8. Bona yleias Coupon payments are fixed, but the percentage return that investors receive varies based on market conditions. This percentage return is referred to as the bond's yield. Yield to maturity (YTM) is the rate of return expected from a bond held until its maturity date. However, the YTM equals the expected rate of return under certain assumptions. Which of the following is one of those assumptions? The bond is callable. The probability of default is zero. Consider the case of Blanche Inc.: Blanche Inc. has 9% annual coupon bonds that are callable and have 18 years left until maturity. The bonds have a par value of $1,000, and their current market price is $1,070.35. However, Blanche Inc. may call the bonds in eight years at a call price of $1,060. What are the YTM and the yield to call (YTC) on Blanche Inc.'s bonds? Value YTM YTC If interest rates are expected to remain constant, what is the best estimate of the remaining life left for Blanche Inc.'s bonds? 18 years 10 years years 8 years If Blanche Inc. issued new bonds today, the coupon rate must be for the bonds have to be issued at par. 7. Valuing semiannual coupon bonds Bonds often pay a coupon twice a year. For the valuation of bonds that make semiannual payments, the number of periods doubles, whereas the amount of cash flow decreases by half. Using the values of cash flows and number of periods, the valuation model is adjusted accordingly. Assume that a $1,000,000 par value, semiannual coupon U.S. Treasury note with five years to maturity has a coupon rate of 3%. The yield to maturity (YTM) of the bond is 8.80%. Using this information and ignoring the other costs involved, calculate the value of the Treasury note: $923,278.49 $653,988.93 $769,398.74 $484,721.21 Based on your calculations and understanding of semiannual coupon bonds, complete the following statements: Assuming that interest rates remain constant, the T-note's price is expected to The T-note described is selling at a When valuing a semiannual coupon bond, the time period variable (N) used to calculate the price of a bond reflects the number of periods remaining in the bond's life. 10. More on types of bonds A legal document that details the rights of bondholders and the issuer is called If the legal document just described includes a sinking fund provision, is the bond considered to have more or less default risk, all else being equal? More default risk Less default risk You can distinguish the various types of bonds by their terms of contract, pledge of collateral, and so on. Identify the type of bond based on each description given in the table that follows: You can distinguish the various types of bonds by their terms of contract, pledge of collateral, and so on. Identify the type of bond based on each description given in the table that follows: Type of Bond Description These bonds are backed by real estate holdings and equipment, and if a company goes bankrupt, the collateral can be sold off to compensate for the default. These bonds, more so than other collateralized securities, have prior claims over assets. These bonds are traded in the bond markets based on investors' belief that the issuer will not default on the repayment. These bonds have no collateral and usually offer higher yields. These bonds are considered the riskiest of all corporate bonds and thus offer the highest interest rates. The California Pollution Control Financing Authority (CPCFA) has a pollution control tax-exempt financing program. This program allows California businesses to get financing for the acquisition, construction, rehabilitation, and equipping of their facilities for pollution control, waste disposal, waste recovery, and other activities conducted in the public's interest. Such bonds are called development or pollution control bonds. Development bonds have interest rates as corporate bonds. Based on your understanding of bond ratings and bond-rating criteria, which of the following statements is true? During a period of economic growth and in an optimistic environment, the yield spread between U.S. government bonds and corporate bonds could be higher than during an economic recession and a pessimistic environment. During an economic recession and in a pessimistic environment, the yield spread between U.S. government bonds and corporate bonds could be higher than during good economic times. 9. Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 4% per year for each of the next two years and 3% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t - 1)%, where t is the security's maturity. The liquidity premium (LP) on all Dare Satellite Corp.'s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Default Risk Premium Rating U.S. Treasury AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Dare Satellite Corp. issues 13-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 7.30% 8.50% 7.95% 5.35% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? The yield on U.S. Treasury securities always remains static. The yield on a AAA-rated bond will be lower than the yield on a AA-rated bond. 12. Price risk and reinvestment rate risk Which of the following statements are true? Check all that apply. When interest rates rise, the coupon rates on newly issued bonds will increase. c Bonds with similar coupons will always have the same percentage price change, no matter the maturity. Purchasing long-term bonds reduces an investor's interest rate risk. As long as bonds are highly rated, there is very little interest rate risk. Which of the following bonds has the highest reinvestment rate risk? 5% municipal bond, callable after 3 years Zero coupon bond 5% corporate bond, 10-year maturity, noncallable 5% corporate bond, callable after 7 years 8. Bona yleias Coupon payments are fixed, but the percentage return that investors receive varies based on market conditions. This percentage return is referred to as the bond's yield. Yield to maturity (YTM) is the rate of return expected from a bond held until its maturity date. However, the YTM equals the expected rate of return under certain assumptions. Which of the following is one of those assumptions? The bond is callable. The probability of default is zero. Consider the case of Blanche Inc.: Blanche Inc. has 9% annual coupon bonds that are callable and have 18 years left until maturity. The bonds have a par value of $1,000, and their current market price is $1,070.35. However, Blanche Inc. may call the bonds in eight years at a call price of $1,060. What are the YTM and the yield to call (YTC) on Blanche Inc.'s bonds? Value YTM YTC If interest rates are expected to remain constant, what is the best estimate of the remaining life left for Blanche Inc.'s bonds? 18 years 10 years years 8 years If Blanche Inc. issued new bonds today, the coupon rate must be for the bonds have to be issued at par. 7. Valuing semiannual coupon bonds Bonds often pay a coupon twice a year. For the valuation of bonds that make semiannual payments, the number of periods doubles, whereas the amount of cash flow decreases by half. Using the values of cash flows and number of periods, the valuation model is adjusted accordingly. Assume that a $1,000,000 par value, semiannual coupon U.S. Treasury note with five years to maturity has a coupon rate of 3%. The yield to maturity (YTM) of the bond is 8.80%. Using this information and ignoring the other costs involved, calculate the value of the Treasury note: $923,278.49 $653,988.93 $769,398.74 $484,721.21 Based on your calculations and understanding of semiannual coupon bonds, complete the following statements: Assuming that interest rates remain constant, the T-note's price is expected to The T-note described is selling at a When valuing a semiannual coupon bond, the time period variable (N) used to calculate the price of a bond reflects the number of periods remaining in the bond's life. 10. More on types of bonds A legal document that details the rights of bondholders and the issuer is called If the legal document just described includes a sinking fund provision, is the bond considered to have more or less default risk, all else being equal? More default risk Less default risk You can distinguish the various types of bonds by their terms of contract, pledge of collateral, and so on. Identify the type of bond based on each description given in the table that follows: You can distinguish the various types of bonds by their terms of contract, pledge of collateral, and so on. Identify the type of bond based on each description given in the table that follows: Type of Bond Description These bonds are backed by real estate holdings and equipment, and if a company goes bankrupt, the collateral can be sold off to compensate for the default. These bonds, more so than other collateralized securities, have prior claims over assets. These bonds are traded in the bond markets based on investors' belief that the issuer will not default on the repayment. These bonds have no collateral and usually offer higher yields. These bonds are considered the riskiest of all corporate bonds and thus offer the highest interest rates. The California Pollution Control Financing Authority (CPCFA) has a pollution control tax-exempt financing program. This program allows California businesses to get financing for the acquisition, construction, rehabilitation, and equipping of their facilities for pollution control, waste disposal, waste recovery, and other activities conducted in the public's interest. Such bonds are called development or pollution control bonds. Development bonds have interest rates as corporate bonds. Based on your understanding of bond ratings and bond-rating criteria, which of the following statements is true? During a period of economic growth and in an optimistic environment, the yield spread between U.S. government bonds and corporate bonds could be higher than during an economic recession and a pessimistic environment. During an economic recession and in a pessimistic environment, the yield spread between U.S. government bonds and corporate bonds could be higher than during good economic times. 9. Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 4% per year for each of the next two years and 3% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t - 1)%, where t is the security's maturity. The liquidity premium (LP) on all Dare Satellite Corp.'s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Default Risk Premium Rating U.S. Treasury AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Dare Satellite Corp. issues 13-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 7.30% 8.50% 7.95% 5.35% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? The yield on U.S. Treasury securities always remains static. The yield on a AAA-rated bond will be lower than the yield on a AA-rated bond. 12. Price risk and reinvestment rate risk Which of the following statements are true? Check all that apply. When interest rates rise, the coupon rates on newly issued bonds will increase. c Bonds with similar coupons will always have the same percentage price change, no matter the maturity. Purchasing long-term bonds reduces an investor's interest rate risk. As long as bonds are highly rated, there is very little interest rate risk. Which of the following bonds has the highest reinvestment rate risk? 5% municipal bond, callable after 3 years Zero coupon bond 5% corporate bond, 10-year maturity, noncallable 5% corporate bond, callable after 7 years