mouse123

Which of the following statements regarding accrued interest on a bond is most accurate?

A) If the buyer must pay the seller the accrued interest, the bond is said to be trading ex-coupon.

B) The bond is trading flat if the bond issuer is in default and the bond is trading without accrued interest.

C) The accrued interest is paid by the seller of the bond to the buyer (new owner) of the bond.

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The accrued interest is paid by the new owner of the bond to the seller of the bond. If the buyer must pay the seller accrued interest, the bond is said to be trading cum-coupon. Otherwise, it is trading ex-coupon.

mouse123

In the context of bonds, accrued interest:

A) equals interest earned from the previous coupon to the sale date.

B) is discounted along with other cash flows to arrive at the dirty, or full price.

C) covers the part of the next coupon payment not earned by seller.

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This is a correct definition of accrued interest on bonds.
The other choices are false. Accrued interest is not discounted when calculating the price of the bond. The statement, "covers the part of the next coupon payment not earned by seller," should read, "…not earned by buyer."

mouse123

If the issuer of a bond is in default, the bond will be trading:

A) flat.

B) on accrual.

C) off the market.

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If an issuer of a bond is in default (i.e., it has not been making periodic contractual coupon payments), the bond is traded without accrued interest and is said to trade flat.

mouse123

A 5% coupon bond with semi-annual coupon payments on a coupon payment date when the coupon has not been paid yet and the bond has a $1,000 par value. What is the accrued interest of the bond and what is the bond's full price?

Accrued Interest

Full Price

A) $25 $1,000

B) $50 $1,050

C) $25 $1,025

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Accrued interest is found by simply dividing the coupon rate by two and then multiplying the result by $1,000. The full price or dirty price of the bond is the price of the bond plus accrued interest, if any.

mouse123

Assume a bond's quoted price is 105.22 and the accrued interest is $3.54. The bond has a par value of $100. What is the bond's clean price?

A) $103.54.

B) $108.76.

C) $105.22.

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The clean price is the bond price without the accrued interest so it is equal to the quoted price.

mouse123

Austin Traynor is considering buying a $1,000 face value, semi-annual coupon bond with a quoted price of 104.75 and accrued interest since the last coupon of $33.50. If Traynor pays the dirty price, how much will the seller receive at the settlement date?

A) $1,081.00.

B) $1,014.00.

C) $1,047.50.

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The dirty price is equal to the agreed upon, or quoted price, plus interest accrued from the last coupon date. Here, the quoted price is 1,000 × 104.75%, or 1,000 × 1.0475 = 1,047.50. Thus, the dirty price = 1,047.50 + 33.50 = 1,081.00.

mouse123

Which of the following statements about refunding and redemption is most accurate?

A) Bonds redeemed at the special redemption price are typically redeemed at par.

B) An investor concerned about premature redemption is indifferent between a noncallable bond and a nonrefundable bond.

C) A sinking fund is an example of refunding.

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This statement is accurate. When bonds are redeemed to comply with a sinking fund provision or because of a property sale mandated by government authority, the redemption prices (typically par value) are referred to as "special redemption prices." When bonds are redeemed under the call provisions specified in the bond indenture, these are known as a regular redemptions and the call prices are referred to as "regular redemption prices."  
The other statements are false. A sinking fund is a type of redemption, which refers to the retirement of bonds. An investor concerned about premature redemption would prefer a noncallable bond because a noncallable bond cannot be called for any reason. A bond that is callable but nonrefundable can be called for any reason other than refunding. The term refunding specifically means redeeming a bond with funds raised from a new bond issued at a lower coupon rate. A nonrefundable bond can be redeemed with funds from operations or a new equity issue.