honeycfa

What is the probable change in price of a 30-year semiannual 6.5% coupon, $1000 par value bond yielding 8% when the nominal risk-free rate changes from 5% to 4%?

A) $107.31.

B) $98.83.

C) $106.34.

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Price at 8% is N = 60, FV = $1,000, I = 4%, PMT = $32.50, CPT PV = $830.32; price at 7% is N = 60, FV = $1,000, I = 3.5%, FV = $1,000, CPT PV = $937.64. Change in price is $107.31.

honeycfa

If a bond's coupon is greater than the prevailing market rate on new issues, the bond is called a:

A) premium bond.

B) discount bond.

C) term bond.

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When the coupon rate on a bond is higher than the prevailing market rate the bond will be selling at a premium.  This occurs because the bonds price will be higher than the face value because as interest rate goes down price goes up.

honeycfa

Assuming the risk-free rate is 5% and the appropriate risk premium for a AAA-rated issuer is 4%, the appropriate discount rate for a 10-year Treasury note is:

A) 5%.

B) 4%.

C) 9%.

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For a 10-year treasury the relevant discount rate is the risk free rate.

honeycfa

 

An investor has the following choices available:

• She can buy a 10% semi annual coupon, 10-year bond for $1,000.> >
• She can reinvest the coupons at 12%.> >
• She can sell the bond in three years at an estimated price of $1,050.> >

Based on this information, the average annual rate of return over the three years is:> >

A) 11.5%.

B) 9.5%.

C) 13.5%.

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Step 1. Find the FV of the coupons and interest on interest:

N = 3(2) = 6; I = 12/2 = 6; PMT = 50; compute FV = 348.77

Step 2. Determine the value of the bond at the end of 3 years:

$348.77 + 1,050.00 = $1,398.77

Step 3. Equate FV (1,398.77) with PV (1,000) over 3 years (n = 6):

compute I = 5.75(2) = 11.5%.

honeycfa

What is the present value of a 7% semi-annual pay corporate bond with a $1,000 face value and 20 years to maturity if it is yielding 6.375%? If a municipal bond is yielding 4.16% and an investors marginal tax rate is 35%, would the investor prefer the corporate bond or the municipal bond?

Value

Investor preference

A) $1,070.09 municipal bond

B) $1,121.23 municipal bond

C) $1,070.09 corporate bond

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N = 20 × 2 = 40; I/Y = 6.375/2 = 3.1875; PMT = 70/2 = 35; FV = 1,000; CPT → PV = $1,070.09.

The taxable-equivalent yield on the municipal bond is: 4.16% / (1 ? 0.35) = 6.4%

The investor would prefer the municipal bond because the taxable-equivalent yield is greater than the yield on the corporate bond: 6.4% > 6.375%

honeycfa

Consider a bond that pays an annual coupon of 5% and that has three years remaining until maturity. Suppose the term structure of interest rates is flat at 6%. How much does the bond price change if the term structure of interest rates shifts down by 1% instantaneously?

A) -2.67.

B) 2.67.

C) 0.00.

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This value is computed as follows:

Bond Price Change = New Price – Old Price = 100 – (5/1.06 + 5/1.06² + 105/1.06³) = 2.67.

-2.67 is the correct value but the wrong sign. The value 0.00 is incorrect because the bond price is not insensitive to interest rate changes.