Bond Prices and Yields

Question 1

A treasury security is quoted at 97-17 and has a par value of $100,000. What is the quoted dollar price?

Answer 1

dollar price = 97 (17/32) % x $100,000 = 0.9753125

32 is for the bonds that are in increments of 1/32.

Question 2

Which of the following statements does NOT accurately describe a characteristic of an inverse floater? A floating-rate issue:

• whose coupon is determined by subtracting a reference rate from some stated maximum rate.
• whose coupon rate will increase as market rates decrease and decrease as market rates increase.
• gives an investor who believes interest rates will decline the opportunity to obtain a higher coupon interest rate.
• may, under certain circumstances, require the bondholders to make payments to the issuer

Answer 2

The bondholder always receives coupon payments made by the issuer and not the opposite, since that would imply a negative interest rate. (D)

Question 3

Which of the following statements is most accurate with regard to a call provision?

• a call provision is an advantage to the bondholder
• a call provision will benefit the issuer in times of declining interest rates.
• a call provision will benefit the issuer in times of rising interest rates.
• a callable bond will trade at a higher price than an identical noncallable bond.

Answer 3

Whenever an interest rate decrease causes the price of the bond to increase above the strike prive stipulated on the call option, it will be optimal for the issuer to call the bond. So theoretically, the price of a currently callable bond should never rise above its call price.

Question 4

The cash flows of catastrophe bonds would least likely be linked to:

• the firm’s dividend payments
• internal loss events
• industrywide underwriting losses
• external risk events.

Answer 4

Cat bonds, as they are known, can include cash flows form internal risk events (as in the case of indemnified notes), external risk events (as with parametric notes), or the value of an index (as with indexed notes). The firm’s dividend payment, however, it not a risk event and can be easily manipulated by the firm.

Question 5

An analyst observes a Widget & Co. 7.125%, 4-year, semiannual-pay bond trading at 102.347% of par (where par = $1,000). The bond is callable at 101 in two years and putable at 100 in two year.

What is the bond’s yield to maturity?

Answer 5

N = 8
FV = 1,000
PMT = 36,625 
PV = -1,023.47 
CPT > I/Y = 3.225 x 2
= 6.45%

Question 6

An analyst observes a Widget & Co. 7.125%, 4-year, semiannual-pay bond trading at 102.347% of par (where par = $1,000). The bond is callable at 101 in two years and putable at 100 in two year.

What is the bond’s yield to call?

Answer 6

N = 4
FV = 1,010
PMT = 36,625 
PV = -1,023.47 
CPT > I/Y = 3.167 x 2
= 6.334%

Question 7

Using the following spot rates for pricing the bond, what is the present value of a 3-year security that pays a fixed annual coupon of 6%?
Year 1: 5.0%
Year 2: 5.5%
Year 3: 6.0%

Answer 7

PV = 6/1.05 + 6/1.0552 + 106/1.063 = 100.10

The value 95.07 results if the coupon payment at maturity of the bond is neglected.

Question 8

A $1,000, 5%, 20-year, annual-pay bond has a yield of 6.5%. If the yield remains unchanged, how much will the bond value increase over the next three years?

Answer 8

With 20 years to maturity the value of the bond with an annual-pay yield 6.5% is:

N = 20 
PMT = 50 
FV = 1,000 
I/Y = 6.5 

CPT > PV = -834.72

With N = 17
CPT > PV = -848.34

So the value will increase $13.62

Question 9

Which of the following is an example of a positive covenant? The company:

• must maintain a times interest earned ratio of at least two times.
• must not use the same collateral to back more than one debt obligation.
• may not sell fixed assets that have been pledged as collateral for the bonds.
• cannot borrow any additional money unless the new debt is subordinated to the current debt.

Answer 9

Positive covenants specify what the company must do; negative covenants specify what they must not do. All other alternatives are examples of negative covenants. (A)

Question 10

Which of the following contains the overall rights of the bondholders?

• negative covenant
• trustee agreement
• indenture
• affirmative covenant

Answer 10

Covenants are part of the indenture. The trustee acts as a representative of the bondholders. (C)

Question 11

A convertible bond is a bond that may be exchanged for:

• 401K options
• a debenture
• cash
• a company’s common stock

Answer 11

A convertible bond is one that may be exchanged for a company’s common stock. Note that a debenture refers to a bond that is backed only by the general credit of the borrower. (D)

Question 12

Junk bonds or high yield bonds have ratings:

• below BBB
• BAA or better
• BAA or lower
• below acceptable levels

Answer 12

Ratings A and above are considered investment grade and are the most credit worthy. Bonds rated BB to B have lower credit quality than investment grade bonds, but are not as speculative as junk bonds rated CCC to D.