QUESTION 9

Part A: Three $1,000 face value, 10-year, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

a. Over the next year, Bond 8s price is expected to decrease, Bond 10s price is expected to stay the same, and Bond 12s price is expected to increase.

b. Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year.

c. Bond 8s current yield will increase each year.

d. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year.

e. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.

Part B: Which of the following about bonds is incorrect?

a. A bond is a long term debt instrument in which a borrower agrees to makes of principal and interest, on specific dates, to the holders of the bond.

b. Most commonly seen bonds are treasury bonds, corporate bonds, and municipal bonds.

c. The coupon rate is fixed across the life the bond and can be used to find the coupon payments.

d. The coupon rate is the same as the yield to maturity, or the required return of holding the bond until maturity.

e. The discount rate (r) is the Yield to Maturity (YTM) of the bond. It is determined by the market (aggregate investors) as the proper interest rate that needs to be received, thus rate of return for investors or debtholders. The discount rate r can also be thought of as the actual cost for the firm when borrowing from investors, thus cost of debt for debt issuers.