LOS b: Identify the types of bonds for which estimating the expected cash flows is difficult, and explain the problems encountered when estimating the cash flows for these bonds.

Q1. Which of the following characteristics would create the least difficulty in estimating a bond’s cash flows?

A)   Variable coupon rate.

B)   Noncallable bond.

C)   Putable bond.

Q2. Which of the following characteristics would create the least difficulty in estimating a bond’s cash flows?

A)   Sinking fund provisions.

B)   Fixed coupon rate.

C)   Conversion privilege.

Q3. Which of the following characteristics would create the most difficulty in estimating a bond's cash flows?

A)   Fixed coupon rate.

B)   Noncallable bond.

C)   Exchange privilege.

LOS b: Identify the types of bonds for which estimating the expected cash flows is difficult, and explain the problems encountered when estimating the cash flows for these bonds.fficeffice" />

Q1. Which of the following characteristics would create the least difficulty in estimating a bond’s cash flows?

A)   Variable coupon rate.

B)   Noncallable bond.

C)   Putable bond.

Correct answer is B)        

Normally, estimating the cash flow stream is straightforward for a high quality, option-free bond due to the high degree of certainty in the timing and amount of the payments. The following four conditions could lead to difficulty in forecasting the bond’s future cash flow stream: (1) increased credit risk, (2) the presence of embedded options (i.e., call/put features or sinking fund provisions), (3) the use of variable rather than fixed coupon rate, and (4) the presence of a conversion or exchange privilege.

Q2. Which of the following characteristics would create the least difficulty in estimating a bond’s cash flows?

A)   Sinking fund provisions.

B)   Fixed coupon rate.

C)   Conversion privilege.

Correct answer is B)        

Normally, estimating the cash flow stream is straightforward for a high quality, option-free bond due to the high degree of certainty in the timing and amount of the payments. The following four conditions could lead to difficulty in forecasting the bond’s future cash flow stream: (1) increased credit risk, (2) the presence of embedded options (i.e., call/put features or sinking fund provisions), (3) the use of variable rather than fixed coupon rate, and (4) the presence of a conversion or exchange privilege.

Q3. Which of the following characteristics would create the most difficulty in estimating a bond's cash flows?

A)   Fixed coupon rate.

B)   Noncallable bond.

C)   Exchange privilege.

Correct answer is C)

Normally, estimating the cash flow stream is straightforward for a high quality, option-free bond due to the high degree of certainty in the timing and amount of the payments. The following four conditions could lead to difficulty in forecasting the bond’s future cash flow stream: (1) increased credit risk, (2) the presence of embedded options (i.e., call/put features or sinking fund provisions), (3) the use of variable rather than fixed coupon rate, and (4) the presence of a conversion or exchange privilege.

ｔｈａｎｋｓ