Chapter 6 TB - Finance-113 PDF

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Financial Management: Core Concepts, 2e (Brooks) Chapter 6 Bonds and Bond Valuation 6.1 Application of the Time Value of Money Tool: Bond Pricing 1) A bond may be issued by ________. A) companies B) state governments C) the federal government D) All of the above Answer: D Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 2) A bond is a ________ instrument by which a borrower of funds agrees to pay back the funds with interest on specific dates in the future. A) long-term equity B) long-term debt C) short-term debt D) short-term equity Answer: B Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 3) Bonds are sometimes called ________ securities because they pay set amounts on specific future dates. A) variable-income B) fixed-income C) bully D) real Answer: B Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 4) The ________ is the annual coupon payment divided by the current price of the bond, and is not always an accurate indicator. A) current yield B) yield to maturity C) bond discount rate D) coupon rate Answer: A Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills

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5) The ________ is the yield an individual would receive if the individual purchased the bond today and held the bond to the end of its life. A) current yield B) yield to maturity C) prime rate D) coupon rate Answer: B Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 6) The four steps to determining the price of a bond are: A) determine the amount and timing of the present cash flows, determine the appropriate discount rate, find the present value of the lump-sum principal and the annuity stream of coupons, and add the PVs of the principal and coupons. B) determine the amount and timing of the future cash flows, determine the appropriate discount rate, find the future value of the lump-sum principal and the annuity stream of coupons, and add the FVs of the principal and coupons. C) determine the amount and timing of the future cash flows, determine the appropriate discount rate, find the present value of the lump-sum principal and the annuity stream of coupons, and multiply the PVs of the principal and coupons. D) determine the amount and timing of the future cash flows, determine the appropriate discount rate, find the present value of the lump-sum principal and the annuity stream of coupons, and add the PVs of the principal and coupons. Answer: D Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 7) Blackburn Inc. has issued 30-year $1,000 face value, 10% annual coupon bonds, with a yield to maturity of 9.0%. The annual interest payment for the bond is ________. A) $100 B) $90 C) $50 D) $45 Answer: A Comment: The annual interest or coupon payment is equal to the coupon rate multiplied by the par value of the bond. Here that is (0.10) × ($1,000) = $100. Diff: 2 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills

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8) Johnson Construction Inc. has issued 20-year $1,000 face value, 8% annual coupon bonds, with a yield to maturity of 10%. The current price of the bond is ________. A) $1,000.00 B) $1,196.36 C) $829.73 D) There is not enough information to answer this question. Answer: C Comment: Bond Price = PMT × (

= $80 × (

)+

)+

= $829.73.

Diff: 2 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 9) Petty Productions Inc. recently issued 30-year $1,000 face value, 12% annual coupon bonds. The market discount rate for this bond is only 7%. What is the current price of this bond? A) $387.59 B) $597.24 C) $1,000.00 D) $1,620.45 Answer: D Comment: Bond Price = PMT × (

= $120 × (

)+

)+

= $1,620.45.

Diff: 2 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 10) The ________ is the face value of the bond. A) coupon rate B) maturity date C) par value D) coupon rate Answer: C Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills

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11) The ________ is the regular interest payment of the bond. A) dividend B) par C) coupon rate D) coupon Answer: D Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 12) The ________ is the return the bondholder receives on the bond if held to maturity. A) coupon B) coupon rate C) yield to maturity D) par rate Answer: C Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 13) The ________ is the expiration date of the bond. A) future value B) yield to maturity C) maturity date D) coupon Answer: C Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 14) Five years ago, Thompson Tarps Inc. issued twenty-five-year 10% annual coupon bonds with a $1,000 face value each. Since then, interest rates in general have risen and the yield to maturity on the Thompson bonds is now 12%. Given this information, what is the price today for a Thompson Tarps bond? A) $843.14 B) $850.61 C) $1,181.54 D) $1,170.27 Answer: B Comment: Bond Price = PMT × (

)+

= $100 × (

)+

= $850.61. Diff: 3 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

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15) Ten years ago Bacon Signs Inc. issued twenty-five-year 8% annual coupon bonds with a $1,000 face value each. Since then, interest rates in general have fallen and the yield to maturity on the Bacon bonds is now 7%. Given this information, what is the price today for a Bacon Signs bond? A) $1,000 B) $1,116.54 C) $1,091.08 D) $914.41 Answer: C Comment: Bond Price = PMT × (

)+

= $80 × (

)+

= $1,091.08. Diff: 3 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 16) Ten years ago Bacon Signs Inc. issued twenty-five-year 8% annual coupon bonds with a $1,000 face value each. Since then, interest rates in general have risen and the yield to maturity on the Bacon bonds is now 9%. Given this information, what is the price today for a Bacon Signs bond? A) $1,000 B) $919.39 C) $901.77 D) $1.085.59 Answer: B Comment: Bond Price = PMT × (

)+

= $80 × (

)+

= $919.39. Diff: 3 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 17) The appropriate rate to use to discount the cash flows of a bond in order to determine the current price is the ________. A) yield to maturity B) coupon rate C) par rate D) current yield Answer: A Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills

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18) The coupon payment for an annual-coupon corporate bond is equal to the yield to maturity multiplied by the par value of the bond. Answer: FALSE Comment: The coupon payment for an annual-coupon corporate bond is equal to the COUPON RATE multiplied by the par value of the bond. Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 19) Johnson Products issued $1,000 face value 20-year bonds five years ago. These bonds are currently selling for $1,218.47. From this information we can conclude that the Johnson Products bonds have a yield-to-maturity greater than the coupon rate on these bonds. Answer: FALSE Comment: Prices and interest rates are inversely related. Therefore, a higher price means the yield-tomaturity is less than the original coupon rate. Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 20) Zero-coupon bonds are more difficult and time-consuming to price because of the extensive revision of the basic bond pricing formula. Answer: FALSE Comment: The bond pricing formula has two components. The first part prices the face value and the second part determines the value of the coupon payments. Because there are no coupon payments, the second part of the equation always has a value of $0. This makes zero coupon bonds comparatively easy to price. Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 21) The coupon payment for an annual-coupon corporate bond is equal to the coupon rate multiplied by the current price of the bond. Answer: FALSE Comment: The coupon payment for an annual-coupon corporate bond is equal to the coupon rate multiplied by the PAR VALUE of the bond. Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 22) The coupon rate for a bond is the interest rate for the coupons, stated in annual terms, and printed on the bond. It normally remains the same throughout the life of the bond. Answer: TRUE Diff: 1 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills

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23) Assume that today's date is August 15, 2010 and that the Rite Aid Bond is an annual-coupon bond. Describe what each of the following terms mean and how each value was determined if appropriate.

Company Price Rite Aid 84.00

Maturity Coupon Rate Date 6.875% 8-15-2015

YTM 10.576%

Current Yield 8.185%

Rating B2

Answer: Rite Aid is the issuer. The price of 84.00 means that the bond is currently selling for 84% of the bond's par value. The coupon rate is the annual interest rate. This bond matures five years from today, and is the date on which the final interest installment is paid and the principal is repaid. A value of 6.875% means the bond pays out this percentage of the bond's par value each year. The YTM is the yield to maturity and represents the return you would receive if you purchased the bond today at the $84.00 price and held it to maturity. The YTM is determined by market forces. The current yield is found by dividing the annual coupon payment by the current price. The rating is the bond rating for this bond--a grade indicating credit quality. Diff: 2 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills 24) Progressive Plastics Inc. issued 30-year 7% annual coupon bonds five years ago. Currently, the yield to maturity is 9.65% on these $1,000 par value bonds. What is the current price per bond? Answer: Bond Price = PMT × (

= $70 × (

)+

)+

= $752.84.

Diff: 2 Topic: 6.1 Application of the Time Value of Money Tool: Bond Pricing AACSB : 3 Analytic Skills

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6.2 Semiannual Bonds and Zero-Coupon Bonds 1) The Cougar Corporation has issued 20-year semi-annual coupon bonds with a face value of $1,000. If the annual coupon rate is 10% and the current yield to maturity is 12%, what is the firm's current price per bond? A) $850.61 B) $849.54 C) $1,170.27 D) $1,171.59 Answer: B Comment: Bond Price = PMT × (

= $50 × (

)+

)+

= $849.54.

Diff: 3 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 2) Endicott Enterprises Inc. has issued 30-year semiannual coupon bonds with a face value of $1,000. If the annual coupon rate is 14% and the current yield to maturity is 8%, what is the firm's current price per bond? A) $578.82 B) $579.84 C) $1,675.47 D) $1,678.70 Answer: D Comment: Bond Price = PMT × (

= $70 × (

)+

)+

= $1,678.70.

Diff: 3 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

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3) Endicott Enterprises Inc. has issued 30-year semiannual coupon bonds with a face value of $1,000. If the annual coupon rate is 14% and the current yield to maturity is 15%, what is the firm's current price per bond? A) $934.20 B) $1,000.00 C) $934.34 D) $466.79 Answer: A Comment: Bond Price = PMT × (

= $70 × (

)+

)+

= $934.20

Diff: 3 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 4) Most U.S. corporate and government bonds choose to make ________ coupon payments. A) annual B) semiannual C) quarterly D) monthly Answer: B Diff: 1 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 5) Which of the following types of bonds, as characterized by a feature, by definition has two coupon payments per year? A) Consol B) Semiannual C) Zero-coupon D) Putable Answer: B Diff: 1 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills

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6) RC Inc. just issued zero-coupon bonds with a par value of $1,000. If the bond has a maturity of 15 years and a yield to maturity of 10%, what is the current price of the bond if it is priced in the conventional manner? A) $1,000 B) $239.39 C) $231.38 D) This question cannot be answered because the coupon payment information is missing. Answer: C Comment: The conventional way to price a zero-coupon bond is to discount the par value assuming semi-annual compounding. Zero-coupon Bond Price =

=

= $231.38.

Diff: 3 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 7) Zero-coupon U.S. Government bonds are known as ________. A) STRIPS B) muni-bonds C) Uncle Sam's Empty Pockets D) BLANKS Answer: A Comment: STRIPS is an acronym for Separate Trading of Registered Interest and Principal. Diff: 2 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 8) The difference between the price and the par value of a zero-coupon bond represents ________. A) taxes payable by the bond buyer B) the accumulated principal over the life of the bond C) the bond premium D) the accumulated interest over the life of the bond Answer: D Diff: 2 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 9) Delagold Corporation is issuing a zero-coupon bond that will have a maturity of fifty years. The bond's par value is $1,000, and the current yield on similar bonds is 7.5%. What is the expected price of this bond, using the semiannual convention? A) $25.19 B) $250.19 C) $750.00 D) $1,000.00 Answer: A Comment: Zero coupon bond price =

=

= $25.19

Diff: 2 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 10 Copyright © 2013 Pearson Education, Inc.

10) Almost all corporate and government bonds pay coupons on an annual basis. Answer: FALSE Comment: Almost all corporate and government bonds pay coupons on a SEMIANNUAL basis. Diff: 1 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 11) When pricing a zero-coupon bond, the convention is to use the semiannual pricing formula rather than the annual pricing formula. Answer: TRUE Diff: 2 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 12) Zero-coupon bonds are priced at deep discounts. Answer: TRUE Diff: 2 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 13) Zero-coupon bonds are priced at steep premiums. Answer: FALSE Comment: Zero-coupon bonds are priced at deep discounts. Diff: 1 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 14) Endicott Enterprises Inc. has twenty years remaining on $1,000 par value semiannual coupon bonds paying an annual coupon of $80. If the yield to maturity on these bonds is 6% per year, what is the current price? Answer: Bond Price = PMT × (

)+

= $40 × (

$1,231.15. Diff: 2 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills

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)+

=

15) Complete the following zero-coupon amortization schedule. Beginning T (Periods) Price 1 $839.62 2 3 $943.40

Interest Ending Earned (6%) Price $890.00 $53.40 $1,000.00

Ans wer :

T (Periods) 1 2 3

Beginning Price $839.62 $890.00 $943.40

Interest Earned (6%) $50.38 $53.40 $56.60

Ending Price $890.00 $943.40 $1,000.00

Diff: 3 Topic: 6.2 Semiannual Bonds and Zero-Coupon Bonds AACSB : 3 Analytic Skills 6.3 Yields and Coupon Rates 1) The ________ is a market derived interest rate used to discount the future cash flows of the bond. A) coupon rate B) semi-annual coupon rate C) yield to maturity D) compound rate Answer: C Diff: 1 Topic: 6.3 Yields and Coupon Rates AACSB : 3 Analytic Skills 2) The ________ is the interest rate printed on the bond. A) coupon rate B) semi-annual coupon rate C) yield to maturity D) compound rate Answer: A Diff: 1 Topic: 6.3 Yields and Coupon Rates AACSB : 3 Analytic Skills

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3) Phillips Fine Fixtures Inc. wishes to issue new bonds but is uncertain how the market would set the yield to maturity. The bonds would be 20-year, 7% annual coupon bonds with a $1,000 par value. Fisher has determined that these bonds would sell for $1,050 each. What is the yield to maturity for these bonds? A) 7.00% B) 6.55% C) 7.35% D) 6.54% Answer: D Comment: The answer is found through an iterative (trial and error) process using the bond pricing formula. Bond Price = PMT × (

)+

$1,050.00 = $70 × (

)+

;

;

r = 6.54%. Diff: 3 Topic: 6.3 Yields and Coupon Rates AACSB : 3 Analytic Skills 4) Rogue Racing Inc. has $1,000 par value bonds with a coupon rate of 8% per year making semiannual coupon payments. If there are twelve years remaining prior to maturity and these bonds are selling for $876.40, what is the yield to maturity for these bonds? A) 9.80% B) 8.00% C) 9.77% D) 8.33% Answer: C Comment: The answer is found through an iterative (trial and error) process using the bond pricing formula. Bond Price = PMT × (

)+

$876.40 = $40 × (

;

)+

;

r = 4.885817 × 2 = 9.77%. Diff: 3 Topic: 6.3 Yields and Coupon Rates AACSB : 3 Analytic Skills

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5) Your firm has issued ten-year zero-coupon bonds with a $1,000 face value. If the bonds are currently selling for $514.87. What is the yield to maturity? A) 6.75% B) 6.86% C) 10.45% D) This question cannot be answered because there is no coupon payment provided. Answer: A Comment: Use the convention of assuming semiannual discounting. Diff: 3 Topic: 6.3 Yields and Coupon Rates AACSB : 3 Analytic Skills 6) When the ________ is less than the yield to maturity, the bond sells at a/the ________ the par value. A) coupon rate, premium over B) coupon rate, discount to C) time to maturity, discount to D) time to maturity, same price as Answer: B Diff: 2 Topic: 6.3 Yields and Coupon Rates AACSB : 3 Analytic Skills 7) MacroMedia Inc. $1,000 par value bonds are selling for $1,265. Which of the following statements is TRUE? A) The bond market currently requires a rate (yield) less than the coupon rate. B) The bonds are selling at a premium to the par value. C) The coupon rate is greater than the yield to maturity. D) All of the above are true. Answer: D Diff: 2 Topic: 6.3 Yields and Coupon Rates AACSB : 3 Analytic Skills 8) MicroMedia Inc. $1,000 par valu...