Sizing Up Risk in the Bond Market
What is a bond?
What are the four main types of bonds?
Why are U.S. Treasury bonds not completely riskless?
In addition to default risk, what key risk do investors in foreign
bonds face?
Define floating-rate bonds, zero coupon bonds, putable bonds,
income bonds, convertible bonds, and inflation indexed bonds.
How is the rate on a floating-rate bond determined? On an indexed
bond?
What are the two ways sinking funds can be handled? Which alter-
native will be used if interest rates have risen? Which if interest rates
have fallen?
A bond that matures in eight years has a par value of $1,000, an annual coupon payment of $70, and a market interest rate of 9 percent. What is its price? ($889.30)
A bond that matures in 12 years has a par value of $1,000, an annual
coupon of 10 percent, and a market interest rate of 8 percent. What
is its price? ($1,150.72)
Which of these bonds is a “discount bond,” and which is a “pre-
mium bond”?
Explain the difference between yield to maturity and yield to call.
Halley Enterprises’ bonds currently sell for $975. They have a seven year maturity, an annual coupon of $90, and a par value of $1,000.
What is their yield to maturity?
Their current yield? (9.51%; 9.23%)
The Henderson Company’s bonds currently sell for $1,275. They pay a $120 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,120. What is their YTM and their YTC, and which is “more relevant” in the sense that investors should expect to earn it? (8.99%; 7.31%; YTC
What is meant by the terms “new issue” and “seasoned issue”?
Last year a firm issued 20-year, 8 percent annual coupon bonds at a
par value of $1,000.
(1) Suppose that one year later the going rate had dropped to 6 per-
cent. What is the new price of the bonds, assuming that they now
have 19 years to maturity? ($1,223.16
Describe how the annual payment bond valuation formula is changed to evaluate semiannual coupon bonds, and write out the revised formula.
Hartwell Corporation bonds have a 20-year maturity, an 8 percent
semiannual coupon, and a face value of $1,000. The going interest
rate (r d) is 7 percent, based on semiannual compounding. What is
the bond’s price? ($1,106.78)
Differentiate between interest rate risk and reinvestment rate risk.
To which type of risk are holders of long-term bonds more exposed?
Short-term bondholders?
What type of security can be used to minimize both interest rate
and reinvestment rate risk for an investor with a fixed investment
horizon?
Differentiate between mortgage bonds and debentures.
Name the major rating agencies, and list some factors that affect
bond ratings.
Why are bond ratings important both to firms and to investors?
Do bond ratings adjust immediately to changes in credit quality?
Explain.
Differentiate between Chapter 7 liquidations and Chapter 11 reor-
ganizations. When should each be used?
Why do most bond trades occur in the over-the-counter market?
If a bond issue is to be sold at par, at what rate must its coupon rate
be set? Explain