SELF-TEST QUESTIONS:

ST-1 Define each of the following terms:

a. Bond; treasury bond; corporate bond; municipal bond; foreign bond
b. Par value; maturity date; original maturity
c. Coupon payment; coupon interest rate
d. Floating-rate bond; zero coupon bond;
e. Convertible bond; warrant; puttable bond; income bond; discount bond; premium
bond;
f. Yield to maturity (YTM); yield to call (YTC); current yield;
g. Interest rate risk; reinvestment rate risk;
h. Default risk; credit risk;
i. Mortgage bond; debenture; subordinated debenture
QUESTIONS (7-7; 7-11)
1. Indicate whether each of the following actions will increase or decrease a bond’s
yield to maturity:
a. The bond’s price increases.
b. The bond is downgraded by the rating agencies.
c. A change in the bankruptcy code makes it more difficult for bondholders to receive
payments in the event the firm declares bankruptcy.
d. The economy seems to be shifting from a boom to a recession. Discuss the effects of
the firm’s credit strength in your answer.
e. Investors learn that these bonds are subordinated to another debt issue.
2. Why are convertibles and bonds with warrants typically offered with lower
coupons than similarly rated straight bonds?
PROBLEMS
7-1 Bond valuation: (7-1; 7-3; 7-5; 7-6)
1. Callaghan Motors’ bonds have 10 years remaining to maturity. Interest is paid
annually; they have a $1,000 par value; the coupon interest rate is 8 percent; and
the yield to maturity is 9 percent. What is the bond’s current market price?
2. Nungesser Corporation’s outstanding bonds have a $1,000 par value, a 9 percent
semiannual coupon, 8 years to maturity, and an 8.5 percent YTM. What is the
bond’s price?
 3. An investor has two bonds in his portfolio that both have a face value of $1,000
and pay a 10 percent annual coupon. Bond L matures in 15 years, while Bond S
matures in 1 year.
a. What will the value of each bond be if the going interest rate is 5 percent, 8 percent,
and 12 percent? Assume that there is only one more interest payment to be made on Bond
S, at its maturity, and 15 more payments on Bond L.
b. Why does the longer-term bond’s price vary more when interest rates change than does
that of the shorter-term bond?
4. An investor has two bonds in his or her portfolio, Bond C and Bond Z. Each
matures in 4 years, has a face value of $1,000, and has a yield to maturity of 9.6
percent. Bond C pays a 10 percent annual coupon, while Bond Z is a zero coupon
bond.
a. Assuming that the yield to maturity of each bond remains at 9.6 percent over the next 4
years, calculate the price of the bonds at the following years to maturity and fill in the
following table:
Years to Maturity Price of Bond C Price of Bond Z
4 _________ _________
3 _________ _________
2 _________ _________
1 _________ _________
1 _________ _________
7-2 Current yield and yield to maturity: (7-2; 7-4; 7-9; 7-10)
1. A bond has a $1,000 par value, 10 years to maturity, a 7 percent annual coupon,
and sells for $985.
a. What is its current yield?
b. What is its yield to maturity (YTM)?
c. Assume that the yield to maturity remains constant for the next 3 years. What will the
price be 3 years from today?
2. A firm’s bonds have a maturity of 10 years with a $1,000 face value, an 8 percent
annual coupon, and currently sell at a price of $1,100. What are their yield to
maturity? What return should investors expect to earn on this bond?
3. Heymann Company bonds have 4 years left to maturity. Interest is paid annually,
and the bonds have a $1,000 par value and a coupon rate of 9 percent.
a. What is the yield to maturity at a current market price of (1) $829 or (2) $1,104?
b. Would you pay $829 for each bond if you thought that a “fair” market interest rate for
such bonds was 12 percent—that is, if rd 12 percent? Explain your answer.
4. Hooper Printing Inc. has bonds outstanding with 9 years left to maturity. The
bonds have an 8 percent annual coupon rate and were issued 1 year ago at their par
value of $1,000, but due to changes in interest rates, the bond’s market price has
fallen to $901.40. The capital gains yield last year was -9.86 percent.
a. What is the yield to maturity?
b. For the coming year, what is the expected current yield and the expected capital gains
yield?
COMPREHENSIVE/SPREADSHEET PROBLEM
7-21 Clifford Clark is a recent retiree who is interested in investing some of his savings in
corporate bonds. His financial planner has suggested the following bonds:
* Bond A has a 7 percent annual coupon, matures in 12 years, and has a $1,000 face
value.
* Bond B has a 9 percent annual coupon, matures in 12 years, and has a $1,000 face
value.
* Bond C has an 11 percent annual coupon, matures in 12 years, and has a $1,000 face
value.
Each bond has a yield to maturity of 9 percent.
a. Before calculating the prices of the bonds, indicate whether each bond is trading at a
premium, discount, or at par.
b. Calculate the price of each of the three bonds.
c. Calculate the current yield for each of the three bonds.
ADDITIONAL HOMEWORK
1. Consider a bond with a 10% coupon and with yield to maturity is 8%. If the
bond’s YTM remain constant, then in one year will the bond price be higher,
lower or unchanged? Why?
2. Consider a bond paying a coupon rate of 10% annually when the market interest
rate is only 8%. The bond has three years until maturity.
a. Find the bond’s price today and six months from now after the next coupon is paid
b. What is the total rate of return on the bond?
 3. A bond with a coupon rate of 7% make annual coupon payment on Jan.15 of each
year. The Wall Street Journal reports the ask price is $800 for the bond on Jan.31
at 110:02. What is invoice price of the bond? The coupon period has 360 days.
4. Consider a bond with a settlement date of Feb.22,2012, and a maturity date of
Mar.15,2020. The coupon rate is 5.5%. If the YTM of the bond is 5.34% (bond
equivalent yield, annually coupon payment), what is the list price of the bond on
the settlement date? What is the accrued interest on bond? What is the full price of
the bond?
5. Suppose that today’s date is April.15. A bond with a 10% coupon paid
semiannually every Jan. 15 and July.15 is listed in The Wall Street Journal as
selling at an ask price of 101:04. If you buy the bond from a dealer today, what
price will you pay for it?
6. Compute the value of a 5-year 7.4% coupon bond that pays interest: (1) annually
and (2) semiannually assuming that the appropriate discount rate is 5.6%.
7. A. Assuming annual interest payments, what is the value of a 5-year 6.2% coupon
bond when the discount rate is (i) 4.5%; (ii) 6.2% and (iii) 7.3%
B. Show that the results obtained in part (A) consistent with the relationship
between the coupon rate, discount rate and price ralative to par value.
8. A 4-year 5.8% coupon bond is selling to yield 7%. The bond pays interest
annually. One year later interest decrease from 7% to 6.2%
a. What is the price of the 4-year 5.8% coupon bond selling to yield 7%.
b. What is the price of this bond one year later assuming the yield is unchanged at 7%?
c. What is the price of this bond one year later if instead of the yield being unchanged the
yield decrease to 6.2%
9. What is the value of a 5-year 5.8% annual coupon bond if the appropriate discount
rate for discounting each cashflow is as follow:
Year discount rate (%)
1 5.9
2 6.4
3 6.6
4 6.9
5 7.3
10. What is the value of a 5-year 7.4% coupon bond selling to yield 5.6% assuming
the coupon payments are made semiannually?