Self-Test Questions and Problems PDF

ELF-TEST QUESTIONS AND PROBLEMS (Solutions Appear in Appendix A) ST-1 KEY TERMS Define each of the following terms: a. Bond; treasury bond; corporate bond; municipal bond; foreign bond b. Par value; maturity date; original maturity...

ELF-TEST QUESTIONS AND PROBLEMS (Solutions Appear in Appendix A) ST-1 KEY TERMS Define each of the following terms: a. Bond; treasury bond; corporate bond; municipal bond; foreign bond b. Par value; maturity date; original maturity C. Coupon payment; coupon interest rate d. Fixed-rate bond; floating-rate bond; zero coupon bond; original issue discount (OID) bond e. Call provision; sinking fund provision f. Convertible bond; warrant; putable bond; income bond; indexed, or purchasing Power, bond g. Discount bond; premium bond h. Yield to maturity (YTM); yield to call (YTC) 1. Current yield; capital gains yield; total return j. Price risk; reinvestment risk; investment horizon; default risk: duration k. Mortgage bond; indenture; debenture; 1. Investment-grade bond; junk bond subordinated debenture ST-2 BOND VALUATION The Pennington January 1, 1988. The bonds were sold atCorporation par issued anew series of bonds on On in 30 years, on December 31, ($1,000): had a |2% coupon; and mature June 30 and 2017. Coupon payments are nmade December 3). semiannually (o a. What was the YTM on January 1, b. What was the price of the bonds on 1988? interest rates had fallen to 10%? January 1, 1993, 5 years later, assuming  C. ind the current vield, capital gains vield, and total return on January l, 1993, given the price as determined in Part b. $916.42. d. On July 1, 2011, 6V5 vears before maturity, Pennington's bonds sold for What were the YTM, the current vield, the capital gains yield, and the total return at that time? e. INow assume that you plan to purchase an outstanding Pennington bond on March 1, 2011,when the going rate of interest given its risk was 15.5%. question. How large d cheCk must yOuwrite to complete the transaction? This is a difficult ST-3 SINKING FUND The Vancouver Development Company (VDC) is planning to sell a $100 million, 10-year, 12%, semiannual payment bond issue. Provisions for a sinking fund to retirethe issue over its life will be included in the indenture. Sinking fund payments will be made at the end of each year, and each payment must be sufficient to retire 10% of the original amount of the issue. The last sinking fund payment will retire the last of the bonds. The bonds to be retired each period can be purchased on the open market orobtained by calling up to 5% of the original issue at par, at VDC' option. a. How large must each sinking fund payment be if the company (1) uses the optiontocall bonds at par or (2) decides to buy bonds on theopen market? For P'art (2), you can only answer in words. b. What will happen to debt service requirements per year associated with ths issue over its 10-year life? C. Now consider an alternative plan where VDC sets up its sinking fund so that equal annual amountsare paid into a sinking fund trust held bya bank, with the proceeds being used to buy government bonds that are expected to pay 7% annual interest. The payments, plus accumulated interest, must total $100 million at the end of 10years, when the proceeds will be used to retire the issue. How large must the annual sinking fund payments be? Is this amount known with certainty, or might it be higher or lower? d. What are the annual cash requirements for covering bond service costs under the trusteeship arrangement described in Part c? (Note: Interest must be paid on Vancouver's outstanding bonds but not on bonds that have been retired.) Assume level interest rates for purposes of answering this question. e. What would have to happen to interest rates to cause the company to buv bonds on the open market rather than call them under the plan where some bonds are retired each year? QUESTIONS  p =5O% + (6.5%)(0.92) = 10.98% C. bN =(0.5) 0.80) + (0.25)(1.10)+ (0.25) (1.25) =0.40 +0.275 +0.3125 =0.9875 r=5%+ (6.5%)(0.9875) =11.42% CHAPTER 9 ST-2 a. Pennington's bonds were sold at par; therefore, the original YTM equaled the COuporn rate of 12%. 50 b. $120/2 $1,000 Vg = 50 E1(1+ 0.10 2 (1+010) 2 With a financial calculator, input the following: N = 50, I/YR = 5, PMT = 60, FV =1000, and PV =?Solve for PV = $1,182.56. C. Current yield = Annual coupon payment/ Price =$120/$1,182.56 =0.1015 = 10.15% Capital gains yield =Total yield- Current yield = 10% -10.15%= -0.15% Total return = YTM = 10% d. With afinancial calculator, input the following: N= 13, PV=-916.42, PMT= 60, FV = 1000, and ra/2 = /YR =? Calculator solution = r/2 = 7.00%; therefore, r., =YTM =14.00%.  Current yield = S120/$916.42 - 13.09% Capital gains yield 140% 13.090% -0.919% Total return = YTM = 14.00% e. The following time line illustrates the voars to maturity of the bond: 1/1/|1 7/1/11 1/1/12 7/1/12 1/1/13 12/31/17 3/1/11 Thus,on March 1, 2011, there were 13% neriods left before the traders actually use the following procedure to determine the bond matured. Bond price of the bond: (1) Find the price of the bond on the next coupon date, July 1, 2011. Using a financial calculator, input N= 13. /YR = 775. PMT =60, FV = 1000, and PV =? Solve for PV = (2) $859.76. Ada the coupon, $60, to the bond price to get the total value of the bond On the next interest payment date: TV = $859.76 + $60.00 = (3) $919.76. Discount this total value back tothe purchase date (March 1,2011): Using afinancial calculator, input N = /YR =7.75, PMT =0, FV =919.76, and PV =? Solve for PV = $875.11. (4) Therefore, you would have written acheck for $875.11 to complete the transaction. Of this amount, $20 = ($60) would represent accrued interest and $855.11 would represent the bond's basic value. This breakdown would affect both your taxes and those of the seller. (5) This problem could be solved very easily using aspreadsheet or a financial calculator with a bond valuation function, such as the HP-12C or the HP-17BI. This is explained in the calculator manual under the heading, "Bond Calculations." ST-3 a. (1) $100,000,000/10 = $10,000,000 per year, or $5 million each 6 months. (2) VDC will purchase bonds on the opern market if they're selling at less than par. So, the sinking fund payment will be less than $5,000,000 each period. b. The debt service requirements will decline. As the amount of bonds out standing declines, so will the interest requirements (amounts given in millions of dollars). If the bonds are called at par, the total bond servicepayments are calculated as follows: Semiannual Sinking Outstanding Payment Fund Bonds on which Interest Total Bond Period Payment Interest Is Paid Payment Service (1) (2) (3) (4) (2) + (4)= (5) 1 $5 $100 $6.0 $11.0 2 5 95 5.7 10.7 3...5 90 5.4 10.4 : 20 5 5 0.3 5.3 Interest is calculated as (0.5)(0.12) (Column 3); for example: Interest in Period 2 =(0.5)(0.12) ($95) = $5.7. The company's total cash bond service requirement will be $21.7 million per year for the first year. For both options, interest willdecline by 0.12($10,000,000) = $1,200,000 per year for the remaining years. The total debt service require ment for the open market purchases cannot be precisely determined, but the above. amounts would be less than whae's shown in Column 5of the table