Robert Black and Carol Alvarez are vice presidents of Western Money Management and codirectors of the companys
Question:
a. What are a bond’s key features?
b. What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
c. How is the value of any asset whose value is based on expected future cash flows determined?
d. How is a bond’s value determined? What is the value of a 10-year, $1,000 par value bond with a 10% annual coupon if its required return is 10%?
e. (1) What is the value of a 13% coupon bond that is otherwise identical to the bond described in Part d? Would we now have a discount or a premium bond?
(2) What is the value of a 7% coupon bond with these characteristics? Would we now have a discount or premium bond?
(3) What would happen to the values of the 7%, 10%, and 13% coupon bonds over time if the required return remained at 10%?
f. (1) What is the yield to maturity on a 10-year, 9%, annual coupon, $1,000 par value bond that sells for $887.00? that sells for $1,134.20? What does the fact that it sells at a discount or at a premium tell you about the relationship between rd and the coupon rate?
(2) What are the total return, the current yield, and the capital gains yield for the discount bond? Assume that it is held to maturity and the company does not default on it. (Hint: Refer to Footnote 8 for the definition of the current yield and to Table 7-1.)
g. What is interest rate (or price) risk? Which has more interest rate risk, an annual payment 1-year bond or a 10-year bond? Why?
h. What is reinvestment rate risk? Which has more reinvestment rate risk, a 1-year bond or a 10-year bond?
i. How does the equation for valuing a bond change if semiannual payments are made? Find the value of a 10-year, semiannual payment, 10% coupon bond if nominal rd ¼ 13%.
j. Suppose for $1,000 you could buy a 10%, 10-year, annual payment bond or a 10%, 10-year, semiannual payment bond. They are equally risky. Which would you prefer? If $1,000 is the proper price for the semiannual bond, what is the equilibrium price for the annual payment bond?
k. Suppose a 10-year, 10%, semiannual coupon bond with a par value of $1,000 is currently selling for $1,135.90, producing a nominal yield to maturity of 8%. However, it can be called after 4 years for $1,050.
(1) What is the bond’s nominal yield to call (YTC)?
(2) If you bought this bond, would you be more likely to earn the YTM or the YTC? Why?
l. Does the yield to maturity represent the promised or expected return on the bond? Explain.
m. These bonds were rated AA- by S&P. Would you consider them investment-grade or junk bonds?
n. What factors determine a company’s bond rating?
o. If this firm were to default on the bonds, would the company be immediately liquidated? Would the bondholders be assured of receiving all of their promised payments? Explain. Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these... Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest... Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...
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Related Book For
Fundamentals of Financial Management
ISBN: 978-0324597707
12th edition
Authors: Eugene F. Brigham, Joel F. Houston
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