Chapter 6 PDF

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Answers to Chapter 6 Questions: 1. Capital markets are markets that trade equity (stocks) and debt (notes, bonds, and mortgages) instruments with maturities of more than one year. 2. In contrast to T-bills which are sold on a discount basis from face value, T-notes and T-bonds pay coupon interest (s...

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Answers to Chapter 6 Questions: 1. Capital markets are markets that trade equity (stocks) and debt (notes, bonds, and mortgages) instruments with maturities of more than one year. 2. In contrast to T-bills which are sold on a discount basis from face value, T-notes and T-bonds pay coupon interest (semiannually). 3. ASTRIP is a Treasury security in which periodic coupon interest payments can be separated from each other and from the final principal payment 4. Like the fixed-coupon bonds issuedby the Treasury, the coupon rate on TIPS is determined by the auction process describedbelow. 5. Similar to primary market T-bill sales, the U.S. Treasury sells T-notes and T-bonds through competitive and noncompetitive Treasury . 6. General obligation (GO) bonds are backed by the full faith and credit of the issuer, i.e., the state or local government promises to use all of its financial resources (e.g., its taxation powers) to repay the bond. GO bonds Revenue bonds are sold to finance a specific revenue generating project and are backed by cash flows from that project. from the bond issuer to the bond holder. The trustee also informs thebond holders if the firm is no longer meeting the terms of the indenture. In this case, thetrustee initiates any legal action on behalf of the bond holders against the issuing firm. Inthe event of a subsequent reorganization or liquidation of the bond issuer, the trustee continuesto act on behalf of the bond holders to protect their principal. 10. Withbearer bonds, coupons are attached to the bond and the holder (bearer) at the time of the coupon payment gets the relevant coupon paid on presentation to the issuer. With a registered bond, the bondholder (or owner) is kept in an electronic record by the issuer and the coupon payments are mailed or wire transferred to the registered owner. Because of the lack of security with bearer bonds, they have largely been replace by registered bonds. 11. Most corporate bonds are term bonds meaning that the entire issue matures on a single date. 12. a. subordinated debenture b. mortgage bond c. subordinated debenture 13. Convertible bonds are bonds that may be exchanged for another security of the issuing . 15. A sinking fund provision which is a requirement that the issuer retire a certain amount of the bond issue early over a number of years, especially as the bond approaches maturity 16. Bonds rated Baa or better by Moody’s and BBB or better by S&P are considered to be investment grade bonds. Financial institutions are generally prohibited by state and federal law from purchasing anything but investment grade bond securities. Bonds rated below Baa by Moody’s and BBB by S&P are considered to be speculative grade bonds and are often termed junk bonds, or high-yield bonds.

18.All else equal, a long-term bond experiences larger price changes when interest rates change than a short-term bond. A bond’s price is the present value of all its cash flows. Changes in the discount rate (the interest rate) impact present values more for cash flows that are further out in time. 19. Rating agencies consider several factors in determining and assigning credit ratingson bond issues. For example, a financial analysis is conducted of the issuer’s operationsand its needs, its position in the industry, and its overall financial strength and ability topay the required interest and principal on the bonds. Rating agencies analyze the

Problems: 1. a. The Ask price is $10,000 x 84.8516%= $8,485.160 b. The Bid price is $10,000 x100.3750% = $10,037.500 2. a. July 18, 2013 to August31, 2014 is 1 year 43 days, or 1.11780822 years. Thus, Vb = (0.250%/2) {[1-(1/(1 + 0.00159/2)2(1.11780822))]/0.00159/2} + 100%/(1 + 0.00159/2)2(1.11780822) = 100.1016% On a financial calculator: N = 1.11780822(2) = 2.23561644, I = 0.002374 x 2 = 0.124, PMT= 0.125, FV= 100, =>PV=100.1094% b. July 18, 2013 to May 31, 2014 is 316 days, or 0.86575342 years. Thus, 100.1094% = (0.250%/2) {[1-(1/(1 + ask yield/2)2(0.86575342))]/ask yield/2} + 100%/(1 + ask yield/2)2(0.86575342) Solving for Asked yield, we get 0.124% On a financial calculator: N = 3.37260274(2) = 6.74520248, PV=-103.0625%, PMT= 1.000, FV= 100, => I = 0.0617647% x 2 = 0.124% 3. a. July 18, 2013 to August 15, 2016 is 3.07945205 years. Also, the Asked price is97.888%. Thus, 97.888% = 100%/ (1 + Asked yield/2)2x3.07945205 Solving for “Asked yield,” we get 0.69% b. July 18, 2013to November 15, 2027 is 14.33424658 years. Thus, Vb = 100%/ (1 + 3.2992%/2)2x14.33424658 = 66.559% 4. a. Accrued interest over the 145 days is calculated as: (4.375%/2) x 145/184 = 1.723845% of the face value of the bond, or $172.38 per $10,000 face value bond. b. Clean price + Accrued interest = Dirty price 105.25% + 1.723845% = 106.973845% of the face value of the bond, or $10,697.3845 per $10,000 face value bond. 5. a. Accrued interest over the 12 days is calculated as: (2.125%/2) x 12/184 = 0.0692935% of the face value of the bond, or $6.92935 per $10,000 face value bond. b. Clean price + Accrued interest = Dirty price 98.250% + 0.0692935% = 98.3192935% of the face value of the bond, or $9,831.92935 per $10,000 face value bond....