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Exam 5: Bonds, Bond Valuation, and Interest Rates

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Question 41

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Currently,Bruner Inc.'s bonds sell for $1,250.They pay a $120 annual coupon,have a 15-year maturity,and a $1,000 par value,but they can be called in 5 years at $1,050.Assume that no costs other than the call premium would be incurred to call and refund the bonds,and also assume that the yield curve is horizontal,with rates expected to remain at current levels on into the future.What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM. )

A) 2.11%
B) 2.32%
C) 2.55%
D) 2.80%
E) 3.09%

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Question 42

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Cornwall Corporation is planning to raise $1,000,000 to finance a new plant.Which of the following statements is CORRECT?

A) If debt is used to raise the million dollars,but $500,000 is raised as first mortgage bonds on the new plant and $500,000 as debentures,the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds.
B) If two tiers of debt are used (with one senior and one subordinated debt class) ,the subordinated debt will carry a lower interest rate.
C) If debt is used to raise the million dollars,the cost of the debt would be lower if the debt were in the form of a fixed-rate bond rather than a floating-rate bond.
D) If debt is used to raise the million dollars,the cost of the debt would be higher if the debt were in the form of a mortgage bond rather than an unsecured term loan.
E) The company would be especially eager to have a call provision included in the indenture if its management thinks that interest rates are almost certain to rise in the foreseeable future.

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Question 43

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Which of the following statements is NOT CORRECT?

Sinking funds are devices used to force companies to retire bonds on a scheduled basis prior to their maturity.Many bond indentures allow the company to acquire bonds for a sinking fund by either purchasing bonds in the market or selecting the bonds to be acquired by a lottery administered by the trustee through a call at face value.

You are considering 2 bonds that will be issued tomorrow.Both are rated triple B (BBB,the lowest investment-grade rating),both mature in 20 years,both have a 10% coupon,neither can be called except for sinking fund purposes,and both are offered to you at their $1,000 par values.However,Bond SF has a sinking fund while Bond NSF does not.Under the sinking fund,the company must call and pay off 5% of the bonds at par each year.The yield curve at the time is upward sloping.The bond's prices,being equal,are probably not in equilibrium,as Bond SF,which has the sinking fund,would generally be expected to have a higher yield than Bond NSF.

There is an inverse relationship between bonds' quality ratings and their required rates of return.Thus,the required return is lowest for AAA-rated bonds,and required returns increase as the ratings get lower.

Which of the following statements is CORRECT?

Field Industries' outstanding bonds have a 25-year maturity and $1,000 par value.Their nominal yield to maturity is 9.25%,they pay interest semiannually,and they sell at a price of $850.What is the bond's nominal (annual) coupon interest rate?

CMS Corporation's balance sheet as of today is as follows: Long-term debt (bonds,at par) $10,000,000 Preferred stock 2,000,000 Common stock ($10 par) 10,000,000 Retained earnings 4,000,000 Total debt and equity $26,000,000 The bonds have a 4.0% coupon rate,payable semiannually,and a par value of $1,000.They mature exactly 10 years from today.The yield to maturity is 12%,so the bonds now sell below par.What is the current market value of the firm's debt?

Noncallable bonds that mature in 10 years were recently issued by Sternglass Inc.They have a par value of $1,000 and an annual coupon of 5.5%.If the current market interest rate is 7.0%,at what price should the bonds sell?

The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal.Bond A has an 8% annual coupon,Bond B has a 10% annual coupon,and Bond C has a 12% annual coupon.Bond B sells at par.Assuming interest rates remain constant for the next 10 years,which of the following statements is CORRECT?

Assume that interest rates on 15-year noncallable Treasury and corporate bonds with different ratings are as follows: T-bond = 7.72% A = 9.64% AAA = 8.72% BBB = 10.18% The differences in rates among these issues were most probably caused primarily by:

Chandler Co.'s 5-year bonds yield 7.00%,and 5-year T-bonds yield 5.15%.The real risk-free rate is r* = 3.0%,the inflation premium for 5-year bonds is IP = 1.75%,the liquidity premium for Chandler's bonds is LP = 0.75% versus zero for T-bonds,and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) × 0.1%,where t = number of years to maturity.What is the default risk premium (DRP) on Chandler's bonds?

Assume that a 10-year Treasury bond has a 12% annual coupon,while a 15-year T-bond has an 8% annual coupon.Assume also that the yield curve is flat,and all Treasury securities have a 10% yield to maturity.Which of the following statements is CORRECT?

Stephenson Co.'s 15-year bond with a face value of $1,000 currently sells for $850.Which of the following statements is CORRECT?

Reinegar Corporation is planning two new issues of 25-year bonds.Bond Par will be sold at its $1,000 par value,and it will have a 10% semiannual coupon.Bond OID will be an Original Issue Discount bond,and it will also have a 25-year maturity and a $1,000 par value,but its semiannual coupon will be only 6.25%.If both bonds are to provide investors with the same effective yield,how many of the OID bonds must Reinegar issue to raise $3,000,000? Disregard flotation costs,and round your final answer up to a whole number of bonds.

The desire for floating-rate bonds,and consequently their increased usage,arose out of the experience of the early 1980s,when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.

Sentry Corp.bonds have an annual coupon payment of 7.25%.The bonds have a par value of $1,000,a current price of $1,125,and they will mature in 13 years.What is the yield to maturity on these bonds?

A bond has a $1,000 par value,makes annual interest payments of $100,has 5 years to maturity,cannot be called,and is not expected to default.The bond should sell at a premium if interest rates are below 10% and at a discount if interest rates are greater than 10%.

Which of the following statements is CORRECT?