1. A 4-year $1,000 par value bond has a 9% coupon rate and an annual interest rate of 7%. Assume the coupon is paid semiannually. What is the price of the bond?
2. Bonds issued by Southeastern Corporation currently yields 12%. A municipal bond of equal risk currently yields 8%. At what marginal tax rate would an investor be indifferent between these two bonds?
3. If the interest rates on one- to five-year bonds are currently 5%, 6%, 7%, 8%, and 9%, and the liquidity premiums for one- to five-year bonds are 0%, 0.1%, 0.2%, 0.3%, and 0.4%. Based on the Liquidity Premium Theory, what is the one-year interest rate from year 3 to year 4?
4. Consider a $1,000-par junk bond with 2 years to maturity paying a 10% annual coupon.
The issuing company has 20% chance of defaulting in the first year; in which case, the bond would not pay anything. If the company survives the first year, paying the annual coupon payment, it then has a 25% chance of defaulting in the second year. If the company defaults in the second year, neither the final coupon payment nor par value of the bond will be paid.
What price must investors pay for this bond to expect a 10% yield to maturity? At that price, what is the expected holding period return? Assume that periodic cash flows are reinvested at 10%.
5. You observe the following market interest rates, for both borrowing and lending:
One-year rate = 5%; two-year rate = 6%; one-year rate one year from now = 8%
How can you take advantage of these rates to earn a riskless profit? Assume that the Pure Expectation Theory for interest rates holds.
6. M&E Inc. has an outstanding convertible bond. The bond can be converted into 20 shares of common equity (currently trading at $52.5/share).
The bond has 5 years of remaining maturity, a $1,000 par value, and a 6% annual coupon. M&E's comparable straight bond is currently trading to yield 5%.
What is the current yield of the straight bond? And what is the minimum price of the convertible bond? (Assume coupon is paid annually)