Chapter 10 - Problem 10 - JustAnswer



Chapter 10 - Problem 10.5, p. 435

Chapter 10 - Problem P10.10, p. 435

Chapter 10 - Case Problem 10.1, p.438

Chapter 11 - Problem P11.1, p. 477

Chapter 11 - Problem P11.13, p. 478

Chapter 11 - Problem P11.19, p. 479

Multiple choice quiz

|1. |Which of the following correctly describes the effect of a decline in interest |

| |rates on bond prices? |

|A. | |

|The prices of existing bonds rise.; | |

| | |

|B. | |

|The prices of existing bonds are not affected.;| |

| | |

|C. | |

|The prices of the existing bonds fall.; | |

| | |

|D. | |

|The prices of newly issued bonds are lowered. | |

| | |

|2. |The major source of risk based by investors who purchase bonds is |

|A. | |

|purchasing power risk.; | |

| | |

|B. | |

|liquidity risk.; | |

| | |

|C. | |

|event risk. | |

| | |

|D. | |

|interest rate risk.; | |

| | |

|3. |A $1000 par value bond that was issued two years ago by the Golden Ibis Corporation has a 6% |

| |coupon. If the prevailing market rate for interest on comparable bonds is now 7%, then the |

| |Golden Ibis bond pays it bondholders an annual interest income of |

|A. | |

|$70, and the bond would sell for | |

|less than its par value.; | |

| | |

|B. | |

|$60, and the bond would sell for | |

|more than its par value.; | |

| | |

|C. | |

|$70, and the bond would sell for | |

|more than its par value. | |

| | |

|D. | |

|$60, and the bond would sell for | |

|less than its par value.; | |

| | |

|4. |A bond which has a deferred |

| |call |

|A. | |

|would not have to be redeemed when it reaches maturity.; | |

| | |

|B. | |

|could be retired at any time prior to maturity.; | |

| | |

|C. | |

|could not be retired for a specified period after the date of issue, but after that could be | |

|retired at any time.; | |

| | |

|D. | |

|could be retired at any time during the initial call period, but after that period (usually the | |

|first five years after issue). | |

| | |

|5. |Some securities are called junk bonds |

| |because |

|A. | |

|they have a high risk of default and the debt is unsecured. | |

| | |

|B. | |

|they have secured by equipment-type collateral rather than by cash.; | |

| | |

|C. | |

|they are issued by foreign companies. | |

| | |

|D. | |

|the companies that issue them have inadequate amounts of debt in their corporate | |

|structures.; | |

| | |

|6. |The specific type of risk that is measured by bond ratings is |

|A. | |

|interest rate risk.; | |

| | |

|B. | |

|market risk.; | |

| | |

|C. | |

|purchasing power risk. | |

| | |

|D. | |

|default risk.; | |

| | |

|7. |The most common yield curve is upward sloping, which means |

| |that |

|A. | |

|the nearer the call date, the more volatile the bond price will | |

|be.; | |

| | |

|B. | |

|yields tend to increase with longer maturities. | |

| | |

|C. | |

|yield spreads tend to increase over time. | |

| | |

|D. | |

|default risk increases with maturity. | |

| | |

|8. |According to the expectation hypothesis, investors' expectations of increasing inflation|

| |will result in |

|A. | |

|an upward-sloping yield curve.; | |

| | |

|B. | |

|a flat yield curve.; | |

| | |

|C. | |

|a downward-sloping yield curve.; | |

| | |

|D. | |

|a humped yield curve. | |

| | |

|9. |At any given time, the yield curve is affected by all of the following |

| |EXCEPT |

|A. | |

|inflationary expectations.; | |

| | |

|B. | |

|the approximate yield formula.; | |

| | |

|C. | |

|short- and long-term supply and demand conditions. | |

| | |

|D. | |

|liquidity preferences.; | |

| | |

|10. |Using the present-value method, all of the following are needed to value a bond |

| |EXCEPT |

|A. | |

|the issue's bond rating. | |

| | |

|B. | |

|the par value.; | |

| | |

|C. | |

|the number of years until maturity.; | |

| | |

|D. | |

|the annual coupon payment.; | |

| | |

|11. |What is the current yield of a $10,000 bond bearing a 14% coupon rate and having a |

| |current market price of 95? |

|A. | |

|14.74%; | |

| | |

|B. | |

|15.36%; | |

| | |

|C. | |

|14.00%; | |

| | |

|D. | |

|insufficient information is provided. | |

| | |

|12. |The rate of return which indicates the return an investor can expect to earn by holding a bond |

| |over a period of time that is less than the life of the issue is known as |

|A. | |

|bond equivalent yield (BEY) | |

| | |

|B. | |

|expected return; | |

| | |

|C. | |

|yield-to-maturity; | |

| | |

|D. | |

|promised yield; | |

| | |

|13. |The main purpose of a bond ladder is to |

|A. | |

|achieve the highest level of capital gains possible.; | |

| | |

|B. | |

|maintain a highly liquid portfolio.; | |

| | |

|C. | |

|less the impact of swings in interest rates.; | |

| | |

|D. | |

|offset the effects of bond duration. | |

| | |

|14. |A corporation that wants to raise funds but that does not want to issue debt or dilute its |

| |EPS will most likely |

|A. | |

|issue preferred stock.; | |

| | |

|B. | |

|execute a stock split.; | |

| | |

|C. | |

|issue convertible debentures.; | |

| | |

|D. | |

|execute a reverse stock split. | |

| | |

|15. |Preferred stock investors are primarily subject to two types of risk. These two |

| |primary types of risk are |

|A. | |

|interest rate and business risk.; | |

| | |

|B. | |

|event risk and liquidity.; | |

| | |

|C. | |

|purchasing power risk and liquidity risk.; | |

| | |

|D. | |

|financial risk and event risk. | |

| | |

|16. |When issuing preferred stock, the issuing company |

| |typically agrees that it will pay preferred |

| |stockholders |

|A. | |

|a dividend that is a certain percentage higher than the dividend payable | |

|to common stockholders.; | |

| | |

|B. | |

|the dividend payable to common stockholders, plus a special conversion | |

|bonus. | |

| | |

|C. | |

|a fixed level of semi-annual dividends, and that such payment are to be | |

|paid only if dividends are also paid to common stockholders. | |

| | |

|D. | |

|a fixed level of quarterly dividends, and that such payments will take | |

|priority over common stock dividends. | |

| | |

|17. |A share of preferred with a $100 par value, which pays a 12% dividend, should have a current price of _____ when |

| |the dividend yield is 10%? |

|A. | |

|$100 | |

| | |

|B. | |

|$12; | |

| | |

|C. | |

|$83; | |

| | |

|D. | |

|$120 | |

| | |

|18. |Convertible bonds can generally be converted into |

|A. | |

|share of the issuing company's common stock.; | |

| | |

|B. | |

|parcels of mortgage pass-through certificates. | |

| | |

|C. | |

|additional shares of debenture bonds. | |

| | |

|D. | |

|shares of the issuing company's preferred stock.; | |

| | |

|19. |A convertible bond has a par value of $1000 and a conversion price of $74. How many shares can the |

| |bondholder receive in exchange for the bond? |

|A. | |

|11.2 shares; | |

| | |

|B. | |

|9.8 shares; | |

| | |

|C. | |

|13.5 shares. | |

| | |

|D. | |

|7.4 shares; | |

| | |

|20. |Which of the following statements about conversion premiums is (are) correct?1. Conversion premiums often |

| |amount to as much as 25 to 30% or more of an issue's true conversion value.2. Conversion premiums tend to |

| |fade away as the price of the convertible goes up. |

|A. | |

|1 only; | |

| | |

|B. | |

|2 only; | |

| | |

|C. | |

|Both 1 and 2; | |

| | |

|D. | |

|Neither 1 or 2. | |

| | |

P10-5)

After-tax yield ’ before-tax yield ( [1 – {ftr + str (1 – ftr)}]

Where: ftr ’ federal tax rate and str ’ state tax rate

0.07 ( [1 – {0.33 + 0.08(1 – 0.33)}] ’ 0.07 [1 – (0.33 + 0.0536)]

’ 0.07 (( [1 – 0.3836] ’ 0.07 [0.6164] ’ 0.043 or 4.3%

P10-10)

Price at 7% yield ($100/0.07) ’ $1,428.57

Price at 6% yield ($100/0.06) ’ –1,666.67

Loss on sale –238.10

Interest Income +100.00

Net Loss –$138.10

Colwyn lost $138.30 on this investment because interest rates went up.

Case Problem10-1)

(a) Max and Veronica don’t rely on the income from their investments for their day-to-day needs. They have an adequate income, so their bond portfolio can be used primarily to maximize total income on a longer-term basis (capital appreciation and high current income). They should invest with a view toward maximizing the total return over their holding period, rather than either interest or capital

gains alone. This implies a middle-of-the-road approach that involves some current income (that can be reinvested) and some capital gains.

(b) Max and Veronica could consider a variety of issues. For example, Treasury obligations maturing in twenty years or more would be one option. Treasury obligations have low risk, are non-callable or have very long call deferment periods, and are exempt from state and local taxes. Agency issues are another good choice for them, since most have low risk but offer higher yields than Treasuries. Many agency issues are also exempt from state and local taxes. Most municipal bonds are exempt from federal income taxes, providing a high fully taxable equivalent yield given the Peters’ tax bracket. Corporate bonds may also be attractive because of their high yields. Also, they might give serious consideration to deep discounted bonds for their capital gains potential; the low coupons also reduce reinvestment problems.

P11-1)

Bond A: $1,000 par value, 5 percent coupon, 15-year life, priced to yield 8 percent

Bond B: $1,000 par value, 7.5 percent coupon, 20-year life, priced to yield 6 percent

Bond A, with a 5 percent coupon and an 8 percent yield, must sell at a discount; it will be priced

below $1,000. Bond B, on the other hand, is a premium bond (its coupon is greater than its yield)

and it will sell at a much higher price than Bond A:

Price of Bond A ’ $50 × PVIFA8%,15 yrs. + $1,000 × PVIF8%,15 yrs.

’ $50 × 8.560 + $1,000 × 0.315

’ $428 + 315 ’ $743

Price of Bond B ’ $75 × PVIFA6%,20 yrs. + $1,000 × PVIF6%,20 yrs.

’ $75 × 11.470 + $1,000 × 0.312

’ $860.25 + 312 ’ $1,172.25

P11-13)

PVIF ’ Price/Par ’ 0.209. PVIF of 0.209 for 15 years ’ 11%.

Calculator Solution:

15N, –209PV, 1000FV; CPT I/Y ’ 11.0%

P11-19)

Percent change in bond price ’ –1 × modified duration × change in interest rates

Modified duration ’ Macaulay Duration/(1 + Yield) ’ 8.62/1.08 ’ 7.98.

Percent change in bond prices ’ –1 × 7.98 × 0.005 ’ –0.0399 or –3.99%

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