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essentials of investments

Questions and Answers of Essentials of Investments

Conservatism implies that investors will at first respond too slowly to new information, leading to trends in prices. Representativeness can lead them to extrapolate trends too far into the future
Out-of-favor stocks will exhibit low prices relative to various proxies for intrinsic value such as earnings. Because of regret avoidance, these stocks will need to offer a more attractive rate of
At liquidation, price will equal NAV. This puts a limit on fundamental risk. Investors need only carry the position for a few months to profit from the elimination of the discount. Moreover, as the
By the time the news of the recession affects bond yields, it also ought to a LO.1 ffect stock prices. The market should fall before the confidence index signals that the time is ripe to sell.
Define the following types of bonds:a. Catastrophe bond.b. Eurobond.c. Zero-coupon bond.d. Samurai bond.e. Junk bond.f. Convertible bond.g. Serial bond.h. Equipment obligation bond.i. Original issue
What is the option embedded in a callable bond? A puttable bond? LO.1
A zero-coupon bond with face value $1,000 and maturity of five years sells for $746.22.What is its yield to maturity? What will happen to its yield to maturity if its price falls immediately to
Why do bond prices go down when interest rates go up? Don’t investors like high interest rates?LO.1
Two bonds have identical times to maturity and coupon rates. One is callable at 105, the other at 110. Which should have the higher yield to maturity? Why? LO.1 LO.1
Consider a bond with a 10% coupon and with yield to maturity 8%. If the bond’s YTM remains constant, then in one year, will the bond price be higher, lower, or unchanged? Why? LO.1
A bond with an annual coupon rate of 4.8% sells for $970. What is the bond’s current yield?Intermediate LO.1
You buy an eight-year bond that has a 6% current yield and a 6% coupon (paid annually).In one year, promised yields to maturity have risen to 7%. What is your holdingperiod return?1 LO.1
The stated yield to maturity and realized compound yield to maturity of a (default-free)zero-coupon bond will always be equal. Why?LO.1
Consider a bond paying a coupon rate of 10% per year semiannually when the market interest rate is only 4% per half-year. The bond has three years until maturity.a. Find the bond’s price today and
Redo the previous problem using the same data, but now assume that the bond makes its coupon payments annually. Why are the yields you compute lower in this case?LO.1
Return to Table 10.1 and calculate both the real and nominal rates of return on the TIPS bond in the second and third years.LO.1
Fill in the table below for the following zero-coupon bonds, all of which have par values of $1,000.Price Maturity (years) Yield to Maturity$400 20 ?$500 20 ?$500 10 ?? 10 10%? 10 8%$400 ? 8%LO.1
A bond with a coupon rate of 7% makes semiannual coupon payments on January 15 and July 15 of each year. The Wall Street Journal reports the ask price for the bond on January 30 at 100:02. What is
A bond has a current yield of 9% and a yield to maturity of 10%. Is the bond selling above or below par value? Explain.LO.1
Is the coupon rate of the bond in the previous problem more or less than 9%?
A 10-year bond of a firm in severe financial distress has a coupon rate of 14% and sells for $900. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to
A two-year bond with par value $1,000 making annual coupon payments of $100 is priced at $1,000. What is the yield to maturity of the bond? What will be the realized compound yield to maturity if the
Suppose that today’s date is April 15.A bond with a 10% coupon paid semiannually every January 15 and July 15 is listed in The Wall Street Journal as selling at an ask price of 101:04. If you buy
A large corporation issued both fixed and floating-rate notes five years ago, with terms given in the following table:9% Coupon Notes Floating-Rate Note Issue size $250 million $280 million Maturity
Masters Corp. issues two bonds with 20-year maturities. Both bonds are callable at$1,050. The first bond is issued at a deep discount with a coupon rate of 4% and a price of $580 to yield 8.4%. The
Under the expectations hypothesis, if the yield curve is upward-sloping, the market must expect an increase in short-term interest rates. True/false/uncertain? Why?LO.1
The yield curve is upward-sloping. Can you conclude that investors expect short-term interest rates to rise? Why or why not?LO.1
Assume you have a one-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 10 years. The first is a zero-coupon bond that pays
The current yield curve for default-free zero-coupon bonds is as follows:Maturity (Years) YTM 1 10%2 11 3 12a. What are the implied one-year forward rates?b. Assume that the pure expectations
The following table contains spot rates and forward rates for three years. However, the labels got mixed up. Can you identify which row of the interest rates represents spot rates and which one the
Consider the following $1,000 par value zero-coupon bonds:Bond Years until Maturity Yield to Maturity AB CD 12 34 5%6%6.5 7%According to the expectations hypothesis, what is the market’s
A newly issued bond pays its coupons once a year. Its coupon rate is 5%, its maturity is 20 years, and its yield to maturity is 8%.a. Find the holding-period return for a one-year investment period
On May 30, 2006, Janice Kerr is considering the newly issued 10-year AAA corporate bonds shown in the following exhibit:Description Coupon Price Callable Call Price Sentinal, due May 30, 2016 6.00%
A convertible bond has the following features:Coupon 5.25%Maturity June 15, 2017 Market price of bond $77.50 Market price of underlying common stock $28.00 Annual dividend $1.20 Conversion ratio
Bonds of Zello Corporation with a par value of $1,000 sell for $960, mature in five years, and have a 7% annual coupon rate paid semiannually.a. Calculate the:(1) Current yie ld.(2) Yield to ma
Use the Financial Highlights section of Market Insight to obtain Standard & Poor’s bond rating of at least 10 fi rms in the database. Try to choose a sample with a wide range of bond ratings. Next
The percentage of bonds that were publicly traded and the percentage that were privately traded.LO.1
The percentage of bonds that were investment grade and the percentage that were high-yield.LO.1
The percentage of bonds that had fixed coupon rates and the percentage that had floating rates. LO.1
Do any patterns emerge over time?LO.1
Repeat the calculations using the information for convertible bond issues (typically in Table 2). LO.1
The c allable bond w ill s ell a t t he lower price. Investors will not be willing to pay as much if they know that the fi rm retains a valuable option to reclaim the bond for the call price if
At a semiannual interest rate of 3%, the bond is worth $40 Annuity factor(3%, 60)$1,000 PV factor(3%, 60) $1,276.76, which results in a capital gain of $276.76. This exceeds the capital loss of
Yield to maturity exceeds current yield, which exceeds coupon rate. Take as an example the 8%coupon bond with a yield to maturity of 10% per year (5% per half year). Its price is $810.71, and
The current price of the bond can be derived from the yield to maturity. Using your calculator, set: n 40 (semiannual periods); PMT $45 per period; FV $1,000; i 4% per semiannual period. Calculate
Price $70 Annuity factor(8%, 1) $1,000 PV factor(8%, 1) $990.74 Rate of return to investor$70($990.74 $982 17 982 17 0 080 8. )$ .. % LO.1
By year-end, remaining maturity is 29 years. If the yield to maturity were still 8%, the bond would still sell at par and the holding-period return would be 8%. At a higher yield, price and return
At the lower yield, the bond price will be $631.67 [ n 29, i 7%, FV $1,000, PMT $40] .Therefore, total after-tax income is Coupon $40 (1 0.38) $24.80 Imputed i nterest ($553.66 $549.69) (1 0.38) 2.46
The yield to maturity on two-year bonds is 8.5%. The forward rate for the third year is f 3 8% 1% 9%. We obtain the yield to maturity on three-year zeros from(1 ) (1 ) (1 ) 1.085 1.09 1.2832 3 32 23
Bond prices and yields are inversely related: As yields increase, bond prices fall; as yields fall, bond prices rise. LO.1
An increase in a bond’s yield to maturity results in a smaller price change than a decrease in yield of equal magnitude.Now compare the interest rate sensitivity of bonds A and B, which are
Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds.LO.1
LO.1 You predict that interest rates are about to fall. Which bond will give you the highest capital gain?a. Low coupon, long maturity.b. High coupon, short maturity.c. High coupon, long maturity.d.
LO.1 A bond currently sells for $1,050, which gives it a yield to maturity of 6%. Suppose that if the yield increases by 25 basis points, the price of the bond falls to $1,025. What is the duration
Macaulay’s duration is less than modified duration except for:a Zero-coupon bonds.b. Premium bonds.c. Bonds selling at par value.d. None of the above.LO.1
Is the decrease in a bond’s price corresponding to an increase in its yield to maturity more or less than the price increase resulting from a decrease in yield of equal magnitude?LO.1
Find the duration of a 6% coupon bond making annual coupon payments if it has three years until maturity and a yield to maturity of 6%. What is the duration if the yield to maturity is 10%?LO.1
A nine-year bond has a yield of 10% and a duration of 7.194 years. If the bond’s yield changes by 50 basis points, what is the percentage change in the bond’s price?Intermediate LO.1
Long-term Treasury bonds currently are selling at yields to maturity of nearly 8%.You expect interest rates to fall. The rest of the market thinks that they will remain unchanged over the coming
Pension funds pay lifetime annuities to recipients. If a firm remains in business indefinitely, the pension obligation will resemble a perpetuity. Suppose, therefore, that you are managing a pension
You are managing a portfolio of $1 million. Your target duration is 10 years, and you can choose from two bonds: a zero-coupon bond with maturity 5 years, and a perpetuity, each currently yielding
Find the duration of a bond with settlement date May 27, 2010, and maturity date November 15, 2019. The coupon rate of the bond is 7%, and the bond pays coupons semiannually. The bond is selling at a
What is the duration of the bond in the previous problem if coupons are paid annually?Explain why the duration changes in the direction it does.LO.1
Find the convexity of a 7-year maturity, 6% coupon bond selling at a yield to maturity of 8%. The bond pays its coupons annually. (Hint: You can use the spreadsheet from this chapter’s Excel
a. Use a spreadsheet to calculate the durations of the two bonds in Spreadsheet 11.1 if the interest rate increases to 12%. Why does the duration of the coupon bond fall while that of the zero
Currently, the term structure is as follows: one-year bonds yield 7%, two-year bonds yield 8%, three-year bonds and greater maturity bonds all yield 9%. You are choosing between one-, two-, and
A 30-year maturity bond has a 7% coupon rate, paid annually. It sells today for $867.42.A 20-year maturity bond has a 6.5% coupon rate, also paid annually. It sells today for$879.50. A bond market
At the Market Insight Company page enter the stock ticker symbol HLT for Hilton Hotels Corporation and do the following:a. Review the recent Industry Outlook (in the S&P Stock Reports section) for
Enter the stock symbol S to locate information for Sprint Nextel Corp. on Market Insight.Find the company’s most recent annual Balance Sheet in the Excel Analytics section.a. Examine the
Select a bond from the most actively traded corporate bond list at www.investinginbonds.com. Go to the “Bond Markets and Prices” link, then select “Corporate Market At-a-Glance”to link to the
Choose the most recent trading date listed and click on the“run calculations” link. The bond’s characteristics are entered for you.LO.1
Confirm the amount of the accrued interest and the cash flow schedule listed.LO.1
Confirm the bond’s duration by either performing the calculations in a spreadsheet or using Excel’s DURATION function.LO.1
Based on the bond’s current price, by what percent would the price change if the yield were to change by .5%?LO.1
Repeat the calculations by entering assumed prices of 90, 100, and 110, then answer the following questions:a. What are the duration and the convexity for the bond at the each of the prices?b. Is the
Slow Growers. Large and aging companies that will grow only slightly faster than the broad economy. These firms have matured from their earlier fast-growth phase. They usually have steady cash flow
Stalwarts. Large, well-known firms like Coca-Cola or Colgate-Palmolive. They grow faster than the slow growers but are not in the very rapid growth start-up stage. They also tend to be in noncyclical
Fast Growers. Small and aggressive new firms with annual growth rates in the neighborhood of 20 to 25%. Company growth can be due to broad industry growth or to an increase in market share in a more
Cyclicals. These are firms with sales and profits that regularly expand and contract along with the business cycle. Examples are auto companies, steel companies, or the construction industry. LO.1
Turnarounds. These are firms that are in bankruptcy or soon might be. If they can recover from what might appear to be imminent disaster, they can offer tremendous investment returns. A good example
Asset Plays. These are firms that have valuable assets not currently reflected in the stock price. For example, a company may own or be located on valuable real estate that is worth as much or more
What are the differences between bottom-up and top-down approaches to security valuation?What are the advantages of a top-down approach? LO.1
Why does it make intuitive sense that the slope of the yield curve is considered a leading economic indicator?LO.1
The price of imported oil fell dramatically in late 2008. What sort of macroeconomic shock would this be considered?LO.1
How do each of the following affect the sensitivity of profits to the business cycle?a. Financial leverageb. Operating leverage LO.1
The present value of a firm’s projected cash flows are $15 million. The break-up value of the firm if you were to sell the major assets and divisions separately would be $20 million. This is an
Define each of the following in the context of a business cycle.a. Peakb. Contractionc. Troughd. Expansion LO.1
What is typically true of corporate dividend payout rates in the early stages of an industry life cycle? Why does this make sense?LO.1
If the nominal interest rate is 5% and the inflation rate is 3%, then what is the real interest rate ? LO.1
FinanceCorp has fixed costs of $7 million and profits of $4 million. What is its degree of operating leverage (DOL)?Intermediate LO.1
Choose an industry and identify the factors that will determine its performance in the next three years. What is your forecast for performance in that time period?LO.1
What monetary and fiscal policies might be prescribed for an economy in a deep recession?LO.1
If you believe the U.S. dollar is about to depreciate more dramatically than do other investors, what will be your stance on investments in U.S. auto producers?LO.1
Unlike other investors, you believe the Fed is going to dramatically loosen monetary policy.What would be your recommendations about investments in the following industries?a. Gold miningb.
Consider two firms producing DVDs. One uses a highly automated robotics process, while the other uses human workers on an assembly line and pays overtime when there is heavy production demand.a.
According to supply-side economists, what will be the long-run impact on prices of a reduction in income tax rates?LO.1
Here are four industries and four forecasts for the macroeconomy. Choose the industry that you would expect to perform best in each scenario.Industries: Housing construction, health care, gold
For each pair of firms, choose the one that you think would be more sensitive to the business cycle.a. General Autos or General Pharmaceuticals.b. Friendly Airlines or Happy Cinemas. LO.1
In which stage of the industry life cycle would you place the following industries?(Warning: There is considerable room for disagreement concerning the “correct”answers to this question.)a. Oil
Why do you think the index of consumer expectations is a useful leading indicator of the macroeconomy? (See Table 12.2 .) LO.1

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