Chapter 08

1. A bond that makes no coupon payments and

is initially priced at a deep discount is called
a _____ bond.

A.
B.
C.
D.
E.

2. The stated interest payment, in dollars,

made on a bond each period is called the
bond's:

A.
B.
C.
D.
E.

3. The principal amount of a bond that is

repaid at the end of the loan term is called
the bond's:

A.
B.
C.
D.
E.

4. The specified date on which the principal

amount of a bond is repaid is called the
bond's:

A.
B.
C.
D.
E.
5. The rate of return required by investors in
the market for owning a bond is called the:

A.
B.
C.
D.
E.

6. The annual interest paid by a bond divided

by the bond’s face value is called the:

A.
B.
C.
D.
E.

7. A bond with a face value of $1,000 that sells

for $1,000 in the market is called a _____
bond.

A.
B.
C.
D.
E.

8. A bond with a face value of $1,000 that sells

for less than $1,000 in the market is called a
_____ bond.

A.
B.
C.
D.
E.
9. The relationship between nominal rates, real
rates, and inflation is known as the:

A.
B.
C.
D.
E.

10. The relationship between nominal interest

rates on default-free, pure discount
securities and the time to maturity is called
the:

A.
B.
C.
D.
E.

11. The _____ premium is that portion of a

nominal interest rate or bond yield that
represents compensation for expected
future loss in purchasing power.

A.
B.
C.
D.
E.

12. The _____ premium is that portion of the

bond yield that represents compensation for
potential difficulties that might be
encountered should the bond holder wish to
sell the bond prior to maturity.

A.
B.
C.
D.
E.
13. A bond with a coupon rate of 6 percent that
pays interest semiannually and is priced at
par will have a market price of _____ and
interest payments in the amount of _____
each.

A.
B.
C.
D.

E.

14. All else constant, a bond will sell at _____

when the yield to maturity is _____ the
coupon rate.

A.
B.
C.
D.
E.

15. All else constant, a coupon bond that is

selling at a premium, must have:

A.
B.
C.
D.
E.

16. The market price of a bond increases when

the:

A.
B.
C.
D.
E.
17. Aspens is preparing a bond offering with a
coupon rate of 5.5 percent. The bonds will
be repaid in 10 years. The company plans to
issue the bonds at par value and pay
interest semiannually. Which one of the
following statements is correct?

A.
B.
C.
D.
E.

18. A par value bond offers a coupon rate of 7

percent with semiannual interest payments.
The effective annual rate provided by these
bonds must be:

A.
B.
C.
D.
E.

19. Rosina purchased a 15-year bond at par

value when it was initially issued. The bond
has a coupon rate of 7 percent and matures
13 years from now. If the current market
rate for this type and quality of bond is 7.5
percent, then Rosina should expect:

A.
B.
C.
D.
E.

20. A zero coupon bond:

A.
B.
C.
D.
E.
21. Which one of these bonds is the most
interest-rate sensitive?

A.
B.
C.
D.
E.

22. The yield to maturity:

A.
B.
C.
D.
E.

23. A newspaper listing of bond prices has an

"Asked yield" column. This yield is based on
the asked price and represents the:

A.
B.
C.
D.
E.

24. A bond is listed in a newspaper at a bid of

105.4844. This quote should be interpreted
to mean:

A.
B.
C.
D.
E.
25. If its yield to maturity is less than its coupon
rate, a bond will sell at a _____, and
increases in market interest rates will:

A.

B.

C.

D.

E.

26. The Fisher formula is expressed as _____

where R is the nominal rate, r is the real
rate, and h is the inflation rate.

A.
B.
C.
D.
E.

27.
Which one of these combinations of bond
ratings represents a crossover situation?

A.

B.
C.
D.

E.
28.
The term structure of interest rates reflects
the:

A.

B.

C.

D.

E.

29.
All else held constant, interest rate risk will
increase when the time to maturity:

A.

B.

C.

D.

E.
30.
The interest paid on any municipal bond is:

A.

B.

C.

D.

E.

31.
The dirty price of a bond is defined as the:

A.

B.

C.

D.

E.
32.
The interest rate for a tax-exempt bond that
equates to the rate paid on a taxable bond
is computed as:

A.

B.

C.

D.

E.

33.
Consider a bond with a coupon rate of 8
percent that pays semiannual interest and
matures in eight years. The market rate of
return on bonds of this risk is currently 11
percent. What is the current value of a
$1,000 face value bond?

A.

B.
C.
D.
E.
34. What is the value of a 20-year, zero-coupon
bond with a face value of $1,000 when the
market required rate of return is 9.6
percent, compounded semiannually?

A.
B.
C.
D.
E.

35. The bonds issued by Manson amp; Son bear

a coupon of 6 percent, payable
semiannually. The bond matures in 15 years
and has a $1,000 face value. Currently, the
bond sells at par. What is the yield to
maturity?

A.
B.
C.
D.
E.

36. A corporate bond has a coupon of 7.5

percent and pays interest annually. The face
value is $1,000 and the current market price
is $1,108.15. The bond matures in 14 years.
What is the yield to maturity?

A.
B.
C.
D.
E.
37. Otto Enterprises has a 15-year bond issue
outstanding with a coupon of 8 percent. The
bond is currently priced at $923.60 and has
a par value of $1,000. Interest is paid
semiannually. What is the yield to maturity?

A.
B.
C.
D.
E.

38. Chocolate and More offers a bond with a

coupon rate of 6 percent, semiannual
payments, and a yield to maturity of 7.73
percent. The bonds mature in 9 years. What
is the market price of a $1,000 face value
bond?

A.
B.
C.
D.
E.

39. Westover’s has an outstanding bond with a

coupon rate of 5.5 percent that matures in
12 years. The bond pays interest
semiannually. What is the market price of a
$1,000 face value bond if the yield to
maturity is 7.13 percent?

A.
B.
C.
D.
E.
40. Guggenheim offers a bond with annual
payments and a coupon rate of 5 percent.
The yield to maturity is 5.62 percent and the
maturity date is 9 years away. What is the
market price of a $1,000 face value bond?

A.
B.
C.
D.
E.

41. The Lo Sun Corporation offers a bond with a

current market price of $1,029.75, a coupon
rate of 8 percent, and a yield to maturity of
7.52 percent. The face value is $1,000.
Interest is paid semiannually. How many
years is it until this bond matures?

A.
B.
C.
D.
E.

42. Moon Lite Cafe has a semiannual, 5 percent

coupon bond with a current market price of
$988.52. The bond has a par value of
$1,000 and a yield to maturity of 5.68%.
How many years is it until this bond
matures?

A.
B.
C.
D.
E.
43. A firm offers a 10-year, zero coupon bond
with a face value of $1,000. What is the
current market price if the yield to maturity
is 7.6 percent, given semiannual
compounding?

A.

B.

C.

D.

E.

44. TJ’s offers a $1,000 face value, zero coupon

bond with a yield to maturity of 11.3
percent, given annual compounding. The
bond matures in 16 years. What is the
current price?

A.
B.
C.
D.
E.
45. The zero coupon bonds of Mark Enterprises
have a market price of $394.47, a face
value of $1,000, and a yield to maturity of
6.87 percent based on semiannual
compounding. How many years is it until
this bond matures?

A.

B.

C.

D.

E.

46. A 12-year, 5 percent coupon bond pays

interest annually. The bond has a face value
of $1,000. What is the percentage change in
the price of this bond if the market yield
rises to 6 percent from the current level of
5.5 percent?

A.

B.

C.

D.
E.
47. Mason’s has a 5-year, 8 percent annual
coupon bond with a $1,000 par value.
Dixon’s has a 10-year, 8 percent annual
coupon bond with a $1,000 par value. Both
bonds currently have a yield to maturity of 8
percent. Which one of the following
statements is correct if the market rate
decreases to 7 percent?

A.
B.
C.
D.
E.

48. A corporate bond is currently quoted at

101.633. What is the market price of a bond
with a $1,000 face value?

A.
B.
C.
D.
E.

49. A zero coupon bond with a face value of

$1,000 is issued with an initial price of
$430.84 based on semiannual
compounding. The bond matures in 20
years. What is the implicit interest, in
dollars, for the first year of the bond's life?

A.
B.
C.
D.
E.
50. Allison’s wants to raise $12.4 million to
expand its business. To accomplish this, it
plans to sell 25-year, $1,000 face value,
zero-coupon bonds. The bonds will be priced
to yield 6.5 percent, with semiannual
compounding. What is the minimum number
of bonds Allison’s must sell to raise the
$12.4 million it needs?

A.
B.
C.
D.
E.

51.
Jackson’s has $1,000 face value, zero-
coupon bonds outstanding that mature in
13.5 years. What is the current value of one
of these bonds if the market rate of interest
is 7.6 percent? Assume semiannual
compounding.

A.

B.
C.
D.
E.

52. A corporate bond with a face value of

$1,000 matures in 4 years and has a coupon
rate of 6.25 percent. The current price of the
bond is $932 and interest is paid
semiannually. What is the yield to maturity?

A.
B.
C.
D.
E.
53. Last year, a bond yielded a nominal return
of 7.37 percent while inflation averaged
3.26 percent. What was the real rate of
return?

A.
B.
C.
D.
E.

54. A $1,000 par value bond carries a coupon

rate of 6.5 percent and has a yield to
maturity of 7.29 percent. The inflation rate
is 3.13 percent. What is the bond’s real rate
of return?

A.
B.
C.
D.
E.

55. If a bond provides a real rate of return of

2.89 percent at a time when inflation is 3.21
percent, what is the nominal rate of return
on the bond?

A.
B.
C.
D.
E.

56. The nominal rate of return on a bond is 7.28

percent while the real rate is 3.09 percent.
What is the rate of inflation?

A.
B.
C.
D.
E.
57. A bond has a coupon rate of 8.2 percent, a
$1,000 par value, matures in 11.5 years,
has a yield to maturity of 7.67 percent, and
pays interest annually. What is the current
yield?

A.
B.
C.

58. Aivree is buying a $1,000 face value bond at

a quoted price of 99.486. The bond carries a
coupon rate of 5.6 percent, with interest
paid semiannually. The next interest
payment is four months from today. What is
the clean price of this bond?

A.

B.

C.

D.

E.
59.
Nathan is buying a $1,000 face value bond
at a quoted price of 101.364. The bond
carries a coupon rate of 7.75 percent, with
interest paid semiannually. The next interest
payment is two months from today. What is
the dirty price of this bond?

A.

B.

C.

D.

E.
60.
Casey just purchased a $1,000 face value
bond at an invoice price of $1,288.16. The
bond has a coupon rate of 6.2 percent,
semiannual interest payments, and the next
interest payment occurs one month from
today. Of the amount paid for the bond,
what was the dollar amount of the accrued
interest?

A.

B.

C.

D.

E.
61.
Exactly three years ago, you purchased a
$1,000 face value bond for $1,211.16. The
coupon rate was 6.5 percent with interest
paid semiannually. Today, you sold that
bond for $1,089.54. What was your rate of
return for the 3-year period, or holding
period yield, on this investment?

A.

B.

C.

D.

E.
62.
Stu wants to earn a real return of 3.4
percent on any bond he acquires. The
inflation rate is 2.8 percent. He has
determined that a particular bond he is
considering should have an interest rate risk
premium of .27 percent, a liquidity premium
of .08 percent, and a taxability premium of
1.69 percent. What nominal rate of return is
Stu demanding from this particular bond?

A.

B.
C.
D.
E.

63. Explain liquidity risk, default risk, and

taxability risk. How does each of these risks
affect the yield of a bond?
64. Define what is meant by interest rate risk.
Assume the manager of a $100 million
portfolio of corporate bonds predicts interest
rates will rise in the near future. What
adjustments should be made to the portfolio
assuming the market has not already
adjusted for this prediction?

65. Why do corporations issue 100-year bonds,

knowing that interest rate risk is highest for
very long-term bonds? How does the
interest rate risk affect the issuer?

66. Normally, the Treasury yield curve is

upward-sloping. Explain the conditions
required for a downward-sloping yield curve
to exist.
67. Interest rate risk is often explained by using
the concept of a teeter-totter. Explain
interest rate risk and how it is related to the
movements of a teeter-totter.

68. Should investors be indifferent between two

bonds which have equal market yields to
maturity as long as the bonds have the
same bond rating? Can you think of any
real-world factors which might make a given
investor prefer one of these bonds over the
other?
 Chapter 08 Key
1. A bond that makes no coupon payments and
is initially priced at a deep discount is called
a _____ bond.

A.
B.
C.
D.
E.
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Ross - Chapter 08 #1
Section: 8.1
Topic: Bond types and features

2. The stated interest payment, in dollars,

made on a bond each period is called the
bond's:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #2
Section: 8.1
Topic: Bond coupons and yields

3. The principal amount of a bond that is

repaid at the end of the loan term is called
the bond's:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #3
Section: 8.1
Topic: Bond terminology

4. The specified date on which the principal

amount of a bond is repaid is called the
bond's:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #4
Section: 8.1
Topic: Bond terminology

5. The rate of return required by investors in

the market for owning a bond is called the:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #5
Section: 8.1
Topic: Bond coupons and yields

6. The annual interest paid by a bond divided

by the bond’s face value is called the:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #6
Section: 8.1
Topic: Bond coupons and yields
7. A bond with a face value of $1,000 that sells
for $1,000 in the market is called a _____
bond.

A.
B.
C.
D.
E.
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Ross - Chapter 08 #7
Section: 8.1
Topic: Bond terminology

8. A bond with a face value of $1,000 that sells

for less than $1,000 in the market is called a
_____ bond.

A.
B.
C.
D.
E.
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Ross - Chapter 08 #8
Section: 8.1
Topic: Bond terminology

9. The relationship between nominal rates, real

rates, and inflation is known as the:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #9
Section: 8.4
Topic: Fisher effect
10. The relationship between nominal interest
rates on default-free, pure discount
securities and the time to maturity is called
the:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #10
Section: 8.5
Topic: Term structure of interest rates

11. The _____ premium is that portion of a

nominal interest rate or bond yield that
represents compensation for expected
future loss in purchasing power.

A.
B.
C.
D.
E.
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Ross - Chapter 08 #11
Section: 8.5
Topic: Bond yields and returns

12. The _____ premium is that portion of the

bond yield that represents compensation for
potential difficulties that might be
encountered should the bond holder wish to
sell the bond prior to maturity.

A.
B.
C.
D.
E.
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Ross - Chapter 08 #12
 Section: 8.5
Topic: Bond yields and returns

13. A bond with a coupon rate of 6 percent that

pays interest semiannually and is priced at
par will have a market price of _____ and
interest payments in the amount of _____
each.

A.
B.
C.
D.

E.

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Ross - Chapter 08 #13
Section: 8.1
Topic: Bond coupons and yields

14. All else constant, a bond will sell at _____

when the yield to maturity is _____ the
coupon rate.

A.
B.
C.
D.
E.
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Ross - Chapter 08 #14
Section: 8.1
Topic: Bond yields and returns
15. All else constant, a coupon bond that is
selling at a premium, must have:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #15
Section: 8.1
Topic: Bond yields and returns

16. The market price of a bond increases when

the:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #16
Section: 8.1
Topic: Bond valuation

17. Aspens is preparing a bond offering with a

coupon rate of 5.5 percent. The bonds will
be repaid in 10 years. The company plans to
issue the bonds at par value and pay
interest semiannually. Which one of the
following statements is correct?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #17
Section: 8.1
Topic: Bond valuation
18. A par value bond offers a coupon rate of 7
percent with semiannual interest payments.
The effective annual rate provided by these
bonds must be:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #18
Section: 8.1
Topic: Bond yields and returns

19. Rosina purchased a 15-year bond at par

value when it was initially issued. The bond
has a coupon rate of 7 percent and matures
13 years from now. If the current market
rate for this type and quality of bond is 7.5
percent, then Rosina should expect:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #19
Section: 8.1
Topic: Interest rate risk

20. A zero coupon bond:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #20
Section: 8.1
Topic: Bond valuation
21. Which one of these bonds is the most
interest-rate sensitive?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #21
Section: 8.1
Topic: Interest rate risk

22. The yield to maturity:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #22
Section: 8.1
Topic: Bond yields and returns

23. A newspaper listing of bond prices has an

"Asked yield" column. This yield is based on
the asked price and represents the:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #23
Section: 8.3
Topic: Bond price and quotes
24. A bond is listed in a newspaper at a bid of
105.4844. This quote should be interpreted
to mean:

A.
B.
C.
D.
E.
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Ross - Chapter 08 #24
Section: 8.3
Topic: Bond price and quotes

25. If its yield to maturity is less than its coupon

rate, a bond will sell at a _____, and
increases in market interest rates will:

A.

B.

C.

D.

E.

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Ross - Chapter 08 #25
Section: 8.1
Topic: Bond yields and returns
26. The Fisher formula is expressed as _____
where R is the nominal rate, r is the real
rate, and h is the inflation rate.

A.
B.
C.
D.
E.
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Ross - Chapter 08 #26
Section: 8.4
Topic: Fisher effect

27.
Which one of these combinations of bond
ratings represents a crossover situation?

A.

B.
C.
D.

E.
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Ross - Chapter 08 #27
Section: 8.2
Topic: Bond ratings and credit risk
28.
The term structure of interest rates reflects
the:

A.

B.

C.

D.

E.

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Ross - Chapter 08 #28
Section: 8.2
Topic: Bond ratings and credit risk
29.
All else held constant, interest rate risk will
increase when the time to maturity:

A.

B.

C.

D.

E.

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Ross - Chapter 08 #29
Section: 8.2
Topic: Bond ratings and credit risk
30.
The interest paid on any municipal bond is:

A.

B.

C.

D.

E.

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Ross - Chapter 08 #30
Section: 8.2
Topic: Bond ratings and credit risk
31.
The dirty price of a bond is defined as the:

A.

B.

C.

D.

E.

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Ross - Chapter 08 #31
Section: 8.2
Topic: Bond ratings and credit risk
32.
The interest rate for a tax-exempt bond that
equates to the rate paid on a taxable bond
is computed as:

A.

B.

C.

D.

E.

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Ross - Chapter 08 #32
Section: 8.2
Topic: Bond ratings and credit risk
33.
Consider a bond with a coupon rate of 8
percent that pays semiannual interest and
matures in eight years. The market rate of
return on bonds of this risk is currently 11
percent. What is the current value of a
$1,000 face value bond?

A.

B.
C.
D.
E.
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Ross - Chapter 08 #33
Section: 8.1
Topic: Bond valuation

34. What is the value of a 20-year, zero-coupon

bond with a face value of $1,000 when the
market required rate of return is 9.6
percent, compounded semiannually?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #34
Section: 8.1
Topic: Bond valuation
35. The bonds issued by Manson amp; Son bear
a coupon of 6 percent, payable
semiannually. The bond matures in 15 years
and has a $1,000 face value. Currently, the
bond sells at par. What is the yield to
maturity?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #35
Section: 8.1
Topic: Bond yields and returns

36. A corporate bond has a coupon of 7.5

percent and pays interest annually. The face
value is $1,000 and the current market price
is $1,108.15. The bond matures in 14 years.
What is the yield to maturity?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #36
Section: 8.1
Topic: Bond yields and returns
37. Otto Enterprises has a 15-year bond issue
outstanding with a coupon of 8 percent. The
bond is currently priced at $923.60 and has
a par value of $1,000. Interest is paid
semiannually. What is the yield to maturity?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #37
Section: 8.1
Topic: Bond yields and returns

38. Chocolate and More offers a bond with a

coupon rate of 6 percent, semiannual
payments, and a yield to maturity of 7.73
percent. The bonds mature in 9 years. What
is the market price of a $1,000 face value
bond?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #38
Section: 8.1
Topic: Bond valuation
39. Westover’s has an outstanding bond with a
coupon rate of 5.5 percent that matures in
12 years. The bond pays interest
semiannually. What is the market price of a
$1,000 face value bond if the yield to
maturity is 7.13 percent?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #39
Section: 8.1
Topic: Bond valuation

40. Guggenheim offers a bond with annual

payments and a coupon rate of 5 percent.
The yield to maturity is 5.62 percent and the
maturity date is 9 years away. What is the
market price of a $1,000 face value bond?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #40
Section: 8.1
Topic: Bond valuation
41. The Lo Sun Corporation offers a bond with a
current market price of $1,029.75, a coupon
rate of 8 percent, and a yield to maturity of
7.52 percent. The face value is $1,000.
Interest is paid semiannually. How many
years is it until this bond matures?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #41
Section: 8.1
Topic: Time to maturity

42. Moon Lite Cafe has a semiannual, 5 percent

coupon bond with a current market price of
$988.52. The bond has a par value of
$1,000 and a yield to maturity of 5.68%.
How many years is it until this bond
matures?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #42
Section: 8.1
Topic: Time to maturity
43. A firm offers a 10-year, zero coupon bond
with a face value of $1,000. What is the
current market price if the yield to maturity
is 7.6 percent, given semiannual
compounding?

A.

B.

C.

D.

E.

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Ross - Chapter 08 #43
Section: 8.1
Topic: Bond valuation

44. TJ’s offers a $1,000 face value, zero coupon

bond with a yield to maturity of 11.3
percent, given annual compounding. The
bond matures in 16 years. What is the
current price?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #44
Section: 8.1
Topic: Bond valuation
45. The zero coupon bonds of Mark Enterprises
have a market price of $394.47, a face
value of $1,000, and a yield to maturity of
6.87 percent based on semiannual
compounding. How many years is it until
this bond matures?

A.

B.

C.

D.

E.

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Ross - Chapter 08 #45
Section: 8.1
Topic: Time to maturity
46. A 12-year, 5 percent coupon bond pays
interest annually. The bond has a face value
of $1,000. What is the percentage change in
the price of this bond if the market yield
rises to 6 percent from the current level of
5.5 percent?

A.

B.

C.

D.
E.

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Ross - Chapter 08 #46
Section: 8.1
Topic: Interest rate risk

47. Mason’s has a 5-year, 8 percent annual

coupon bond with a $1,000 par value.
Dixon’s has a 10-year, 8 percent annual
coupon bond with a $1,000 par value. Both
bonds currently have a yield to maturity of 8
percent. Which one of the following
statements is correct if the market rate
decreases to 7 percent?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #47
Section: 8.1
Topic: Interest rate risk
48. A corporate bond is currently quoted at
101.633. What is the market price of a bond
with a $1,000 face value?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #48
Section: 8.1
Topic: Bond price and quotes

49. A zero coupon bond with a face value of

$1,000 is issued with an initial price of
$430.84 based on semiannual
compounding. The bond matures in 20
years. What is the implicit interest, in
dollars, for the first year of the bond's life?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #49
Section: 8.1
Topic: Accrued and implicit interest
50. Allison’s wants to raise $12.4 million to
expand its business. To accomplish this, it
plans to sell 25-year, $1,000 face value,
zero-coupon bonds. The bonds will be priced
to yield 6.5 percent, with semiannual
compounding. What is the minimum number
of bonds Allison’s must sell to raise the
$12.4 million it needs?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #50
Section: 8.1
Topic: Bond valuation

51.
Jackson’s has $1,000 face value, zero-
coupon bonds outstanding that mature in
13.5 years. What is the current value of one
of these bonds if the market rate of interest
is 7.6 percent? Assume semiannual
compounding.

A.

B.
C.
D.
E.
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Ross - Chapter 08 #51
Section: 8.1
Topic: Bond valuation
52. A corporate bond with a face value of
$1,000 matures in 4 years and has a coupon
rate of 6.25 percent. The current price of the
bond is $932 and interest is paid
semiannually. What is the yield to maturity?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #52
Section: 8.1
Topic: Bond yields and returns

53. Last year, a bond yielded a nominal return

of 7.37 percent while inflation averaged
3.26 percent. What was the real rate of
return?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #53
Section: 8.4
Topic: Fisher effect

54. A $1,000 par value bond carries a coupon

rate of 6.5 percent and has a yield to
maturity of 7.29 percent. The inflation rate
is 3.13 percent. What is the bond’s real rate
of return?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #54
Section: 8.4
Topic: Fisher effect

55. If a bond provides a real rate of return of

2.89 percent at a time when inflation is 3.21
percent, what is the nominal rate of return
on the bond?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #55
Section: 8.4
Topic: Fisher effect

56. The nominal rate of return on a bond is 7.28

percent while the real rate is 3.09 percent.
What is the rate of inflation?

A.
B.
C.
D.
E.
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Ross - Chapter 08 #56
Section: 8.4
Topic: Fisher effect

57. A bond has a coupon rate of 8.2 percent, a

$1,000 par value, matures in 11.5 years,
has a yield to maturity of 7.67 percent, and
pays interest annually. What is the current
yield?

A.
B.
C.
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 Ross - Chapter 08 #57
Section: 8.1
Topic: Bond yields and returns

58. Aivree is buying a $1,000 face value bond at

a quoted price of 99.486. The bond carries a
coupon rate of 5.6 percent, with interest
paid semiannually. The next interest
payment is four months from today. What is
the clean price of this bond?

A.

B.

C.

D.

E.

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Ross - Chapter 08 #58
Section: 8.1
Topic: Bond price and quotes
59.
Nathan is buying a $1,000 face value bond
at a quoted price of 101.364. The bond
carries a coupon rate of 7.75 percent, with
interest paid semiannually. The next interest
payment is two months from today. What is
the dirty price of this bond?

A.

B.

C.

D.

E.

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Ross - Chapter 08 #59
Section: 8.1
Topic: Bond price and quotes
60.
Casey just purchased a $1,000 face value
bond at an invoice price of $1,288.16. The
bond has a coupon rate of 6.2 percent,
semiannual interest payments, and the next
interest payment occurs one month from
today. Of the amount paid for the bond,
what was the dollar amount of the accrued
interest?

A.

B.

C.

D.

E.

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Ross - Chapter 08 #60
Section: 8.1
Topic: Bond price and quotes
61.
Exactly three years ago, you purchased a
$1,000 face value bond for $1,211.16. The
coupon rate was 6.5 percent with interest
paid semiannually. Today, you sold that
bond for $1,089.54. What was your rate of
return for the 3-year period, or holding
period yield, on this investment?

A.

B.

C.

D.

E.

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Ross - Chapter 08 #61
Section: 8.1
Topic: Bond price and quotes
62.
Stu wants to earn a real return of 3.4
percent on any bond he acquires. The
inflation rate is 2.8 percent. He has
determined that a particular bond he is
considering should have an interest rate risk
premium of .27 percent, a liquidity premium
of .08 percent, and a taxability premium of
1.69 percent. What nominal rate of return is
Stu demanding from this particular bond?

A.

B.
C.
D.
E.
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Ross - Chapter 08 #62
Section: 8.5
Topic: Bond yields and returns
63. Explain liquidity risk, default risk, and
taxability risk. How does each of these risks
affect the yield of a bond?

Liquidity problems exist in thinly traded

bonds making some bonds difficult to sell at
their actual value. The greater this difficulty,
the higher the liquidity risk, and the higher
the premium demanded. Default risk is the
likelihood the issuer will default on its bond
obligations. The higher this probability, the
higher the default risk, and the higher the
premium demanded. Taxability risk reflects
the fact that some bonds have their interest
taxed at the federal, state, and local levels,
while others are taxed by only some, or
none, of these government levels. The more
taxes that are applied to a bond’s interest
payments, the higher the premium
demanded.

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Ross - Chapter 08 #63
Section: 8.5
Topic: Bond yields and returns
64. Define what is meant by interest rate risk.
Assume the manager of a $100 million
portfolio of corporate bonds predicts interest
rates will rise in the near future. What
adjustments should be made to the portfolio
assuming the market has not already
adjusted for this prediction?

Interest rates and bond prices have an

inverse relationship. It is this effect on bond
prices caused by changes in market interest
rates that is referred to as interest rate risk.
All else the same, if interest rates are
expected to rise, bond prices should be
expected to decline. Since short-term, high-
coupon bonds are less sensitive to interest
rate risk, the portfolio should be moved into
these types of securities to limit the
downside risk.

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Ross - Chapter 08 #64
Section: 8.1
Topic: Interest rate risk
65. Why do corporations issue 100-year bonds,
knowing that interest rate risk is highest for
very long-term bonds? How does the
interest rate risk affect the issuer?

Essentially, the issuer takes the opposite

side of the interest rate risk position. By
issuing long-term bonds, the corporation is
essentially betting that rates won't fall
significantly. If rates do decline, the
corporation will incur a loss due to
borrowing at rates higher than the future
market rates. On the other hand, if rates
rise, the corporation benefits by having
locked in its borrowing rate for up to 100
years. In addition, these bonds are a source
of long-term financing where the interest is
tax deductible. If the firm should issue
stocks, the dividends would not be tax
deductible.

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Ross - Chapter 08 #65
Section: 8.1
Topic: Interest rate risk

66. Normally, the Treasury yield curve is

upward-sloping. Explain the conditions
required for a downward-sloping yield curve
to exist.

A downward-sloping yield curve exists when

the expected inflation premium is declining
over time. The decline in the inflation
premium must be significant enough to
overcome the interest rate risk premium,
which increases with time.

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Ross - Chapter 08 #66
Section: 8.5
Topic: Term structure of interest rates
67. Interest rate risk is often explained by using
the concept of a teeter-totter. Explain
interest rate risk and how it is related to the
movements of a teeter-totter.

Interest rates sit on one end of the teeter-

totter while bond prices sit on the other end.
As interest rates move up, bond prices
move down as seen by the movements of a
teeter-totter. Likewise, as interest rates
move down, bond prices move up. In
addition, short-term bonds are located a
short distance from the fulcrum while long-
term bonds are situated towards the end of
the teeter-totter, illustrating that long-term
bonds move further in reaction to a change
in interest rates than do short-term bonds.

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Ross - Chapter 08 #67
Section: 8.1
Topic: Interest rate risk
68. Should investors be indifferent between two
bonds which have equal market yields to
maturity as long as the bonds have the
same bond rating? Can you think of any
real-world factors which might make a given
investor prefer one of these bonds over the
other?

The question only states the bonds have the

same market yield to maturity and bond
rating. The market yield is comprised of
several factors which may be valued
differently by different investors. One key
difference is the taxability premium that
each investor applies to a bond. Since
investors face different tax situations and
tax rates, this premium can vary. Also, an
investor who plans on holding a bond until
maturity will not place as much emphasis on
the liquidity premium as will an investor
who plans to sell prior to maturity. Individual
investors may also differ in their outlook for
inflation, causing each to assign a different
inflation premium to the same bond.
Likewise, individual investors may have
differing opinions on a bond’s rating as they
may view the probability of default
differently. Any one of these differences may
cause an investor to assign a discount rate
to the bond that varies from that assigned
by the overall market. This can cause
investors to have differing preferences on
which bonds they prefer as each bond’s
value depends on the discount rate used to
value the bond’s cash flows.

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Ross - Chapter 08 #68
Section: 8.5
Topic: Bond yields and returns
Chapter 08 Summary