Part I: True or False
Problem 1: A 20-year original maturity bond with 1 year left to maturity has more interest rate price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates.)
Problem 2: You have just noticed in the financial pages of the local newspaper that you can buy a bond ($1000 par) for $800. If the coupon rate is 10 percent with annual interest payments, and there are 10 year to maturity, should you make the purchase if your required return on investments of this type is 12 percent?
Problem 3: A bond with a $100 annual interest payment and $1000 face value with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates were greater than 11%.
Problem 4: If a bond is callable, and if interest rates in the economy decline, then the company can sell a new issue of low-interest-rate bonds and use the proceeds to "call" the old bonds in and have effectively refinanced at a lower rate.
Problem 5: If you buy a bond that is selling for less than its face, or maturity, value then the price (value) of the bond will increase the maturity date nears if market interest rates do not change during the life of the bond.
Problem 6: If we have two bonds with a simple interest rate yield of 9% where one bond is compounded quarterly and the other bond is compounded monthly, the bond compounded quarterly will have a higher effective annual yield.
Multiple choice:
Problem 7: Stephanie just purchased a corporate bond that matures in three years. The bond has a coupon interest rate equal to 9 percent and its yield to maturity is 6 percent. If market conditions do not change - that is market interest rates remain constant - and Stephanie sells the bond in 12 months, what will be her capital gain from holding the bond?
a. Positive; because she bought the bond for a discount, which means its price has to increase as the maturity date nears.
b. Negative; because she bought the bond for a premium, which means its price has to decrease as the maturity date nears.
c. Zero, because she must have bought the bond for par, which means its price will not change as the maturity date nears.
d. This question cannot be answered, because the face (maturity) value of the bond is not given.
e. None of the above is correct.
Problem 8: You have just purchased a 10-year, $1000 par value bond. The coupon rate on this bond is 8 percent annually, with interest being paid each 6 months. If you expect to earn a 10 percent simple rate of return on this bond, how much did you pay for it?
a. $1,122.87
b. $1,003.42
c. $875.38
d. $950.75
e. $812.15
Problem 9: Assume that you wish to purchase a 20-year bond that has a maturity value of $1000 and makes semiannual interest payments of $40. If you require a 10 percent simple yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
a. $619
b. $674
c. $761
d. $828
e. $902
Problem 10: A $1000 par value bond pays interest of $35 each quarter and will mature in 10 years. If yours simple annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond?
a. $941.36
b. $1,051.25
c. $1,115.57
d. $1,391.00
e. $825.49
Problem 11: Assume that a 15-year, $1000 face value bond pays interest of $37.50 every 3 months. If you require a simple annual rate of return of 12 percent, with quarterly compounding, how much should you be will to pay for this bond?
a. $821.92
b. $1,207.57
c. $986.43
d. $1,120.71
e. $1,358.24
Problem 12: Cold Boxes Ltd. has 100 bonds outstanding (maturity value = $1,000). The required rate of return on these bonds is currently 10 percent, and interest is paid semiannually. The bonds mature in 5 years, and their current market value is $768 per bond. What is the annual coupon interest rate?
a. 8%
b. 6%
c. 4%
d. 2%
e. 0%
Problem 13: Rick bought a bond when it was issued by Macroflex Corporation 14 years ago. The bond, which has a $1,000 face value and a coupon rate equal to 10 percent, matures in six years. Interest is paid every six months; the next interest payment is scheduled for six months from today. If the yield on similar risk investments is 14 percent, what is the current market value (price) of the bond?
a. $841.15
b. $1,238.28
c. $904.67
d. $757.26
e. $844.45