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Questions and Answers of
Corporate Finance
Municipal zoning laws often are used as a means of controlling the population and income levels of citizens in a political jurisdiction. How can zoning laws that require homes to be built on a
The elasticity of the property tax base for the town of Elderberry is estimated to be 22. Assuming that this estimate is correct, what effect would a 10 percent increase in the property tax have on
All voters in a city pay an equal marginal tax rate of $10 per mile of roads paved per year. The federal government has a matching grant program of road paving whereby 75 percent of the cost of road
Explain why using the local property tax to finance a given quantity and quality of public schooling can result in low tax rates in rich jurisdictions but high tax rates in poor jurisdictions. How do
What is the cash flow of a 10-year bond that pays coupon interest semiannually, has a coupon rate of 7%, and has a par value of $100,000?
(a) What is the advantage of a call provision for an issuer?(b) What are the disadvantages of a call provision for the bondholder?
(a) What is meant by JPY LIBORBBA?(b) Describe the coupon interest characteristics of this bond.(c) What are the risks associated with investing in this bond if the investor’s home currency is not
(a) What is meant by JPY LIBORBBA?(b) Describe the coupon interest characteristics of this bond.(c) What are the risks associated with investing in this bond if the investor’s home currency is not
What are convertible bonds and exchangeable bonds?
How do market participants gauge the default risk of a bond issue?
Comment on the following statement: Credit risk is more than the risk that an issuer will default.
Explain whether you agree or disagree with the following statement: “Because my bond is guaranteed by an insurance company, I have eliminated credit risk.”
(a) What is counterparty risk?(b) Give two examples of transactions where one faces counterparty risk.
Does an investor who purchases a zero-coupon bond face reinvestment risk?
What is the cash flow of a seven-year bond that pays no coupon interest and has a par value of $10,000?
What is meant by marking a position to market?
What is meant by a CUSIP number, and why is it important?
Give three reasons why the maturity of a bond is important.
Explain whether or not an investor can determine today what the cash flow of a floating-rate bond will be.
(a) What is the reference rate?(b) What is the quoted margin?(c) Suppose that on a coupon reset date that 1-month LIBOR is 2.8%. What will the coupon rate be for the period?
What is a deferred coupon bond?
What is meant by a linker?
(a) What is meant by an amortizing security? (b) Why is the maturity of an amortizing security not a useful measure?
What is a bond with an embedded option?
A pension fund manager invests $10 million in a debt obligation that promises to pay 7.3% per year for four years. What is the future value of the $10 million?
Suppose that you purchased a debt obligation three years ago at its par value of $100,000 and nine years remaining to maturity. The market price of this debt obligation today is $90,000. What are
Suppose that you are reviewing a price sheet for bonds and see the following prices (per $100 par value) reported. You observe what seem to be several errors. Without calculating the price of each
What is the maximum price of a bond?
What is the “dirty” price of a bond?
Explain why you agree or disagree with the following statement: “The price of a floater will always trade at its par value.”
Explain why you agree or disagree with the following statement: “The price of an inverse floater will increase when the reference rate decreases.”
Suppose that a life insurance company has guaranteed a payment of $14 million to a pension fund 4.5 years from now. If the life insurance company receives a premium of $10.4 million from the pension
(a) The portfolio manager of a tax-exempt fund is considering investing $500,000 in a debt instrument that pays an annual interest rate of 5.7% for four years. At the end of four years, the portfolio
Suppose that a portfolio manager purchases $10 million of par value of an eight-year bond that has a coupon rate of 7% and pays interest once per year. The first annual coupon payment will be made
(a) If the discount rate that is used to calculate the present value of a debt obligation’s cash flow is increased, what happens to the price of that debt obligation?(b) Suppose that the discount
The pension fund obligation of a corporation is calculated as the present value of the actuarially projected benefits that will have to be paid to beneficiaries. Why is the interest rate used to
Suppose that the pension fund manager wants to invest a sum of money that will satisfy this liability stream. Assuming that any amount that can be invested today can earn an annual interest rate of
Calculate for each of the following bonds the price per $1,000 of par value assuming semiannual coupon payments.
Consider a bond selling at par ($100) with a coupon rate of 6% and 10 years to maturity.(a) What is the price of this bond if the required yield is 15%?(b) What is the price of this bond if the
A debt obligation offers the following payments:Years from Now Cash Flow to Investor1...........$2,0002...........$2,0003...........$2,5004...........$4,000Suppose that the price of this debt
What is the limitation of using the internal rate of return of a portfolio as a measure of the portfolio’s yield?
Suppose that the coupon rate of a floating-rate security resets every six months at a spread of 70 basis points over the reference rate. If the bond is trading at below par value, explain whether the
An investor is considering the purchase of a 20-year 7% coupon bond selling for $816 and a par value of $1,000. The yield to maturity for this bond is 9%.Answer the below questions.(a) What would be
What is the total return for a 20-year zero-coupon bond that is offering a yield to maturity of 8% if the bond is held to maturity?
Explain why the total return from holding a bond to maturity will be between the yield to maturity and the reinvestment rate.
For a long-term high-yield coupon bond, do you think that the total return from holding a bond to maturity will be closer to the yield to maturity or the reinvestment rate?
Suppose that an investor with a five-year investment horizon is considering purchasing a seven-year 9% coupon bond selling at par. The investor expects that he can reinvest the coupon payments at an
Two portfolio managers are discussing the investment characteristics of amortizing securities. Manager A believes that the advantage of these securities relative to nonamortizing securities is that
Assuming the following yields:Week 1: 3.84%Week 2: 3.51%Week 3: 3.95%(a) Compute the absolute yield change and relative yield change from week 1 to week 2.(b) Compute the absolute yield change and
What is the effective annual yield if the semiannual periodic interest rate is 4.3%?
What is the yield to maturity of a bond?
What is the yield to maturity calculated on a bond-equivalent basis?
(a) Show the cash flows for the following four bonds, each of which has a par value of $1,000 and pays interest semiannually.(b) Calculate the yield to maturity for the four bonds.BondCoupon
A portfolio manager is considering buying two bonds. Bond A matures in three years and has a coupon rate of 10% payable semiannually. Bond B, of the same credit quality, matures in 10 years and has a
Consider the following bond:Coupon rate = 11%Maturity = 18 yearsPar value = $1,000First par call in 13 yearsOnly put date in five years and putable at par valueSuppose that the market price for this
(a) What is meant by an amortizing security?(b) What are the three components of the cash flow for an amortizing security?(c) What is meant by a cash flow yield?
How is the internal rate of return of a portfolio calculated?
The price value of a basis point will be the same regardless if the yield is increased or decreased by 1 basis point. However, the price value of 100 basis points (i.e., the change in price for a
Consider the following two Treasury securities:Which bond will have the greater dollar price volatility for a 25-basis-point change in interest rates?
What are the limitations of using duration as a measure of a bond’s price sensitivity to interest-rate changes?
The following excerpt is taken from an article titled “Denver Investment to Make $800 Million Treasury Move,” that appeared in the December 9, 1991, issue of BondWeek, p. 1: “Denver Investment
You are a portfolio manager who has presented a report to a client. The report indicates the duration of each security in the portfolio. One of the securities has a maturity of 15 years but a
Answer the below questions.(a) Suppose that the spread duration for a fixed-rate bond is 2.5. What is the approximate change in the bond’s price if the spread changes by 50 basis points?(b) What is
What is meant by the spread duration for a floating-rate bond?
Explain why the duration of an inverse floater is a multiple of the duration of the collateral from which the inverse floater is created.
Consider the following portfolio:(a) What is the portfolio’s duration?(b) If interest rates for all maturities change by 50 basis points, what is the approximate percentage change in the value of
“If two portfolios have the same duration, the change in their value when interest rates change will be the same.” Explain why you agree or disagree with this statement.
For a corporate bond that has a low credit rating, why might an analytical duration be limited as a measure of interest-rate risk?
Calculate the requested measures in parts (a) through (f) for bonds A and B (assume that each bond pays interest semiannually):(a) What is the price value of a basis point for bonds A and B?(b)
Some authors give the following formula for the approximate convexity measure:where the variables are defined as in equation (4.24) of this chapter. Compare this formula with the approximate
(a) How is the short-end duration of a portfolio computed?(b) How is the long-end duration of a portfolio computed?(c) How is the short end and long end of a portfolio defined?(d) Suppose that the
(a) Explain what a 10-year key rate duration of 0.35 means?(b) How is a key rate duration computed?
Can you tell from the following information which of the following three bonds will have the greatest price volatility, assuming that each is trading to offer the same yield to
Answer the below questions for bonds A and B.(a) Calculate the actual price of the bonds for a 100-basis-point increase in interest rates.(b) Using duration, estimate the price of the bonds for a
State why you would agree or disagree with the following statement: As the duration of a zero-coupon bond is equal to its maturity, the price responsiveness of a zero-coupon bond to yield changes is
State why you would agree or disagree with the following statement: When interest rates are low, there will be little difference between the Macaulay duration and modified duration measures.
State why you would agree or disagree with the following statement: If two bonds have the same dollar duration, yield, and price, their dollar price sensitivity will be the same for a given change in
State why you would agree or disagree with the following statement: For a 1-basis point change in yield, the price value of a basis point is equal to the dollar duration.
The November 26, 1990, issue of BondWeek includes an article, “Van Kampen Merritt Shortens.” The article begins as follows: “Peter Hegel, first V.P. at Van Kampen Merritt Investment Advisory,
Following are U.S. Treasury benchmarks available on December 31, 2007:US/T 3.125 11/30/2009 3.133US/T 3.375 11/30/2012
Explain why a financial asset can be viewed as a package of zero-coupon instruments.
How are spot rates related to forward rates?
You are a financial consultant. At various times you have heard comments on interest rates from one of your clients. How would you respond to each comment? (a) Respond to: “The yield curve is
You observe the yields of the following Treasury securities (all yields are shown on a bond-equivalent basis):All the securities maturing from 1.5 years on are selling at par. The 0.5 and 1.0-year
You observe the following Treasury yields (all yields are shown on a bond equivalent basis):All the securities maturing from 1.5 years on are selling at par. The 0.5 and 1.0-year securities are
What Treasury issues can be used to construct the theoretical spot rate curve?
What are the problems with using only on-the-run Treasury issues to construct the theoretical spot rate curve?
When all Treasury issues are used to construct the theoretical spot rate curve, what methodology is used to construct the curve?
Answer the below questions. (a) What are the limitations of using Treasury strips to construct the theoretical spot rate curve?(b) When Treasury strips are used to construct the curve, why are only
What actions force a Treasury’s bond price to be valued in the market at the present value of the cash flows discounted at the Treasury spot rates?
The yield spread between two corporate bond issues reflects more than just differences in their credit risk. What other factors would the spread reflect?
Explain the role that forward rates play in making investment decisions.
.“Forward rates are poor predictors of the actual future rates that are realized. Consequently, they are of little value to an investor.” Explain why you agree or disagree with this statement.
Bart Simpson is considering two alternative investments. The first alternative is to invest in an instrument that matures in two years. The second alternative is to invest in an instrument that
Answer the below questions.(a) What is the common hypothesis about the behavior of short-term forward rates shared by the various forms of the expectations theory?(b) What is price risk and
Answer the below questions.(a) What are the two biased expectations theories about the term structure of interest rates?(b) What are the underlying hypotheses of these two theories?
Answer the below questions. (a) “Empirical evidence suggests that with respect to bond risk premiums that influence the shape of the Treasury yield curve, there is a linear relationship between
Answer the below questions.a. What is meant by the swap rate?b. What is meant by the swap curve?c. Explain whether you agree or disagree with the following statement: “A country’s swap curve is a
Why do market participants in some countries prefer to use the swap curve rather than the government bond yield curve?
A client observes that a corporate bond that he is interested in purchasing with a triple A rating has a benchmark spread that is positive when the benchmark is U.S. Treasuries but negative when the
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