224 Part 3 Financial Assets
What are the advantages and disadvantages of each procedure from the viewpoint of
(a) the firm and (b) the bondholders?
Is it true that the following equation can be used to find the value of a bond with N years to
maturity that pays interest once a year? Assume that the bond was issued several years ago.VB! ∑
t! 1N__Annual interest(1 # (^) r
d)
t^ #^
____Par value
(1 # rd)N^
The values of outstanding bonds change whenever the going rate of interest changes. In
general, short-term interest rates are more volatile than long-term interest rates. Therefore,
short-term bond prices are more sensitive to interest rate changes than are long-term bond
prices. Is that statement true or false? Explain. (Hint: Make up a “reasonable” example
based on a 1-year and a 20-year bond to help answer the question.)
If interest rates rise after a bond issue, what will happen to the bond’s price and YTM?
Does the time to maturity affect the extent to which interest rate changes affect the bond’s
price? (Again, an example might help you answer this question.)
If you buy a callable bond and interest rates decline, will the value of your bond rise by as
much as it would have risen if the bond had not been callable? Explain.
Assume that you have a short investment horizon (less than 1 year). You are considering
two investments: a 1-year Treasury security and a 20-year Treasury security. Which of the
two investments would you view as being riskier? Explain.
Indicate whether each of the following actions will increase or decrease a bond’s yield to
maturity:
a. The bond’s price increases.
b. The bond is downgraded by the rating agencies.
c. A change in the bankruptcy code makes it more difficult for bondholders to receive
payments in the event the firm declares bankruptcy.
d. The economy seems to be shifting from a boom to a recession. Discuss the effects of
the firm’s credit strength in your answer.
e. Investors learn that the bonds are subordinated to another debt issue.
Why is a call provision advantageous to a bond issuer? When would the issuer be likely to
initiate a refunding call?
Are securities that provide for a sinking fund more or less risky from the bondholder’s
perspective than those without this type of provision? Explain.
What’s the difference between a call for sinking fund purposes and a refunding call?
Why are convertibles and bonds with warrants typically offered with lower coupons than
similarly rated straight bonds?
Explain whether the following statement is true or false: Only weak companies issue
debentures.
Would the yield spread on a corporate bond over a Treasury bond with the same maturity
tend to become wider or narrower if the economy appeared to be heading toward a
recession? Would the change in the spread for a given company be affected by the firm’s
credit strength? Explain.
A bond’s expected return is sometimes estimated by its YTM and sometimes by its YTC.
Under what conditions would the YTM provide a better estimate, and when would the
YTC be better?
BOND VALUATION Callaghan Motors’ bonds have 10 years remaining to maturity. Inter-
est is paid annually, they have a $1,000 par value, the coupon interest rate is 8%, and the
yield to maturity is 9%. What is the bond’s current market price?
YIELD TO MATURITY AND FUTURE PRICE A bond has a $1,000 par value, 10 years to ma-
turity, and a 7% annual coupon and sells for $985.
7-27-2
7-37-3
7-47-4
7-57-5
7-67-6
7-77-7
7-87-8
7-97-9
7-107-10
7-117-11
7-127-12
7-137-13
7-147-14
PROBLEMPROBLEMSS
Easy 7-17-1
Problems 1–4Easy
Problems 1–4