Chapter 14 The Valuation of Fixed Income Securities
TRUE/FALSE
principal, when it matures, and the interest it pays.
bonds increase.
interest rates fall.
are also expecting bond prices to rise.
matures after eight years, the price of the bond will
exceed $1,000 if the current interest rate is 9 percent.
would increase.
exceeds the yield to maturity.
maturity exceeds the current yield.
sell for $978, the current interest rate exceeds 7 percent.
current yield exceeds the yield to maturity.
bond if interest rates rise.
encourage early retirement of the bond.
rates have fallen.
repurchase the bonds on the market instead of calling and
redeeming them.
more than the prices of high coupon bonds.
economy allocates scarce credit.
AAA–rated bonds and B–rated bonds tends to rise when yields
increase.
less than bonds with five years to maturity.
bonds with large coupons.
make its payments to bondholders.
duration.
smaller duration even though it may have a longer term to
maturity.
coupon bonds.
bond’s price.
are needed reduces reinvestment risk.
the investor reinvests the interest payment, the realized
yield exceeds the yield to maturity.
often valued as if it were a bond.
is riskier than bonds issued by the same firm.
with changes in interest rates.
should sell preferred stock and buy bonds.
retirement, its price is more volatile than preferred stock
without the retirement feature.
MULTIPLE CHOICE
1. the coupon rate
2. the terms of the indenture
3. the maturity date
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
and current interest rates are 9 percent, the current price
of the bond should not be
1. $1,000
2. $872
3. $1,140
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. only 2
ten years, and costs $1,100, the current yield is
a. 8.2 percent
b. 10.1 percent
c. 9.0 percent
d. 9.6 percent
1. the current yield is 5 percent
2. the yield to maturity is 5 percent
3. the bond is selling for par
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
a. coupon interest divided by the price of the bond
b. coupon
c. interest paid, adjusted for price changes
d. going rate of interest
a. the yield to maturity exceeds the current yield
b. the current yield exceeds the yield to maturity
c. the current yield has risen
d. the bond cannot be called
1. the prices of existing bonds would rise
2. the prices of existing bonds would fall
3. yields to maturity would rise
4. yields to maturity would fall
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
rates were going to fall, that individual should
a. take no action
b. buy bonds
c. sell bonds
d. acquire money market securities
1. the yield to maturity exceeds the current yield
2. the yield to maturity is less than the current
yield
3. interest rates have risen
4. interest rates have fallen
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
a. is important if interest rates have fallen
b. is important if interest rates have risen
c. equals the yield to maturity
d. equals the current yield
a. yields are constant
b. coupons are constant
c. the spread between yields is constant
d. short–term bond prices fluctuate more
a. the timing of interest payments
b. the timing of principal repayment
c. the current rate of interest
d. the timing of both interest and principal
repayment
funds are needed
a. reduces reinvestment rate risk
b. increases impact of higher interest rates
c. reduces the impact of default
d. increases the bond’s yield
a. a variable dividend
b. a fixed dividend
c. a stock dividend
d. no dividend
because
a. they both have voting power
b. interest and dividend payments are fixed
c. interest and dividend payments are legal
obligations
d. interest and dividend payments are tax–deductible
expenses
a. rises
b. falls
c. is not affected
d. rises or falls
dividend of $5 and comparable yields are 10 percent,
the price of this preferred stock will be
a. $100
b. $75
c. $50
d. $25
1. in anticipation of lower interest rates
2. in anticipation of higher interest rates
3. to receive a flow of tax–free income
4. to receive a flow of income
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
PROBLEMS
1. A high–yield bond has the following terms:
Principal amount $1,000
Annual interest paid $100
Maturity 10 years
a. What is the bond’s price if comparable debt yields 12
percent?
b. What would be the price if comparable debt yields 12
percent and the bond matures after five years?
c. What are the current yields and yields to maturity in a
and b?
d. What would be the bond’s price in a and b if interest
rates declined to 9 percent?
e. What are the current yield and yield to maturity in d?
f. What two generalizations may be drawn from the above
price changes?
2. A bond with a 5 percent coupon ($50 a year) that
matures after eight years is selling for $779. What is the
yield to maturity?
3. A bond has the following terms:
Annual interest $100
Term 15 years
Principal $1,000
a. What is the current price of the bond if comparable
yields are 7 percent?
b. What are the current yield and yield to maturity given
the price of the bond in the previous question?
c. If you expect the bond to be called at the end of the
year, what would be the maximum price you should pay for
the bond?
d. Is there a reason to expect that the bond will be
called?
4. Compute the durations of the following bonds and rank
them on the basis of their price volatility. Assume that
the current rate of interest is 8 percent.
Bond Coupon Term
A 8 percent 10 years
B 12 percent 10 years
C 8 percent 5 years
Confirm your ranking by calculating the percentage change
in the price of each bond when interest rates rise from 8
to 12 percent.
5. If a preferred stock pays an annual $4.50 dividend,
what should be the price of the stock if comparable yields
are 10 percent? What would be the loss if yields rose to 12
percent?
6. a. What is the value (i.e., price) of the following
preferred stocks if the comparable yield is 10 percent?
MN Inc. $6 preferred stock, $100 par
ST Inc. $6 preferred stock, $100 par and the
stock is to be retired after twenty years
b. What is the current yield offered by each preferred
stock?
c. Why are the prices of these preferred stocks different
even though they both pay the same dividend?
7. If you purchase a $5 preferred stock for $40 a share,
what is the current yield? If you anticipate that yields
will decline to 10 percent, what will be the anticipated
capital gain on this investment?
8. Junk Corp.’s high–yield bond has the following features:
Principal $1,000
Coupon 10%
Maturity 5 years
Special features: Company may extend the life
of the bond to 10 years
a. If interest rates are currently 12 percent on
comparable high-yield securities and are not expected to
change, what is the price of this bond?
b. If interest rates are currently 9 percent on comparable
high–yield securities and are not expected to change, what
is the price of this bond?
c. If interest rates are currently 9 percent on comparable
high–yield securities but the investor has no forecast as
to future rates, what is the possible range of prices for
this bond?
9. You purchase a high–yield, junk bond for $1,000 that
pays $140 annually. After buying the bond, yields decline
and you are able to reinvest the interest at only 9
percent. You reinvest all the interest payments. How much
will you have when the bond is retired after twelve years?
What was the annual return you earned on this investment?
10. An investor buys a $1,000, 20 year 7 percent (interest
paid semiannually) bond at par. After five years have
passed, interest rates are 10 percent. How much did the
investor lose on the purchase of the bond?
SOLUTIONS TO PROBLEMS
