978-1259720697 Chapter 18 Solution Manual

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Chapter 18

Corporate Bonds

Concept Questions

1. A bond refunding is a call in which an outstanding issue is replaced with a lower coupon issue. The

2. Call protection refers to the period during which the bond is not callable, typically five to ten years

3. A put bond gives the owner the right to force the issuer to buy the bond back, typically either at face

4. All else the same, a callable bond will have a higher yield (because buyers don’t like call features

5. The advantage is that the coupon adjusts up when interest rates rise, so the bond’s price won’t fall (at

6. Some examples of embedded options in bonds are: 1) Put bonds have a put option feature that gives

7. The critical distinction lies in their credit ratings when they were first issued. Original issue junk

8. Because of the negative convexity effect, callable bonds cannot rise in value as far as noncallable

bonds, so they do have less interest rate sensitivity. Also, a callable bond may “mature” sooner than

9. A refunding provision restricts the ability of an issuer to call their bonds. Such a provision specifies

that the issuer cannot call their bonds for the purpose of refunding their debt with a new bond issue.

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10. T-bills are pure discount, zero-coupon instruments with original maturities of one year or less. T–

11. Agencies have slightly more credit risk. They are subject to state taxes, they have a variety of call

features, and they are less liquid (and have wider spreads). These factors translate into a somewhat

12. Treasuries are subject to federal taxes, but not state and local taxes. Munis are tax-exempt at the

14. To a certain extent, it’s an apples and oranges issue. Munis are much less liquid, have greater default

15. It is true. The reason is that Treasuries are callable at par. Referring back to Chapter 10, if two

Solutions to Questions and Problems

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple

steps. Due to space and readability constraints, when these intermediate steps are included in this

solutions manual, rounding may appear to have occurred. However, the final answer for each problem is

found without rounding during any step in the problem.

While we show calculations using equations, many from this chapter are more easily completed using a

financial calculator. Each input, however, is easily identified from the equations we provide.

Core Questions

1. $1,000 / 45 = $22.22

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6. The minimum value is the larger of the conversion value or the intrinsic bond value. The conversion

value is 25 × $49 = $1,225. To calculate the intrinsic bond value, note that we have a face value of

7. You can convert or tender the bond (i.e., surrender the bond in exchange for the call price). If you

10. Bonds available for competitive bids = $60B – 8B = $52 billion

Intermediate Questions

16. You must buy at the asked yield of 2.73%. This implies a price of: $1,000 × (1 – .0273 × 152 / 360)

17. You must sell at the bid yield of 2.75%. This implies a price of: $1,000 × (1 – .0275 × 152 / 360) =

18. The minimum face value is $1,000. You must pay the ask price of 102.375 percent of face. This

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21. An increase in the stock’s price volatility increases the bond price. The conversion option on the

22. Conversion price = $960 / 25 = $38.40

23. The two components are the straight bond value (its value as a bond) and the option value (the value

associated with the potential conversion into equity).

The increase in equity price does not affect the straight value of the Sands’ convertible but does

Spreadsheet Problems

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CFA Exam Review by Kaplan Schweser

1. c

2. a

3. c

Since the bond has a fixed coupon, it becomes relatively less attractive to investors when interest

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