a. An investment in a coupon bond will provide the investor with a return equal to the bond’s yield to maturity at the time of purchase if: i. The bond is not called for redemption at a price that exceeds its par value. ii. All sinking fund payments are made in a prompt and timely fashion over the life of the issue. iii. The reinvestment rate is the same as the bond’s yield to maturity and the bond is held until maturity. iv. All of the above. b. A bond with a call feature: i. Is attractive because the immediate receipt of principal plus premium produces a high return. ii. Is more apt to be called when interest rates are high because the interest savings will be greater. iii. Will usually have a higher yield to maturity than a similar non-callable bond. iv. None of the above. c. In which one of the following cases is the bond selling at a discount? i. Coupon rate is greater than current yield, which is greater than yield to maturity. ii. Coupon rate, current yield, and yield to maturity are all the same. iii. Coupon rate is less than current yield, which is less than yield to maturity. iv. Coupon rate is less than current yield, which is greater than yield to maturity. d. Consider a 5-year bond with a 10% coupon that has a present yield to maturity of 8%. If interest rates remain constant, 1 year from now the price of this bond will be: i. Higher. ii. Lower. iii. The same. iv. Par.
a. A 6% coupon bond paying interest annually has a modified duration of 10 years, sells for $800, and is priced at a yield to maturity of 8%. If the YTM increases to 9%, what is the predicted change in price using the duration concept? b. A 6% coupon bond with semiannual coupons has a convexity (in years) of 120, sells for 80% of par, and is priced at a yield to maturity of 8%. If the YTM increases to 9.5%, what is the predicted contribution to the percentage change in price due to convexity? c. A bond with annual coupon payments has a coupon rate of 8%, yield to maturity of 10%, and Macaulay duration of 9 years. What is the bond’s modified duration? d. When interest rates decline, the duration of a 30-year bond selling at a premium: i. Increases. ii. Decreases. iii. Remains the same. iv. Increases at first, then declines. e. If a bond manager swaps a bond for one that is identical in terms of coupon rate, maturity, and credit quality but offers a higher yield to maturity, the swap is: i. A substitution swap. ii. An interest rate anticipation swap. iii. A tax swap. iv. An intermarket spread swap. f. Which bond has the longest duration? i. 8-year maturity, 6% coupon. ii. 8-year maturity, 11% coupon. iii. 15-year maturity, 6% coupon. iv. 15-year maturity, 11% coupon.
Q1. Bond Prices For example, if a $100,000 bond is issued at 102 the bond will sell for 102% of the face value or for $102,000. a. A $100,000 bond issued @ 99 will sell for ___________ of the face value, which is ________. b. A $50,000 bond issued @ 103 will sell for ___________ of the face value, which is ________. A Bond Issuance raises large amounts of capital ($$$) by issuing many bonds of small denominations (e.g. $1,000). Principal = Maturity Value = Face Value = the amount the issuing corporation pays to the holder of the bond at maturity Stated Rate = Coupon Rate = the rate of the required annual interest payment Principal x Stated Rate = Annual Interest Payment Use the information on the bond payable below to answer the following question. Bond Payable Principal $10,000 Stated rate 10% Matures in 10 years Q2. The issuing corporation makes interest payments of (___________ / $10,000 / $20,000) annually to the holder of this bond. Over the life of the bond, the corporation will pay out ($1,000 / ___________ / $20,000) in interest payments and repay ($1,000 / ___________ / $20,000) of principal at maturity, for a total cash outflow of ($1,000 / $10,000 / ___________) over the life of the bond. Q3. Assume the bond was originally issued for $10,000 and held to maturity. a. The corporation paid out ___________ in total interest payments + paid out ___________ of principal at maturity = total amounts paid of ___________ b. At issuance the corporation received from the investor ___________ c. The difference is the cost of borrowing over the ten years = ___________ d. This bond was issued at (a premium / ___________ / a discount) because the market rate of interest was (less than 10% / ___________ / more than 10%). Q4. Assume the bond was originally issued for $8,000 and held to maturity. a. The corporation paid out ___________ in total interest payments + paid out ___________ of principal at maturity = total amounts paid of ___________ b. At issuance the corporation received from the investor ___________ c. The difference is the cost of borrowing over the ten years = ___________ d. This bond was issued at (a premium / par / ___________) because the market rate of interest was (less than 10% / 10% / ___________). Q5. Assume the bond was originally issued for $12,000 and held to maturity. a. The corporation paid out ___________ in total interest payments + paid out ___________ of principal at maturity = total amounts paid of ___________ b. At issuance the corporation received from the investor ___________ c. The difference is the cost of borrowing over the ten years = ___________ d. This bond was issued at (___________ / par / a discount) because the market rate of interest was (___________ / 10% / more than 10%). Q6. The issuing corporation would prefer to borrow money in a (___________ / 8% / 12%) market, while an investor would prefer a (4% / 8% / ___________) market. Q7. When will a bond be issued at a premium? Par? A discount? Q8. A corporation would prefer to issue bonds at a (___________ / par / discount). Why?
A 12.75-year maturity zero-coupon bond selling at a yield to maturity of 8% (effective annual yield) has convexity of 150.3 and modified duration of 11.81 years. A 30-year maturity 6% coupon bond making annual coupon payments also selling at a yield to maturity of 8% has nearly identical duration—11.79 years—but considerably higher convexity of 231.2. a. Suppose the yield to maturity on both bonds increases to 9%. What will be the actual percentage capital loss on each bond? What percentage capital loss would be predicted by the duration-with-convexity rule? b. Repeat part (a), but this time assume the yield to maturity decreases to 7%. c. Compare the performance of the two bonds in the two scenarios, one involving an increase in rates, the other a decrease. Based on the comparative investment performance, explain the attraction of convexity. d. In view of your answer to (c), do you think it would be possible for two bonds with equal duration but different convexity to be priced initially at the same yield to maturity if the yields on both bonds always increased or decreased by equal amounts, as in this example? Would anyone be willing to buy the bond with lower convexity under these circumstances?
Long-term Treasury bonds currently are selling at yields to maturity of nearly 6%. You expect interest rates to fall. The rest of the market thinks that they will remain unchanged over the coming year. In each question, choose the bond that will provide the higher holding-period return over the next year if you are correct. Briefly explain your answer. a. i. A Baa-rated bond with coupon rate 6% and time to maturity 20 years. ii. An Aaa-rated bond with coupon rate of 6% and time to maturity 20 years. b. i. An A-rated bond with coupon rate 3% and maturity 20 years, callable at 105. ii. An A-rated bond with coupon rate 6% and maturity 20 years, callable at 105. c. i. A 4% coupon non callable T-bond with maturity 20 years and YTM = 6%. ii. A 7% coupon non callable T-bond with maturity 20 years and YTM = 6%.
Long-term Treasury bonds currently are selling at yields to maturity of nearly 8%. You expect interest rates to fall. The rest of the market thinks that they will remain unchanged over the coming year. In each question, choose the bond that will provide the higher holding-period return over the next year if you are correct. Briefly explain your answer. a. i. A Baa-rated bond with coupon rate 8% and time to maturity 20 years. ii. An Aaa-rated bond with coupon rate of 8% and time to maturity 20 years. b. i. An A-rated bond with coupon rate 4% and maturity 20 years, callable at 105. ii. An A-rated bond with coupon rate 8% and maturity 20 years, callable at 105. c. i. A 6% coupon noncallable T-bond with maturity 20 years and YTM 5 8%. ii. A 9% coupon noncallable T-bond with maturity 20 years and YTM 5 8%.
The following information was taken from the financial statements of ALZA Corporation. Note 6: Borrowings On July 28, 2000, ALZA completed a private offering of the 3% Zero Coupon Convertible Subordinated Debentures, which were issued at a price of $551.26 per $1,000 principal amount at maturity. At December 29, 2002, the outstanding 3% Debentures had a total principal amount at maturity of $1.0 billion with a yield to maturity of 3% per annum, computed on a semiannual bond equivalent basis... . At December 29, 2002, the fair value based on quoted market value of the 3% Debentures was $813 million.... Required: 1. ALZA issued zero coupon debentures with a total maturity value of $1.0 billion at a price of $551.26 per $1,000 principal amount at maturity. How much cash did the company receive when it issued these debentures? 2. The debentures mature in 20 years from the date of issuance, but no interest payments are made until maturity. Show that the issue price of $551.26 gives investors a 3% yield to maturity. 3. Suppose that the debentures were issued on January 1, 2000, instead of July 28, 2000. Reproduce the journal entries ALZA would record in 2000 for the debentures. For each cash entry indicate whether the cash increase or decrease represents an operating, investing, or financing activity. 4. Explain why the debentures have a market value of $813 million at the end of 2002, almost $300 million more than the 2000 issue price.
Andre Weather by, an aspiring artist, had just sold his fifth painting of the year and now had $5,000 in cash to invest. His first inclination was to place his money in a CDIC insured savings account, but he was disappointed to find out that his annual return would be less than 2 percent. Knowing little about investment alternatives, Andre knew he must seek advice from a pro. He recalled that at his ten-year high school reunion he had run into Carol Upshaw, a University of Saskatchewan finance major, who was now a stockbroker with Dominion Securities. Early Monday morning Andre called Carol and she said she would be able to provide him with help. During the course of their conversation, Andre indicated that he wanted to invest his funds in a stock or bond that provided a good annual return and also hadthe potential to increase in value. Beyond that, he was able to stipulate little else. Carol considered a number of alternatives, but decided on Hamilton Products. She was particularly interested in the firm's convertible securities, which paid 6.5 percent annual interest and were also convertible in 27 shares of common stock. The bonds had a maturity date 20 years in the future. She explained to Andre that not only would he receive a good annual return, but he could enjoy appreciation in value if the common stock did well. The bonds were to be issued at a par value of $1,000 on the day that Andre called. The common stock of Hamilton Products was currently selling for $32.75 per share. Straight, nonconvertible bonds of equal risk and maturity to those of Hamilton Products were currently yielding 8 percent. Carol said that because the bonds paid 6.5 percent interest, they should hold up well in value even if the stock did poorly. The initial pure bond price value was $853.17. Hamilton Products produced hot asphalt and ready-mixed concrete and was located in Vancouver, British Columbia. Plans called for $12 billion for highway and mass transit projects over the next six years. Although the design and approval of new projects was taking longer than expected, by late 2003 competitive bidding on projects was starting and Hamilton Products stood to be a major winner in the process. For this reason Carol thought the firm's share price could well increase in the future. Andre decided to buy the convertible bonds. Since his expertise was in painting and not investing, he wanted to get back to his main endeavour as quickly as possible. Fortunately, the stock did well over the next two years, increasing in value to $45.50. The bonds also increased in value to $1,250. It was at this point that Carol called Andre and warned him that a major provincial investigation into highway construction contracts might be undertaken by a subcommittee of the B.C. legislature. She thought Hamilton Products could be a target of the investigation and suggested that he take his profits and look elsewhere for an investment. However, Andre was now intrigued by his high returns and decided to hold onto his bonds (somewhat to Carol's disappointment). As it turned out, Hamilton Products was found in violation of provincial regulations on a number of major contracts and the share price plummeted to $29.75 per share in the next year. During the same time period, a combination of a downgrading of the firm's credit rating and an increase in interest rates caused the yield on straight, nonconvertible bonds of those of equal risk and maturity to Hamilton Products to go to 10 percent. Hamilton Product's bonds had 17 years remaining to maturity. Although Andre was disappointed in the drop in the firm's common stock price, he thought he could take some comfort in the fact that the convertible bonds were an interest-paying security, which gave them a basic value below which they normally would not fall. a. At the time that Andre purchased the bonds, what was the conversion value? What was the conversion premium? b. When the bonds got up to $1 ,250, what was the conversion premium? c. Assume there is a conversion premium of $98 when the common stock price fell to $29.75. What is the price of the convertible bond? d. What is the pure bond value after interest rates have gone up to 10 percent? The yield to maturity (required rate of return) is 10 percent and there are 17 years left to maturity. The bonds are continuing to make annual interest payments of 6.5 percent ($65). The principal payment at maturity is $1 ,000. e. How much comfort should Andre take in the pure bond value computed in part d?
On October 1, 2005, Fannie Mae issued a mortgage pass-through security and the prospectus supplement stated the following: FANNIE MAE MORTGAGE-BACKED SECURITIES PROGRAM SUPPLEMENT TO PROSPECTUS DATED JULY 01, 2004 $464,927,576.00 ISSUE DATE OCTOBER 01, 2005 SECURITY DESCRIPTION FNMS 05.0000 CL-844801 5.0000 PERCENT PASS-THROUGH RATE FANNIE MAE POOL NUMBER CL-844801 CUSIP 31407YRW1 PRINCIPAL AND INTEREST PAYABLE ON THE 25TH OF EACH MONTH BEGINNING NOVEMBER 25, 2005 POOL STATISTICS SELLER WELLS FARGO BANK, N.A SERVICER WELLS FARGO BANK, N.A NUMBER OF MORTGAGE LOANS 1986 AVERAGE LOAN SIZE $234,312.06 MATURITY DATE 10/01/2035 WEIGHTED AVERAGE COUPON RATE 5.7500% WEIGHTED AVERAGE LOAN AGE 1 mo WEIGHTED AVERAGE LOAN TERM 360 mo WEIGHTED AVERAGE REMAINING MATURITY 359 mo WEIGHTED AVERAGE LTV 73% WEIGHTED AVERAGE CREDIT SCORE 729 Answer the below questions. (a) What does the “pass-through rate” of 5% for this security mean? It means that the coupon rate for the security is 5.00%. (b) What is the average note rate being paid by the borrowers in the loan pool for this security? (c) Why does the pass-through rate differ from the average note rate paid by the borrowers in the loan pool for this security? (d) What is the pool number for this security, and why is the pool number important? (e) What is the prefix for this security, and what does a prefix indicate? (f) The “maturity date” for this security is shown as “10/01/2035.” An investor in this security might be concerned about its very long maturity (30 years). Why is the maturity date a misleading measure of the security’s maturity? (g) If an investor purchased $15 million principal of this security and, in some month, the cash flow available to be paid to the security holders (after all fees are paid) is $12 million, how much is the investor entitled to receive? (h) Every month a pool factor would be reported for this security. If the pool factor for some month is 0.92, what is the outstanding mortgage balance for the loan pool for that month? (i) Why does the weighted average loan term differ from the weighted average remaining maturity? (j) Wells Fargo Bank, N.A. is identified as the seller and the servicer. What does that mean? (k) What does the following mean: “MORTGAGE-BACKED SECURITIES PROGRAM SUPPLEMENT TO PROSPECTUS DATED JULY 01, 2004”?
Movado Suppliers had the following transactions: Mar. 1 Sold merchandise on account to R. Sticca, $5,000. 20 R. Sticca gave a $5,000, 90-day, 12% note to extend time for payment. 30 R. Sticca’s note is discounted at Commerce Bank at a discount rate of 15%. Apr. 20 Received a $3,000, 60-day, 10% note from K. Jones in payment for sale of merchandise. May 5 K. Jones’s note is discounted at Commerce Bank at a discount rate of 12%. June 19 K. Jones’s note is dishonored. The bank bills Movado for the maturity value of the note plus a $40 bank fee. July 31 K. Jones’s dishonored note is collected; Jones pays Movado the maturity value of the note, the $40 bank fee, and interest at 10% on the maturity value plus the bank fee. Aug. 1 Sold merchandise on account to R. Brown, $5,600. 12 R. Brown paid $400 and gave a $5,200, 30-day, 12% note to extend time for payment. Sept. 11 R. Brown paid $400, plus interest, and gave a new $4,800, 60-day, 14% note to extend time for payment. 26 R. Brown’s note is discounted at Commerce Bank at a discount rate of 16%. Nov. 10 R. Brown’s note is dishonored. The bank bills Movado for the maturity value of the note plus a $40 bank fee. Dec. 15 R. Brown’s dishonored note is collected. Brown pays Movado the maturity value of the note, the $40 bank fee, and interest at 14% on the maturity value plus the bank fee. REQUIRED Record the transactions in a general journal.
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