates significantly.
e. Inflation increases significantly.
Page 232 Con&eptual #/C Chapter 9: Bonds
(9-+) 'on ratings C G Answer: " EASY
+
. !ssume that interest rates on 0,year Treasury and corporate bonds with
different ratings, all of which are noncallable, are as followsC
T,bond D 2.27 ! D ..1)7
!!! D /.27 333 D 10.1/7
The differences in rates among these issues were most probably caused
primarily byC
a. <eal risk,free rate differences.
b. Ta- effects.
c. Eefault and liquidity risk differences.
d. %aturity risk differences.
e. Inflation differences.
(9-2) 'on "oupon rate C G Answer: b 1E$/21
1
. ;nder normal conditions, which of the following would be most likely to
increase the coupon rate required for a bond to be issued at parA
a. !dding additional restricti"e co"enants that limit management(s
actions.
b. !dding a call pro"ision.
c. The rating agencies change the bond(s rating from 3aa to !aa.
d. %aking the bond a first mortgage bond rather than a debenture.
e. !dding a sinking fund.
(9-2) Sinking funs C G Answer: a 1E$/21
2
a. $inking fund pro"isions sometimes turn out to ad"ersely affect
bondholders, and this is most likely to occur if interest rates
decline after the bond was issued.
b. %ost sinking funds require the issuer to pro"ide funds to a trustee,
who holds the money so that it will be a"ailable to pay off
bondholders when the bonds mature.
c. ! sinking fund pro"ision makes a bond more risky to in"estors at the
time of issuance.
d. $inking fund pro"isions ne"er require companies to retire their debtF
they only establish targets for the company to reduce its debt o"er
time.
e. If interest rates increase after a company has issued bonds with a
sinking fund, the company will be less likely to buy bonds on the
open market to meet its sinking fund obligation and more likely to
call them in at the sinking fund call price.
(9-2) Convertible7 "allable bons C G Answer: b 1E$/21
/
. !mram Inc. can issue a 0,year bond with a 17 annual coupon at par.
This bond is not con"ertible, not callable, and has no sinking fund.
!lternati"ely, !mram could issue a 0,year bond that is con"ertible into
common equity, may be called, and has a sinking fund. >hich of the
following most accurately describes the coupon rate that !mram would
ha"e to pay on the second bond, the con"ertible, callable bond with the
sinking fund, to ha"e it sell initially at parA
a. The coupon rate should be e-actly equal to 17.
b. The coupon rate could be less than, equal to, or greater than 17,
depending on the specific terms set, but in the real world the
con"ertible feature would probably cause the coupon rate to be less
than 17.
c. The rate should be slightly greater than 17.
d. The rate should be o"er 27.
e. The rate should be o"er /7.
(9-5) 'on 3iels C G Answer: 1E$/21
.
. Tucker ?orporation is planning to issue new 0,year bonds. The current
plan is to make the bonds non,callable, but this may be changed. If the
bonds are made callable after + years at a +7 call premium, how would
this affect their required rate of returnA
a. 3ecause of the call premium, the required rate of return would
decline.
b. There is no reason to e-pect a change in the required rate of return.
c. The required rate of return would decline because the bond would then
be less risky to a bondholder.
d. The required rate of return would increase because the bond would
then be more risky to a bondholder.
e. It is impossible to say without more information.
(9-5) 'on 3iels C G Answer: a 1E$/21
#0
. ! 10,year corporate bond has an annual coupon of .7. The bond is
currently selling at par &81,000'. >hich of the following statements is
?=<<@?TA
a. The bondBs e-pected capital gains yield is *ero.
b. The bondBs yield to maturity is abo"e .7.
c. The bondBs current yield is abo"e .7.
d. If the bondBs yield to maturity declines, the bond will sell at a
discount.
e. The bondBs current yield is less than its e-pected capital gains
yield.
(9-5) 'on 3iels C G Answer: " 1E$/21
#1
a. ! *ero coupon bond(s current yield is equal to its yield to maturity.
b. If a bondBs yield to maturity e-ceeds its coupon rate, the bond will
sell at par.
c. !ll else equal, if a bondBs yield to maturity increases, its price
will fall.
Page 23. Con&eptual #/C Chapter 9: Bonds
d. If a bondBs yield to maturity e-ceeds its coupon rate, the bond will
sell at a premium o"er par.
e. !ll else equal, if a bondBs yield to maturity increases, its current
yield will fall.
(9-5) 'on 3iels C G Answer: " 1E$/21
#
. ! 1+,year bond with a face "alue of 81,000 currently sells for 8/+0.
>hich of the following statements is ?=<<@?TA
a. The bondBs coupon rate e-ceeds its current yield.
b. The bondBs current yield e-ceeds its yield to maturity.
c. The bondBs yield to maturity is greater than its coupon rate.
d. The bondBs current yield is equal to its coupon rate.
e. If the yield to maturity stays constant until the bond matures, the
bondBs price will remain at 8/+0.
(9-5) 'on 3iels C G Answer: 1E$/21
##
a. If a bond is selling at a discount, the yield to call is a better
measure of return than is the yield to maturity.
b. =n an e-pected yield basis, the e-pected capital gains yield will
always be positi"e because an in"estor would not purchase a bond with
an e-pected capital loss.
c. =n an e-pected yield basis, the e-pected current yield will always be
positi"e because an in"estor would not purchase a bond that is not
e-pected to pay any cash coupon interest.
d. If a coupon bond is selling at par, its current yield equals its
yield to maturity, and its e-pected capital gains yield is *ero.
e. The current yield on 3ond ! e-ceeds the current yield on 3ond 3F
therefore, 3ond ! must ha"e a higher yield to maturity than 3ond 3.
(9-&) 'on values over ti0e C G Answer: 1E$/21
#)
. Three 81,000 face "alue, 10,year, noncallable, bonds ha"e the same
amount of risk, hence their 6T%s are equal. 3ond / has an /7 annual
coupon, 3ond 10 has a 107 annual coupon, and 3ond 1 has a 17 annual
coupon. 3ond 10 sells at par. !ssuming that interest rates remain
constant for the ne-t 10 years, which of the following statements is
?=<<@?TA
a. 3ond /Bs current yield will increase each year.
b. $ince the bonds ha"e the same 6T%, they should all ha"e the same
price, and since interest rates are not e-pected to change, their
prices should all remain at their current le"els until maturity.
c. 3ond 1 sells at a premium &its price is greater than par', and its
price is e-pected to increase o"er the ne-t year.
d. 3ond / sells at a discount &its price is less than par', and its
price is e-pected to increase o"er the ne-t year.
e. ="er the ne-t year, 3ond /Bs price is e-pected to decrease, 3ond 10Bs
price is e-pected to stay the same, and 3ond 1Bs price is e-pected
to increase.
Chapter 9: Bonds Con&eptual #/C Page 23/
(9-&) /nt( rates an bon pri"es C G Answer: b 1E$/21
#+
. ! 10,year bond pays an annual coupon, its 6T% is /7, and it currently
trades at a premium. >hich of the following statements is ?=<<@?TA
a. The bondBs current yield is less than /7.
b. If the yield to maturity remains at /7, then the bondBs price will
decline o"er the ne-t year.
c. The bondBs coupon rate is less than /7.
d. If the yield to maturity increases, then the bondBs price will
increase.
e. If the yield to maturity remains at /7, then the bondBs price will
remain constant o"er the ne-t year.
(9-&) /nt( rates an bon pri"es C G Answer: " 1E$/21
#1
. ! 1,year bond has an annual coupon of .7. The coupon rate will remain
fi-ed until the bond matures. The bond has a yield to maturity of 27.
a. If market interest rates decline, the price of the bond will also
decline.
b. The bond is currently selling at a price below its par "alue.
c. If market interest rates remain unchanged, the bondBs price one year
from now will be lower than it is today.
d. The bond should currently be selling at its par "alue.
e. If market interest rates remain unchanged, the bondBs price one year
from now will be higher than it is today.
(9-&) /nt( rates an bon pri"es C G Answer: b 1E$/21
#2
. ! 10,year Treasury bond has an /7 coupon, and an /,year Treasury bond
has a 107 coupon. :either is callable, and both ha"e the same yield to
maturity. If the yield to maturity of both bonds increases by the same
amount, which of the following statements would be ?=<<@?TA
a. The prices of both bonds will decrease by the same amount.
b. 3oth bonds would decline in price, but the 10,year bond would ha"e
the greater percentage decline in price.
c. The prices of both bonds would increase by the same amount.
d. =ne bond(s price would increase, while the other bondBs price would
decrease.
e. The prices of the two bonds would remain constant.
(9-&) 'on 3iels an pri"es C G Answer: " 1E$/21
#/
. 6ou are considering two bonds. 3ond ! has a .7 annual coupon while 3ond
3 has a 17 annual coupon. 3oth bonds ha"e a 27 yield to maturity, and
the 6T% is e-pected to remain constant. >hich of the following
statements is ?=<<@?TA
a. The price of 3ond 3 will decrease o"er time, but the price of 3ond !
will increase o"er time.
b. The prices of both bonds will remain unchanged.
c. The price of 3ond ! will decrease o"er time, but the price of 3ond 3
will increase o"er time.
d. The prices of both bonds will increase by 27 per year.
Page 230 Con&eptual #/C Chapter 9: Bonds
e. The prices of both bonds will increase o"er time, but the price of
3ond ! will increase at a faster rate.
(9-)) *ri"e risk C G Answer: e 1E$/21
#.
. >hich of the following bonds would ha"e the greatest percentage increase
in "alue if all interest rates in the economy fall by 17A
a. 10,year, *ero coupon bond.
b. 0,year, 107 coupon bond.
c. 0,year, +7 coupon bond.
d. 1,year, 107 coupon bond.
e. 0,year, *ero coupon bond.
(9-)) *ri"e risk C G Answer: 1E$/21
)0
. !ssume that all interest rates in the economy decline from 107 to .7.
>hich of the following bonds would ha"e the largest percentage increase
in priceA
a. !n /,year bond with a .7 coupon.
b. ! 1,year bond with a 1+7 coupon.
c. ! #,year bond with a 107 coupon.
d. ! 10,year *ero coupon bond.
e. ! 10,year bond with a 107 coupon.
(9-)) *ri"e risk C G Answer: b 1E$/21
)1
. >hich of the following bonds has the greatest price riskA
a. ! 10,year 8100 annuity.
b. ! 10,year, 81,000 face "alue, *ero coupon bond.
c. ! 10,year, 81,000 face "alue, 107 coupon bond with annual interest
payments.
d. !ll 10,year bonds ha"e the same price risk since they ha"e the same
maturity.
e. ! 10,year, 81,000 face "alue, 107 coupon bond with semiannual
interest payments.
(9-)) *ri"e risk C G Answer: e 1E$/21
)
. If its yield to maturity declined by 17, which of the following bonds
would ha"e the largest percentage increase in "alueA
a. ! 1,year *ero coupon bond.
b. ! 1,year bond with an /7 coupon.
c. ! 10,year bond with an /7 coupon.
d. ! 10,year bond with a 17 coupon.
e. ! 10,year *ero coupon bond.
(9-)) *ri"e vs( reinvest( risk C G Answer: e 1E$/21
)#
a. !ll else equal, high,coupon bonds ha"e less rein"estment risk than
low,coupon bonds.
b. !ll else equal, long,term bonds ha"e less price risk than short,term
bonds.
c. !ll else equal, low,coupon bonds ha"e less price risk than high,
coupon bonds.
Page 23- Con&eptual #/C Chapter 9: Bonds
d. !ll else equal, short,term bonds ha"e less rein"estment risk than
long,term bonds.
e. !ll else equal, long,term bonds ha"e less rein"estment risk than
short,term bonds.
(9-)) *ri"e vs( reinvest( risk C G Answer: 1E$/21
))
a. =ne ad"antage of a *ero coupon Treasury bond is that no one who owns
the bond has to pay any ta-es on it until it matures or is sold.
b. Gong,term bonds ha"e less price risk but more rein"estment risk than
short,term bonds.
c. If interest rates increase, all bond prices will increase, but the
increase will be greater for bonds that ha"e less price risk.
d. <elati"e to a coupon,bearing bond with the same maturity, a *ero
coupon bond has more price risk but less rein"estment risk.
e. Gong,term bonds ha"e less price risk and also less rein"estment risk
than short,term bonds.
(Co0p() 8er0 stru"ture C G 6 Answer: e 1E$/21
)+
a. If the maturity risk premium were *ero and interest rates were
e-pected to decrease in the future, then the yield cur"e for ;.$.
Treasury securities would, other things held constant, ha"e an upward
slope.
b. Giquidity premiums are generally higher on Treasury than corporate
bonds.
c. The maturity premiums embedded in the interest rates on ;.$. Treasury
securities are due primarily to the fact that the probability of
default is higher on long,term bonds than on short,term bonds.
d. Eefault risk premiums are generally lower on corporate than on
Treasury bonds.
e. <ein"estment risk is lower, other things held constant, on long,term
than on short,term bonds.
(Co0p() 'ons - efault risk C G Answer: a 1E$/21
)1
a. !ll else equal, senior debt generally has a lower yield to maturity
than subordinated debt.
b. !n indenture is a bond that is less risky than a mortgage bond.
c. The e-pected return on a corporate bond will generally e-ceed the
bond(s yield to maturity.
d. If a bondBs coupon rate e-ceeds its yield to maturity, then its
e-pected return to in"estors will also e-ceed its yield to maturity.
e. ;nder our bankruptcy laws, any firm

that

is in financial distress will
be forced to declare bankruptcy and then be liquidated.
(Co0p() 'on "on"epts C G Answer: a 1E$/21
)2
a. If a coupon bond is selling at par, its current yield equals its
yield to maturity.
b. If a coupon bond is selling at a discount, its price will continue to
decline until it reaches its par "alue at maturity.
c. If interest rates increase, the price of a 10,year coupon bond will
decline by a greater percentage than the price of a 10,year *ero
coupon bond.
Page 2.0 Con&eptual #/C Chapter 9: Bonds
d. If a bondBs yield to maturity e-ceeds its annual coupon, then the
bond will trade at a premium.
e. If a coupon bond is selling at a premium, its current yield equals
its yield to maturity.
(Co0p() 'on "on"epts C G Answer: 1E$/21
)/
. ! 10,year bond with a .7 annual coupon has a yield to maturity of /7.
a. If the yield to maturity remains constant, the bondBs price one year
from now will be higher than its current price.
b. The bond is selling below its par "alue.
c. The bond is selling at a discount.
d. If the yield to maturity remains constant, the bondBs price one year
from now will be lower than its current price.
e. The bondBs current yield is greater than .7.
(Co0p() 'on "on"epts C G Answer: e 1E$/21
).
. ! Treasury bond has an /7 annual coupon and a 2.+7 yield to maturity.
a. The bond sells at a price below par.
b. The bond has a current yield greater than /7.
c. The bond sells at a discount.
d. The bondBs required rate of return is less than 2.+7.
e. If the yield to maturity remains constant, the price of the bond will
decline o"er time.
(Co0p() 'on "on"epts C G Answer: b 1E$/21
+0
. !n in"estor is considering buying one of two 10,year, 81,000 face "alue,
noncallable bondsC 3ond ! has a 27 annual coupon, while 3ond 3 has a .7
annual coupon. 3oth bonds ha"e a yield to maturity of /7, and the 6T%
is e-pected to remain constant for the ne-t 10 years. >hich of the
following statements is ?=<<@?TA
a. 3ond 3 has a higher price than 3ond ! today, but one year from now
the bonds will ha"e the same price.
b. =ne year from now, 3ond !Bs price will be higher than it is today.
c. 3ond !Bs current yield is greater than /7.
d. 3ond ! has a higher price than 3ond 3 today, but one year from now
the bonds will ha"e the same price.
e. 3oth bonds ha"e the same price today, and the price of each bond is
e-pected to remain constant until the bonds mature.
+1
a. If a bond is selling at a discount to par, its current yield will be
greater than its yield to maturity.
b. !ll else equal, bonds with longer maturities ha"e less price risk
than bonds with shorter maturities.
c. If a bond is selling at its par "alue, its current yield equals its
capital gains yield.
Chapter 9: Bonds Con&eptual #/C Page 2.1
d. If a bond is selling at a premium, its current yield will be less
than its capital gains yield.
e. !ll else equal, bonds with larger coupons ha"e less price risk than
bonds with smaller coupons.
(Co0p() 'on "on"epts C G Answer: b 1E$/21
+
a. If a 10,year, 81,000 par, *ero coupon bond were issued at a price
that ga"e in"estors a 107 yield to maturity, and if interest rates
then dropped to the point where r
d
D 6T% D +7, the bond would sell at
a premium o"er its 81,000 par "alue.
b. If a 10,year, 81,000 par, 107 coupon bond were issued at par, and if
interest rates then dropped to the point where r
d
D 6T% D +7, we
could be sure that the bond would sell at a premium abo"e its 81,000
par "alue.
c. =ther things held constant, including the coupon rate, a corporation
would rather issue noncallable bonds than callable bonds.
d. =ther things held constant, a callable bond would ha"e a lower
required rate of return than a noncallable bond because it would ha"e
a shorter e-pected life.
e. 3onds are e-posed to both rein"estment risk and price risk. Gonger,
term low,coupon bonds, relati"e to shorter,term high,coupon bonds,
are generally more e-posed to rein"estment risk than price risk.
+#
a. If the Federal <eser"e une-pectedly announces that it e-pects
inflation to increase, then we would probably obser"e an immediate
increase in bond prices.
b. The total yield on a bond is deri"ed from di"idends plus changes in
the price of the bond.
c. 3onds are generally regarded as being riskier than common stocks, and
therefore bonds ha"e higher required returns.
d. 3onds issued by larger companies always ha"e lower yields to maturity
&due to less risk' than bonds issued by smaller companies.
e. The market price of a bond will always approach its par "alue as its
maturity date approaches, pro"ided the bondBs required return remains
constant.
+)
a. If a coupon bond is selling at par, its current yield equals its
yield to maturity.
b. If rates fall after its issue, a *ero coupon bond could trade at a
price abo"e its maturity &or par' "alue.
c. If rates fall rapidly, a *ero coupon bondBs e-pected appreciation
could become negati"e.
d. If a firm mo"es from a position of strength toward financial
distress, its bondsB yield to maturity would probably decline.
e. If a bond is selling at a premium, this implies that its yield to
maturity e-ceeds its coupon rate.
++
. 3ond H has an /7 annual coupon, 3ond 6 has a 107 annual coupon, and 3ond
I has a 17 annual coupon. @ach of the bonds is noncallable, has a
maturity of 10 years, and has a yield to maturity of 107. >hich of the
a. If the bonds( market interest rate remains at 107, 3ond IBs price
will be lower one year from now than it is today.
b. 3ond H has the greatest rein"estment risk.
c. If market interest rates decline, the prices of all three bonds will
increase, but I(s price will ha"e the largest percentage increase.
d. If market interest rates remain at 107, 3ond IBs price will be 107
higher one year from today.
e. If market interest rates increase, 3ond HBs price will increase, 3ond
IBs price will decline, and 3ond 6Bs price will remain the same.
(Co0p() 'on "on"epts C G Answer: 1E$/21
+1
. 3onds !, 3, and ? all ha"e a maturity of 10 years and a yield to
maturity of 27. 3ond !Bs price e-ceeds its par "alue, 3ond 3Bs price
equals its par "alue, and 3ond ?Bs price is less than its par "alue.
:one of the bonds can be called. >hich of the following statements is
?=<<@?TA
a. If the yield to maturity on each bond decreases to 17, 3ond ! will
ha"e the largest percentage increase in its price.
b. 3ond ! has the most price risk.
c. If the yield to maturity on the three bonds remains constant, the
prices of the three bonds will remain the same o"er the ne-t year.
d. If the yield to maturity on each bond increases to /7, the prices of
all three bonds will decline.
e. 3ond ? sells at a premium o"er its par "alue.
(Co0p() 'on "on"epts C G Answer: " 1E$/21
+2
a. 10,year, *ero coupon bonds ha"e more rein"estment risk than 10,year,
107 coupon bonds.
b. ! 10,year, 107 coupon bond has less rein"estment risk than a 10,year,
+7 coupon bond &assuming all else equal'.
c. The total &rate of' return on a bond during a gi"en year is the sum
of the coupon interest payments recei"ed during the year and the
change in the "alue of the bond from the beginning to the end of the
year, di"ided by the bond(s price at the beginning of the year.
d. The price of a 0,year, 107 bond is less sensiti"e to changes in
interest rates than the price of a +,year, 107 bond.
e. ! 81,000 bond with 8100 annual interest payments that has + years to
maturity and is not e-pected to default would sell at a discount if
interest rates were below .7 and at a premium if interest rates were
greater than 117.
Page 2.. Con&eptual #/C Chapter 9: Bonds
(Co0p() 'on 3iels C G Answer: 1E$/21
+/
a. The yield to maturity for a coupon bond that sells at a premium
consists entirely of a positi"e capital gains yieldF it has a *ero
current interest yield.
b. The market "alue of a bond will always approach its par "alue as its
maturity date approaches. This holds true e"en if the firm has filed
for bankruptcy.
c. <ising inflation makes the actual yield to maturity on a bond greater
than a quoted yield to maturity that is based on market prices.
d. The yield to maturity on a coupon bond that sells at its par "alue
consists entirely of a current interest yieldF it has a *ero e-pected
capital gains yield.
e. The e-pected capital gains yield on a bond will always be *ero or
positi"e because no in"estor would purchase a bond with an e-pected
capital loss.
(Co0p() 'on 3iels C G Answer: e 1E$/21
+.
a. If a coupon bond is selling at a premium, then the bond(s current
yield is *ero.
b. If a coupon bond is selling at a discount, then the bond(s e-pected
capital gains yield is negati"e.
c. If a bond is selling at a discount, the yield to call is a better
measure of the e-pected return than the yield to maturity.
d. The current yield on 3ond ! e-ceeds the current yield on 3ond 3.
Therefore, 3ond ! must ha"e a higher yield to maturity than 3ond 3.
e. If a coupon bond is selling at par, its current yield equals its
yield to maturity.
(Co0p() 'on 3iels an pri"es C G Answer: 1E$/21
10
a. If two bonds ha"e the same maturity, the same yield to maturity, and
the same le"el of risk, the bonds should sell for the same price
regardless of their coupon rates.
b. !ll else equal, an increase in interest rates will ha"e a greater
effect on the prices of short,term than long,term bonds.
c. !ll else equal, an increase in interest rates will ha"e a greater
effect on higher,coupon bonds than it will ha"e on lower,coupon
bonds.
d. If a bondBs yield to maturity e-ceeds its coupon rate, the bondBs
price must be less than its maturity "alue.
e. If a bondBs yield to maturity e-ceeds its coupon rate, the bondBs
current yield must be less than its coupon rate.
Chapter 9: Bonds Con&eptual #/C Page 2./
(Co0p() 'on rates an pri"es C G Answer: e 1E$/21
11
. 3ond ! has a .7 annual coupon, while 3ond 3 has a 27 annual coupon.
3oth bonds ha"e the same maturity, a face "alue of 81,000, an /7 yield
to maturity, and are noncallable. >hich of the following statements is
?=<<@?TA
a. 3ond !Bs capital gains yield is greater than 3ond 3Bs capital gains
yield.
b. 3ond ! trades at a discount, whereas 3ond 3 trades at a premium.
c. If the yield to maturity for both bonds remains at /7, 3ond !Bs price
one year from now will be higher than it is today, but 3ond 3Bs price
one year from now will be lower than it is today.
d. If the yield to maturity for both bonds immediately decreases to 17,
3ond !Bs bond will ha"e a larger percentage increase in "alue.
e. 3ond !Bs current yield is greater than that of 3ond 3.
(Co0p() Callable bons C G Answer: a 1E$/21
1
a. Two bonds ha"e the same maturity and the same coupon rate. 9owe"er,
one is callable and the other is not. The difference in prices
between the bonds will be greater if the current market interest rate
is below the coupon rate than if it is abo"e the coupon rate.
b. ! callable 10,year, 107 bond should sell at a higher price than an
otherwise similar noncallable bond.
c. ?orporate treasurers dislike issuing callable bonds because these
bonds may require the company to raise additional funds earlier than
would be true if noncallable bonds with the same maturity were used.
d. Two bonds ha"e the same maturity and the same coupon rate. 9owe"er,
one is callable and the other is not. The difference in prices
between the bonds will be greater if the current market interest rate
is abo"e the coupon rate than if it is below the coupon rate.
e. The actual life of a callable bond will always be equal to or less
than the actual life of a noncallable bond with the same maturity.
Therefore, if the yield cur"e is upward sloping, the required rate of
return will be lower on the callable bond.
(Co0p() 83pes of ebt C G Answer: " 1E$/21
1#
a. $enior debt is debt that has been more recently issued, and in
bankruptcy it is paid off after 4unior debt because the 4unior debt
was issued first.
b. ! company(s subordinated debt has less default risk than its senior
debt.
c. ?on"ertible bonds generally ha"e lower coupon rates than non,
con"ertible bonds of similar default risk because they offer the
possibility of capital gains.
d. 5unk bonds typically pro"ide a lower yield to maturity than
in"estment,grade bonds.
e. ! debenture is a secured bond that is backed by some or all of the
firmBs fi-ed assets.
(Co0p() 1is"ellaneous "on"epts C G Answer: 1E$/21
1)
a. =ne disad"antage of *ero coupon bonds is that the issuing firm cannot
reali*e any ta- sa"ings from the use of debt until the bonds mature.
b. =ther things held constant, a callable bond should ha"e a lower yield
to maturity than a noncallable bond.
c. =nce a firm declares bankruptcy, it must be liquidated by the
trustee, who uses the proceeds to pay bondholders, unpaid wages,
ta-es, and legal fees.
d. Income bonds must pay interest only if the company earns the
interest. Thus, these securities cannot bankrupt a company prior to
their maturity, and this makes them safer to the issuing corporation
than regular bonds.
e. ! firm with a sinking fund that gi"es it the choice of calling the
required bonds at par or buying the bonds in the open market would
generally choose the open market purchase if the coupon rate e-ceeded
the going interest rate.
(Co0p() 1is"ellaneous "on"epts C G Answer: " 1E$/21
1+
a. The total return on a bond during a gi"en year is based only on the
coupon interest payments recei"ed.
b. !ll else equal, a bond that has a coupon rate of 107 will sell at a
discount if the required return for bonds of similar risk is /7.
c. The price of a discount bond will increase o"er time, assuming that
the bondBs yield to maturity remains constant.
d. For a gi"en firm, its debentures are likely to ha"e a lower yield to
maturity than its mortgage bonds.
e. >hen large firms are in financial distress, they are almost always
liquidated, whereas smaller firms are generally reorgani*ed.
(Co0p() $efault an bankrupt"3 C G Answer: e 1E$/21
11
a. !ll else equal, secured debt is more risky than unsecured debt.
b. The e-pected return on a corporate bond must be greater than its
promised return if the probability of default is greater than *ero.
c. !ll else equal, senior debt has more default risk than subordinated
debt.
d. ! companyBs bond rating is affected by its financial ratios but not
by pro"isions in its indenture.
e. ;nder ?hapter 11 of the 3ankruptcy !ct, the assets of a firm that
declares bankruptcy must be liquidated, and the sale proceeds must be
used to pay off claims against it according to the priority of the
claims as spelled out in the !ct.
(Co0p() Calling a bon C G Answer: " 1E$/2196A4$
12
a. ! bond is likely to be called if its coupon rate is below its 6T%.
b. ! bond is likely to be called if its market price is below its par
"alue.
c. @"en if a bond(s 6T? e-ceeds its 6T%, an in"estor with an in"estment
hori*on longer than the bond(s maturity would be worse off if the
bond were called.
d. ! bond is likely to be called if its market price is equal to its par
"alue.
e. ! bond is likely to be called if it sells at a discount below par.
(9-5) Current 3iel an Y81 C G Answer: b 6A4$
1/
a. !ssume that two bonds ha"e equal maturities and are of equal risk,
but one bond sells at par while the other sells at a premium abo"e
par. The premium bond must ha"e a lower current yield and a higher
capital gains yield than the par bond.
b. ! bondBs current yield must always be either equal to its yield to
maturity or between its yield to maturity and its coupon rate.
c. If a bond sells at par, then its current yield will be less than its
yield to maturity.
d. If a bond sells for less than par, then its yield to maturity is less
than its coupon rate.
e. ! discount bondBs price declines each year until it matures, when its
"alue equals its par "alue.
(9-&) /nt( rates an bon pri"es C G Answer: a 6A4$
1.
. !ssume that a noncallable 10,year T,bond has a 17 annual coupon, while
a 1+,year noncallable T,bond has an /7 annual coupon. !ssume also that
the yield cur"e is flat, and all Treasury securities ha"e a 107 yield to
maturity. >hich of the following statements is ?=<<@?TA
a. If interest rates decline, the prices of both bonds would increase,
but the 1+,year bond would ha"e a larger percentage increase in
price.
b. If interest rates decline, the prices of both bonds would increase,
but the 10,year bond would ha"e a larger percentage increase in
price.
c. The 10,year bond would sell at a discount, while the 1+,year bond
would sell at a premium.
d. The 10,year bond would sell at a premium, while the 1+,year bond
would sell at par.
e. If the yield to maturity on both bonds remains at 107 o"er the ne-t
year, the price of the 10,year bond would increase, but the price of
the 1+,year bond would fall.
Page 2.- Con&eptual #/C Chapter 9: Bonds
(9-)) *ri"e an reinvest( risk C G Answer: b 6A4$
20
a. ! *ero coupon bond of any maturity will ha"e more price risk than any
coupon bond, e"en a perpetuity.
b. If their maturities and other characteristics were the same, a +7
coupon bond would ha"e more price risk than a 107 coupon bond.
c. ! 10,year coupon bond would ha"e more rein"estment risk than a +,year
coupon bond, but all 10,year coupon bonds ha"e the same amount of
rein"estment risk.
d. ! 10,year coupon bond would ha"e more price risk than a +,year coupon
bond, but all 10,year coupon bonds ha"e the same amount of price
risk.
e. If their maturities and other characteristics were the same, a +7
coupon bond would ha"e less price risk than a 107 coupon bond.
(9-+) 'on inenture C G Answer: a 6A4$
21
. Gisted below are some pro"isions that are often contained in bond
indentures. >hich of these pro"isions, "iewed alone, would tend to
reduce the yield to maturity that in"estors would otherwise require on a
newly issued bondA
1. Fi-ed assets are used as security for a bond.
. ! gi"en bond is subordinated to other classes of debt.
#. The bond can be con"erted into the firm(s common stock.
). The bond has a sinking fund.
+. The bond has a call pro"ision.
1. The indenture contains co"enants that restrict the use of additional
debt.
a. 1, #, ), 1
b. 1, ), 1
c. 1, , #, ), 1
d. 1, , #, ), +, 1
e. 1, #, ), +, 1
(Co0p() Costs of t3pes of ebt C G Answer: " 6A4$
2
. $uppose a new company decides to raise a total of 800 million, with
8100 million as common equity and 8100 million as long,term debt. The
debt can be mortgage bonds or debentures, but by an iron,clad pro"ision
in its charter, the company can ne"er raise any additional debt beyond
the original 8100 million. Ji"en these conditions, which of the
a. The higher the percentage of debt represented by mortgage bonds, the
riskier both types of bonds will be and, consequently, the higher the
firmBs total dollar interest charges will be.
b. If the debt were raised by issuing 8+0 million of debentures and 8+0
million of first mortgage bonds, we could be certain that the firmBs
total interest e-pense would be lower than if the debt were raised by
issuing 8100 million of debentures.
c. In this situation, we cannot tell for sure how, or e"en whether, the
firmBs total interest e-pense on the 8100 million of debt would be
affected by the mi- of debentures "ersus first mortgage bonds. The
interest rate on each type of bond would increase as the percentage
of mortgage bonds used was increased, but the a"erage cost might well
be such that the firmBs total interest charges would not be affected
materially by the mi- between the two.
d. The higher the percentage of debentures, the greater the risk borne
by each debenture, and thus the higher the required rate of return on
the debentures.
e. If the debt were raised by issuing 8+0 million of debentures and 8+0
million of first mortgage bonds, we could be certain that the firmBs
total interest e-pense would be lower than if the debt were raised by
issuing 8100 million of first mortgage bonds.
(Co0p() Costs of t3pes of ebt C G Answer: b 6A4$
2#
. ! company is planning to raise 81,000,000 to finance a new plant. >hich
of the following statements is ?=<<@?TA
a. The company would be especially eager to ha"e a call pro"ision
included in the indenture if its management thinks that interest
rates are almost certain to rise in the foreseeable future.
b. If debt is used to raise the million dollars, but 8+00,000 is raised
as first mortgage bonds on the new plant and 8+00,000 as debentures,
the interest rate on the first mortgage bonds would be lower than it
would be if the entire 81 million were raised by selling first
mortgage bonds.
c. If two classes of debt are used &with one senior and the other
subordinated to all other debt', the subordinated debt will carry a
lower interest rate.
d. If debt is used to raise the million dollars, the cost of the debt
would be lower if the debt were in the form of a fi-ed,rate bond
rather than a floating,rate bond.
e. If debt is used to raise the million dollars, the cost of the debt
would be higher if the debt were in the form of a mortgage bond
rather than an unsecured term loan.
Page 2/0 Con&eptual #/C Chapter 9: Bonds
(Co0p() 'on "on"epts C G Answer: e 6A4$
2)
. !ssuming all else is constant, which of the following statements is
?=<<@?TA
a. =ther things held constant, a 0,year *ero coupon bond has more
rein"estment risk than a 0,year coupon bond.
b. =ther things held constant, for any gi"en maturity, a 1.0 percentage
point decrease in the market interest rate would cause a smaller
dollar capital gain than the capital loss stemming from a 1.0
percentage point increase in the interest rate.
c. From a corporate borrowerBs point of "iew, interest paid on bonds is
not ta-,deductible.
d. =ther things held constant, price sensiti"ity as measured by the
percentage change in price due to a gi"en change in the required rate
of return decreases as a bondBs maturity increases.
e. For a bond of any maturity, a 1.0 percentage point increase in the
market interest rate &r
d
' causes a larger dollar capital loss than
the capital gain stemming from a 1.0 percentage point decrease in the
interest rate.
Multiple Choice: "ro,lems
(9-#) 'on valuation: annual C G Answer: a EASY
2+
. %orin ?ompany(s bonds mature in / years, ha"e a par "alue of 81,000, and
make an annual coupon interest payment of 81+. The market requires an
interest rate of /.7 on these bonds. >hat is the bond(s priceA
a. 8.0#.0)
b. 8.+.1
c. 8.)/.21
d. 8.2.)/
e. 8..1.2.
(9-#) 'on valuation: annual C G Answer: EASY
21
. <yngaert Inc. recently issued noncallable bonds that mature in 1+ years.
They ha"e a par "alue of 81,000 and an annual coupon of +.27. If the
current market interest rate is 2.07, at what price should the bonds
sellA
a. 8/12.1
b. 8/#/.02
c. 8/+..+1
d. 8//1.10
e. 8.0#.1)
(9-5) Yiel to 0aturit3 C G Answer: e EASY
22
. !dams @nterprisesB noncallable bonds currently sell for 81,10. They
ha"e a 1+,year maturity, an annual coupon of 8/+, and a par "alue of
81,000. >hat is their yield to maturityA
a. +./)7
b. 1.1+7
c. 1.)27
Chapter 9: Bonds #/C Pro%le+s Page 2/1
d. 1./17
e. 2.127
Page 2/2 #/C Pro%le+s Chapter 9: Bonds
(9-5) Yiel to 0aturit3 C G Answer: b EASY
2/
. Eyl Inc.(s bonds currently sell for 81,0)0 and ha"e a par "alue of
81,000. They pay a 81+ annual coupon and ha"e a 1+,year maturity, but
they can be called in + years at 81,100. >hat is their yield to
maturity &6T%'A
a. +.2/7
b. 1.0.7
c. 1.#.7
d. 1.217
e. 2.0+7
(9-5) Yiel to 0aturit3 C G Answer: b EASY
2.
. <adoski ?orporation(s bonds make an annual coupon interest payment of
2.#+7. The bonds ha"e a par "alue of 81,000, a current price of 81,1#0,
and mature in 1 years. >hat is the yield to maturity on these bondsA
a. +.+7
b. +./7
c. 1.117
d. 1.)17
e. 1.2#7
(9-5) Yiel to "all C G Answer: EASY
/0
. $adik Inc.(s bonds currently sell for 81,1/0 and ha"e a par "alue of
81,000. They pay a 810+ annual coupon and ha"e a 1+,year maturity, but
they can be called in + years at 81,100. >hat is their yield to call
&6T?'A
a. 1.1#7
b. 1../7
c. 2.#+7
d. 2.2)7
e. /.17
(9-5) Current 3iel C G Answer: a EASY
/1
. %alko @nterprisesB bonds currently sell for 81,0+0. They ha"e a 1,year
maturity, an annual coupon of 82+, and a par "alue of 81,000. >hat is
their current yieldA
a. 2.1)7
b. 2.+07
c. 2.//7
d. /.27
e. /.1/7
(9-:) 'on valuation: se0iannual C G Answer: a EASY
/
. !ssume that you are considering the purchase of a 0,year, noncallable
bond with an annual coupon rate of ..+7. The bond has a face "alue of
81,000, and it makes semiannual interest payments. If you require an
/.)7 nominal yield to maturity on this in"estment, what is the ma-imum
price you should be willing to pay for the bondA
a. 81,10+.1.
b. 81,1##.#)
c. 81,111.12
d. 81,1.0.21
e. 81,0.)/
(9-#) 'on valuation: annual C G Answer: e 1E$/21
/#
. Jrossnickle ?orporation issued 0,year, noncallable, 2.+7 annual coupon
bonds at their par "alue of 81,000 one year ago. Today, the market
interest rate on these bonds is +.+7. >hat is the current price of the
bonds, gi"en that they now ha"e 1. years to maturityA
a. 81,11#.)/
b. 81,1).0#
c. 81,121.#
d. 81,01.#+
e. 81,#.1+
(9-5) Y81 an Y8C C G Answer: a 1E$/21
/)
. %c?ue Inc.(s bonds currently sell for 81,+0. They pay a 8.0 annual
coupon, ha"e a +,year maturity, and a 81,000 par "alue, but they can be
called in + years at 81,0+0. !ssume that no costs other than the call
premium would be incurred to call and refund the bonds, and also assume
that the yield cur"e is hori*ontal, with rates e-pected to remain at
current le"els on into the future. >hat is the difference between this
bond(s 6T% and its 6T?A &$ubtract the 6T? from the 6T%F it is possible
to get a negati"e answer.'
a. .17
b. .//7
c. #.127
d. #.)/7
e. #./#7
(9-5) Y81 an Y8C C G Answer: e 1E$/21
/+
. Taussig ?orp.(s bonds currently sell for 81,1+0. They ha"e a 1.#+7
annual coupon rate and a 0,year maturity, but they can be called in +
years at 81,012.+0. !ssume that no costs other than the call premium
would be incurred to call and refund the bonds, and also assume that the
yield cur"e is hori*ontal, with rates e-pected to remain at current
le"els on into the future. ;nder these conditions, what rate of return
should an in"estor e-pect to earn if he or she purchases these bondsA
a. #.)7
b. #.107
c. #.2.7
d. #...7
e. ).07
(9-&) Future annual bon value C G Answer: " 1E$/21
/1
. ! +,year, 81,000 par "alue bond has an /.+7 annual payment coupon. The
bond currently sells for 8.+. If the yield to maturity remains at its
current rate, what will the price be + years from nowA
a. 8//).1.
Page 2/. #/C Pro%le+s Chapter 9: Bonds
b. 8.01./1
c. 8.#0.11
d. 8.+#.#1
e. 8.22.0
Chapter 9: Bonds #/C Pro%le+s Page 2//
(9-:) 'on valuation: se0iannual C G Answer: " 1E$/21
/2
. %oerdyk ?orporation(s bonds ha"e a 1+,year maturity, a 2.+7 semiannual
coupon, and a par "alue of 81,000. The going interest rate &r
d
' is
1.07, based on semiannual compounding. >hat is the bondBs priceA
a. 81,0)2.1.
b. 81,02).0+
c. 81,101.+/
d. 81,1..1
e. 81,1+2.#+
(9-:) 1arket value: se0iannual C G Answer: b 1E$/21
//
. In order to accurately assess the capital structure of a firm, it is
necessary to con"ert its balance sheet figures from historical book
"alues to market "alues. K5% ?orporation(s balance sheet &book "alues'
as of today is as followsC
Gong,term debt &bonds, at par' 8#,+00,000
Lreferred stock ,000,000
?ommon stock &810 par' 10,000,000
<etained earnings ),000,000
Total debt and equity 8#.,+00,000
The bonds ha"e a 2.07 coupon rate, payable semiannually, and a par
"alue of 81,000. They mature e-actly 10 years from today. The yield to
maturity is 117, so the bonds now sell below par. >hat is the current
market "alue of the firm(s debtA
a. 812,)#1,#2
b. 812,//#,#0
c. 81/,##0,)0#
d. 8 2,201,000
e. 8 2,/./,1+0
(9-:) Se0iannual Y81 an Y8C C G Answer: b 6A4$
/.
. Keenan Industries has a bond outstanding with 1+ years to maturity, an
/.+7 nominal coupon, semiannual payments, and a 81,000 par "alue. The
bond has a 1.+07 nominal yield to maturity, but it can be called in 1
years at a price of 81,10. >hat is the bondBs nominal yield to callA
a. 1.07
b. 1.+#7
c. 1./+7
d. 2.07
e. 2.++7
(9-:) Se0iannual bon "oupon C G Answer: e 6A4$
.0
. =(3rien Gtd.(s outstanding bonds ha"e a 81,000 par "alue, and they
mature in + years. Their nominal yield to maturity is ..+7, they pay
interest semiannually, and they sell at a price of 8.2+. >hat is the
bond(s nominal coupon interest rateA
a. 2.#7
b. 2.217
Page 2/0 #/C Pro%le+s Chapter 9: Bonds
c. /.17
d. /.+)7
e. /...7
(9-:) 'ons: se0iannual EFF; C G Answer: " 6A4$
.1
. Kebt ?orporation(s ?lass $emi bonds ha"e a 1,year maturity and an /.2+7
coupon paid semiannually &).#2+7 each 1 months', and those bonds sell at
their 81,000 par "alue. The firm(s ?lass !nn bonds ha"e the same risk,
maturity, nominal interest rate, and par "alue, but these bonds pay
interest annually. :either bond is callable. !t what price should the
annual payment bond sellA
a. 8 .#2.+1
b. 8 .11.10
c. 8 ./1.+
d. 81,010..1
e. 81,0#1.1/
(9-:) 'ons: se0iannual - </$ C G Answer: 6A4$
.
. %oon $oftware Inc. is planning to issue two types of +,year,
noncallable bonds to raise a total of 81 million, 8# million from each
type of bond. First, #,000 bonds with a 107 semiannual coupon will be
sold at their 81,000 par "alue to raise 8#,000,000. These are called
par bonds. $econd, =riginal Issue Eiscount &=IE' bonds, also with a
+,year maturity and a 81,000 par "alue, will be sold, but these bonds
will ha"e a semiannual coupon of only 1.+7. The =IE bonds must be
offered at below par in order to pro"ide in"estors with the same
effecti"e yield as the par bonds. 9ow many =IE bonds must the firm
issue to raise 8#,000,000A Eisregard flotation costs, and round your
final answer up to a whole number of bonds.
a. ),/
b. ),##2
c. ),))/
d. ),+1
e. ),121
Page 2/- #/C Pro%le+s Chapter 9: Bonds
Chapter 9: Bonds ns(ers Page 2/9
CH!"TE# $
!'(-E#( !'D (&L+T)&'(
1( (9-2) Coupon rate F G Answer: a EASY
( (9-2) Call provision F G Answer: b EASY
#( (9-2) Sinking fun F G Answer: a EASY
)( (9-2) !ero "oupon bon F G Answer: b EASY
+( (9-2) Floating-rate ebt F G Answer: a EASY
1( (9-#) $is"ounte "as% flows F G Answer: a EASY
2( (9-&) 'on pri"es an int( rates F G Answer: a EASY
/( (9-)) *ri"e risk F G Answer: b EASY
.( (9-)) *ri"e risk F G Answer: b EASY
10( (9-+) 'ons an ebentures F G Answer: a EASY
11( (9-+) ,unk bon F G Answer: a EASY
1( (9-+) 'on ratings - re.( returns F G Answer: a EASY
1#( (9-2) /n"o0e bon F G Answer: b 1E$/21
1)( (9-2) Sinking fun F G Answer: b 1E$/21
The sinking fund would give Bond SF a lower average maturity, and it would also lower its risk. Therefore,
Bond SF should have a lower, not a higher, yield.
1+( (9-2) Floating-rate ebt F G Answer: b 1E$/21
Floating rates can benefit issuers if rates decline, so a company that thinks rates are likely to fall would want
to issue such bonds.
11( (9-#) 'on pre0iu0s an is"ounts F G Answer: a 1E$/21
12( (9-#) 'on value--annual pa30ent F G Answer: a 1E$/21
The bonds expected return (T!" is #$.%#&, which exceeds the #'& re(uired return, so buy the bond.
1/( (9-&) 'on pri"es an returns F G Answer: a 1E$/21
1.( (9-&) *ri"es an interest rates F G Answer: a 1E$/21
The reason for this is that more of the cash flows of a low)coupon bond comes late in the bond*s life (as the
maturity payment", and later cash flows are impacted most heavily by changing market rates.
0( (9-+) 4estri"tive "ovenants F G Answer: a 1E$/21
1( (9-+) 'ons an ebentures F G Answer: a 1E$/21
( (9-5) Callable bons F G Answer: b 6A4$
The callable bond will be called if rates fall far enough below the coupon rate, but it will not be called
otherwise. Thus, the call provision can only harm bondholders. Therefore, callable bonds sell at higher
yields than noncallable bonds, regardless of the slope of the yield curve.
#( (9-&) /nterest rates C G Answer: a EASY
)( (9-)) Calling bons C G Answer: " EASY
+( (9-+) 'on ratings C G Answer: " EASY
1( (9-2) 'on "oupon rate C G Answer: b 1E$/21
2( (9-2) Sinking funs C G Answer: a 1E$/21
/( (9-2) Convertible7 "allable bons C G Answer: b 1E$/21
The second bond*s convertible feature and sinking fund would tend to lower its re(uired rate of return, but
the call feature would raise its rate. +iven these opposing forces, the second bond*s re(uired coupon rate
could be above or below that of the first bond. ,owever, the convertible feature generally dominates in the
real world, so convertibles* coupon rates are generally less than comparable non)convertible issues* rates.
.( (9-5) 'on 3iels C G Answer: 1E$/21
#0( (9-5) 'on 3iels C G Answer: a 1E$/21
#1( (9-5) 'on 3iels C G Answer: " 1E$/21
#( (9-5) 'on 3iels C G Answer: " 1E$/21
##( (9-5) 'on 3iels C G Answer: 1E$/21
#)( (9-&) 'on values over ti0e C G Answer: 1E$/21
-ote that Bond #. sells at par, so the re(uired return on all these bonds is #.&. #.*s price will remain
constant/ % will sell initially at a discount and will rise, and #' will sell initially at a premium and will
decline. -ote too that since it has larger cash flows from its higher coupons, Bond #' would be less
sensitive to interest rate changes, i.e., it has less price risk. 0t has more default risk.
#+( (9-&) /nt( rates an bon pri"es C G Answer: b 1E$/21
1nswers c, d, and e are clearly wrong, and answer b is clearly correct. 1nswer a is also wrong, but this is
not obvious to most people. 2e can demonstrate that a is incorrect by using the following example.
3ar 4#,...
T! %...&
!aturity #.
3rice 4#,#..
3ayment 456.5.
7oupon rate 5.65&
7urrent yield %.8$& The current yield is greater than %&.
#1( (9-&) /nt( rates an bon pri"es C G Answer: " 1E$/21
#2( (9-&) /nt( rates an bon pri"es C G Answer: b 1E$/21
2e can tell by inspection that c, d, and e are all incorrect. a is also incorrect because the #.)year bond will
fall more due to its longer maturity and lower coupon. That leaves 1nswer b as the only possibly correct
statement. 9ecogni:e that longer)term bonds, and ones where payments come late (like low coupon bonds"
are most sensitive to changes in interest rates. Thus, the #.)year, %& coupon bond should be more sensitive
to a decline in rates. ou could also do some calculations to confirm that b is correct.
#/( (9-&) 'on 3iels an pri"es C G Answer: " 1E$/21
#.( (9-)) *ri"e risk C G Answer: e 1E$/21
)0( (9-)) *ri"e risk C G Answer: 1E$/21
)1( (9-)) *ri"e risk C G Answer: b 1E$/21
)( (9-)) *ri"e risk C G Answer: e 1E$/21
)#( (9-)) *ri"e vs( reinvest( risk C G Answer: e 1E$/21
))( (9-)) *ri"e vs( reinvest( risk C G Answer: 1E$/21
)+( (Co0p() 8er0 stru"ture C G 6 Answer: e 1E$/21
)1( (Co0p() 'ons - efault risk C G Answer: a 1E$/21
)2( (Co0p() 'on "on"epts C G Answer: a 1E$/21
)/( (Co0p() 'on "on"epts C G Answer: 1E$/21
).( (Co0p() 'on "on"epts C G Answer: e 1E$/21
+0( (Co0p() 'on "on"epts C G Answer: b 1E$/21
+1( (Co0p() 'on "on"epts C G Answer: e 1E$/21
+( (Co0p() 'on "on"epts C G Answer: b 1E$/21
+#( (Co0p() 'on "on"epts C G Answer: e 1E$/21
+)( (Co0p() 'on "on"epts C G Answer: a 1E$/21
++( (Co0p() 'on "on"epts C G Answer: a 1E$/21
+1( (Co0p() 'on "on"epts C G Answer: 1E$/21
1 is a high coupon bond because it sells above par, 7 is a low coupon bond, and B yields the going market
rate. 7onsider this when ruling out a, b, c, and e. d is obviously correct.
+2( (Co0p() 'on "on"epts C G Answer: " 1E$/21
+/( (Co0p() 'on 3iels C G Answer: 1E$/21
+.( (Co0p() 'on 3iels C G Answer: e 1E$/21
10( (Co0p() 'on 3iels an pri"es C G Answer: 1E$/21
11( (Co0p() 'on rates an pri"es C G Answer: e 1E$/21
1( (Co0p() Callable bons C G Answer: a 1E$/21
a is correct because, with the current market rate below the coupon bond, both bonds will sell at a premium,
but the premium will be larger for the noncallable bond. The same logic explains why d is false.
1#( (Co0p() 83pes of ebt C G Answer: " 1E$/21
1)( (Co0p() 1is"ellaneous "on"epts C G Answer: 1E$/21
1+( (Co0p() 1is"ellaneous "on"epts C G Answer: " 1E$/21
11( (Co0p() $efault an bankrupt"3 C G Answer: e 1E$/21
12( (Co0p() Calling a bon C G Answer: " 1E$/2196A4$
1 bond would not be called unless the current rate was below the T!, in which case it would sell at a
premium, because only then would it be profitable to refund the bond. The investor would get the funds,
then reinvest at the new low market rate. Thus, the investor would end up earning less than the T!, even
after receiving the call premium.
1/( (9-5) Current 3iel an Y81 C G Answer: b 6A4$
1nswer a is incorrect because a premium bond must have a negative capital gains yield. 1nswer c is
incorrect because a bond selling at par must have a current yield e(ual to its T!. 1nswer d is incorrect
because a bond selling at below par must have a T! ; the coupon rate. 1nswer e is incorrect because a
discount bond*s price must rise over time. That leaves answer b as the only possibly correct answer. -ote
that T! < 7urrent yield =>) 7apital gains yield, so 7urrent yield < T! =>) 7apital gains yield. The
capital gains yield will be positive or negative depending on whether the coupon rate is above or below the
T!. That means that the current yield must either e(ual the T! or be between the T! and the coupon
rate. b*s correctness is also demonstrated below?
3ar bond 3remium @iscount
3ar 4#,... 4#,... 4#,...
!aturity #. #. #.
7oup rate #.& ##& 5&
T! #....& #....& #....&
1nn coup 4#..... 4##.... 45....
3rice 4#,...... 4#,.8#.6A 45$%.AA
7ur ield #....& #..$8& 5.A5& B(ual to or between T! and coupon rate.
7ap gain ....& )..$8& ..6#&
1.( (9-&) /nt( rates an bon pri"es C G Answer: a 6A4$
2e can tell by inspection that c, d, and e are all incorrect. That leaves 1nswers a and b as the only possibly
correct statements. 1lso, recogni:e that longer)term bonds, and also bonds whose payments come late (like low
coupon bonds" are most sensitive to changes in interest rates. Thus, the #A)year, %& coupon bond would be more
sensitive to a decline in rates. Finally, we can do some calculations to confirm that a is the correct answer?
7urrent situation 9ates decline
#.)year #A)year #.)year #A)year
3ar 4#,... 4#,... 4#,... 4#,...
!aturity #. #A #. #A
7oup rate #'& %& #'& %&
T! #....& #....& 5...& 5...&
1nn coup 4#'. 4%. 4#'. 4%.
3rice 4#,#''.%5 4%6C.%% 4#,#5'.A$ 45#5.$5
& +ain 8.'& %.6&
20( (9-)) *ri"e an reinvest( risk C G Answer: b 6A4$
21( (9-+) 'on inenture C G Answer: a 6A4$
2( (Co0p() Costs of t3pes of ebt C G Answer: " 6A4$
The higher the percentage of mortgage bonds, the less the collateral backing each bond, so these bonds* risk
and thus re(uired return would be higher. 1lso, the higher the percentage of mortgage bonds, the less free
assets would be backing the debentures, so their risk and re(uired return would also be higher. ,owever,
mortgage bonds are less risky than debentures, so mortgage bond rates are lower than rates on debentures. 2e
end up with a situation where the greater the percentage of mortgage bonds, the higher the rate on both types
of bonds, but the average cost to the company could be higher, lower, or constant. -ote that we could draw a
graph of the situation, with & mortgage on the hori:ontal axis and rates on the vertical axis, the graph would
look like the 2177 graph in the cost of capital chapter.
2#( (Co0p() Costs of t3pes of ebt C G Answer: b 6A4$
0n Statement b, note that if only 4A..,... of #st mortgage bonds were secured by 4# million of property, each
of those bonds would be less risky than if there were 4# million of bonds backed by the 4# million of property.
-ote too that the cost of the total 4# million of debt would be an average of the cost of the mortgage bonds and
the debentures, and that average cost could be higher, lower, or the same as if only mortgage bonds or only
debentures were used.
2)( (Co0p() 'on "on"epts C G Answer: e 6A4$
0t is relatively easy to eliminate a, c, and d. 2hen choosing between b and e, think about the graph that shows
the relationship between a bond*s price and the going interest rate. This curve is concave, indicating that at
any interest rate, the decline in price from an increase in rates is less than the gain in price from a similar
interest rate decline. 0t would be easy to confirm this statement with an example.
2+( (9-#) 'on valuation: annual C G Answer: a EASY
- %
0>9 %.'&
3!T 48A
FD 4#,...
3D 45.$..6
21( (9-#) 'on valuation: annual C G Answer: EASY
7oupon rate A.C.&
3!T 4AC...
- #A
0>9 C...&
FD 4#,...
3D 4%%#.8.
22( (9-5) Yiel to 0aturit3 C G Answer: e EASY
- #A
3D 4#,#'.
3!T 4%A
FD 4#,...
0>9 C.#C&
2/( (9-5) Yiel to 0aturit3 C G Answer: b EASY
- #A
3D 4#,.6.
3!T 48A
FD 4#,...
0>9 8..5& < T!
2.( (9-5) Yiel to 0aturit3 C G Answer: b EASY
7oupon rate C.$A&
- #'
3D < 3rice 4#,#$.
3!T 4C$.A.
FD < 3ar 4#,...
0>9 A.%'& < T!
/0( (9-5) Yiel to "all C G Answer: EASY
- A
3D 4#,#%.
3!T 4#.A
FD 4#,#..
0>9 < T7 C.C6&
/1( (9-5) Current 3iel C G Answer: a EASY
3D 4#,.A.
3!T 4CA
7urrent yield < C.#6&
/( (9-:) 'on valuation: se0iannual C G Answer: a EASY
3ar value 4#,...
7oupon rate 5.A&
3eriods>year '
rs to maturity '.
3eriods < rs to maturity E 3eriods>year 6.
9e(uired rate %.6&
3eriodic rate < 9e(uired rate>' < 0>9 6.'.&
3!T per period < 7oupon rate>' E 3ar value 46C.A.
!aturity value < FD 4#,...
3D 4#,#.A.85
/#( (9-#) 'on valuation: annual C G Answer: e 1E$/21
3ar value < !aturity value < FD 4#,...
7oupon rate C.A&
ears to maturity < - #5
9e(uired rate < 0>9 A.A&
(7oupon rate"(3ar value" < 3!T 4CA
3D 4#,'$'.#A
/)( (9-5) Y81 an Y8C C G Answer: a 1E$/21
0f held to maturity? 0f called in A years?
- < !aturity 'A - < 7all A
3rice < 3D 4#,'A. 3D 4#,'A.
3!T 45. 3!T 45.
FD < 3ar 4#,... FD < 7all 3rice 4#,.A.
0>9 < T! 8.%%& 0>9 < T7 6.'8&
@ifference? T! F T7 < '.8'&
/+( (9-5) Y81 an Y8C C G Answer: e 1E$/21
0f the coupon rate exceeds the T!, then it is likely that the bonds will be called and replaced with new,
lower coupon bonds. 0n that case, the T7 will be earned. Gtherwise, one should expect to earn the T!.
0f held to maturity? 0f called?
3ar value 4#,... 3ar value 4#,...
7oupon 8.$A& 7oupon 8.$A&
- '. - A
3rice < 3D 4#,#A. 3D 4#,#A.
3!T < 3ar E 7oupon 48$.A. 3!T 48$.A.
FD 4#,...... FD 4#,.8C.A.
0>9 < T! A.#$& 0>9 < T7 6.'.&
Bxpected rate of return < T7 if 7oupon ; T!, 6.'.& T7
otherwise T!
/1( (9-&) Future annual bon value C G Answer: " 1E$/21
First find the T! at this time, then use the T! with the other data to find the bond*s price A years hence.
3ar value 4#,...
7oupon rate %.A.& Dalue in A years?
- 'A - '.
3D 45'A 0>9 5.'%&
3!T 4%A 3!T 4%A
FD 4#,... FD 4#,...
0>9 5.'%& 3D 45$..##
/2( (9-:) 'on valuation: se0iannual C G Answer: " 1E$/21
3ar value < FD 4#,...
7oupon rate C.'A&
3eriods>year '
rs to maturity #A
3eriods < ears E ' < - $.
+oing annual rate < T! < rd 8.'.&
3eriodic rate < rd>' < 0>9 $.#.&
7oupon rate E 3ar>' < 3!T 4$8.'A
3D 4#,#.#.A%
//( (9-:) 1arket value: se0iannual C G Answer: b 1E$/21
7alculate the price of each bond?
7oupon rate C..&
rs to maturity #.
3eriods>r '
3eriods < ears E ' < - '.
+oing annual rate < rd < T! ##..&
3eriodic rate < rd>' < 0>9 A.A&
7oupon rate E 3ar>' < 3!T 4$A...
3rice of the bonds < 3D 4C8..55
@etermine the number of bonds?
Book value on balance sheet 4'$,A..,...
3ar value 4#,...
-umber of bonds < Book value>3ar value '$,A..
7alculate the market value of bonds?
!kt value < 3D E -umber of bonds < 4#C,%%$,$'.
/.( (9-:) Se0iannual Y81 an Y8C C G Answer: b 6A4$
First, use the given data to find the bond*s current price. Then use that price to find the T7.
7oupon rate %.'A&
T! 8.A.&
!aturity #A rs to call 8
3ar value 4#,... 7all price 4#,#'.
3eriods>year ' @etermine the bond*s T7?
@etermine the bond*s price? - #'
3!T>period 46#.'A 3D 4#,#88..5
- $. 3!T 46#.'A
0>9 $.'A& FD 4#,#'....
FD 4#,...... 0>9 $.'8&
3D < 3rice 4#,#88..5 -om. T7 8.A$&
.0( (9-:) Se0iannual bon "oupon C G Answer: e 6A4$
First, use the data provided to find the dollar coupon payment per 8 months, then multiply by ' to get the annual
coupon, and then divide by the par value to find the coupon rate. Gne could use the indicated data and solve for
the price. 0t would be 45CA, which confirms the rate.
ears to maturity 'A
3eriods>year '
ears E periods>year < - A.
T! 5.'A&
3eriodic rate < T!>' < 0>9 6.8'A&
3rice today < 3D 45CA
3!T, function of -, 0>9, 3D, and FD < semiannual pymt 466.58
1nnual coupon payment < semiannual payment E ' < 4%5.5'
7oupon rate < 1nnual coupon payment>3ar value < %.55&
.1( (9-:) 'ons: se0iannual EFF; C G Answer: " 6A4$
These two bonds should provide the same BFF&. Therefore, we can find the BFF& for the semiannual bond and
then use it as the T! for the annual payment bond. 1t the calculated price, the two bonds will have T!s with
the same BFF&. -ote too that the semiannual payment bond must have a higher price than the annual bond
because then it receives the same cash flow, but faster. Therefore, the annual bond must sell at a price below the
4#,... par value at which the semiannual bond sells.
Semiannual bond? 1nnual bond?
7oupon rate<-ominal rate %.CA& 7oupon rate %.CA&
3ayment per period 46$.CA 3mt>3eriod 4%C.A.
ears to maturity #' rs to maturity #'
3eriods>year ' 3eriods>year #
Total periods '6 Total periods #'
BFF& < (#=-om rate>'"
'
H # < %.56#& BFF& < T! %.56#&
3rice 4#,...... 3rice 45%8.'A
.( (9-:) 'ons: se0iannual - </$ C G Answer: 6A4$
The par bond has a coupon rate of #.& and a periodic rate of A&, and it sells at par. Therefore, the going
nominal rate must be #.& with an BFF& of #..'A&. The G0@ bond must provide the same BFF&, because it is
e(ually risky. Therefore, it must be evaluated with the parameters shown below to find its price, which is then
used to find the number of bonds to be issued. -ote that if the G0@ bond is based on a A& periodic rate, its BFF&
will also be #..'A&.
Bond 1? 0ssued at par? Bond B? 0ssued at a discount (G0@ bonds"?
7oupon rate #....& 7oupon rate 8.'A&
3eriods>year ' 3eriods>year '
3eriodic rate A...& 3eriodic rate A...&
ears to maturity 'A ears to maturity 'A
ears E 3eriods>year < - A. ears E 3eriod>year < - A.
3!T per period < 7oupon E 3ar>' 4A.... 3!T per period < 7oupon E 3ar>' 4$#.'A
3D < 3rice 4#,... 3D < 3rice 48AC.C.#6
Funds needed from G0@ bonds 4$,...,...
-umber of bonds < 4$,...,...>G0@ price 6,A8#.$6
-umber of bonds, rounded up 6,A8'

Bonds and Their Valuation Exercise

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