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1 . Three $1,000 face value
bonds that mature in 10 years have the same level of risk, hence their YTMs are
equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond
C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain
constant for the next 10 years, which of the following statements is CORRECT?
a. Bond A’s current yield will
increase each year.
b. Since the bonds have the same
YTM, they should all have the same price, and since interest rates are not
expected to change, their prices should all remain at their current levels
until maturity.
c. Bond C sells at a premium (its
price is greater than par), and its price is expected to increase over the next
year.
d. Bond A sells at a discount
(its price is less than par), and its price is expected to increase over the
next year.
e. Over the next year, Bond A’s
price is expected to decrease, Bond B’s price is expected to stay the same, and
Bond C’s price is expected to increase.
2. Which of the following
statements is CORRECT?
a. Two bonds have the same
maturity and the same coupon rate. However, 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 above the coupon
rate.
b. A callable 10-year, 10% bond
should sell at a higher price than an otherwise similar noncallable bond.
c. Corporate 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 have the same
maturity and the same coupon rate. However, 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 above 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 curve is upward sloping, the
required rate of return will be lower on the callable bond.
3. Which of the following
statements is CORRECT?
a. Assume that two bonds have
equal maturities and are of equal risk, but one bond sells at par while the
other sells at a premium above par. The premium bond must have a lower current
yield and a higher capital gains yield than the par bond.
b. A bond’s 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. A discount bond’s price
declines each year until it matures, when its value equals its par value.
4. Suppose a new company decides
to raise a total of $200 million, with $100 million as common equity and $100
million as long-term debt. The debt can be mortgage bonds or debentures, but by
an iron-clad provision in its charter, the company can never raise any
additional debt beyond the original $100 million. Given these conditions, which
of the following statements is CORRECT?
a. The higher the percentage of
debt represented by mortgage bonds, the riskier both types of bonds will be
and, consequently, the higher the firm’s total dollar interest charges will be.
b. If the debt were raised by
issuing $50 million of debentures and $50 million of first mortgage bonds, we
could be certain that the firm’s total interest expense would be lower than if
the debt were raised by issuing $100 million of debentures.
c. In this situation, we cannot
tell for sure how, or whether, the firm’s total interest expense on the $100
million of debt would be affected by the mix of debentures versus first
mortgage bonds. The interest rate on each of the two types of bonds would
increase as the percentage of mortgage bonds used was increased, but the result
might well be such that the firm’s total interest charges would not be affected
materially by the mix 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 $50 million of debentures and $50 million of first mortgage bonds, we
could be certain that the firm’s total interest expense would be lower than if
the debt were raised by issuing $100 million of first mortgage bonds.
5. Cosmic Communications Inc. is
planning two new issues of 25-year bonds. Bond Par will be sold at its $1,000
par value, and it will have a 10% semiannual coupon. Bond OID will be an
Original Issue Discount bond, and it will also have a 25-year maturity and a
$1,000 par value, but its semiannual coupon will be only 6.25%. If both bonds
are to provide investors with the same effective yield, how many of the OID
bonds must Cosmic issue to raise $3,000,000? Disregard flotation costs, and
round your final answer up to a whole number of bonds.
a. 4,228
b. 4,337
c. 4,448
d. 4,562
e. 4,676
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