FIN350- Questions and Applications

Chapter 7: Questions and Applications 8, 14, and 15; Problems 1 and 2

8. Variable-Rate Bonds Are variable-rate bonds attractive to investors who expect interest rates to decrease? Explain. Would a firm that needs to borrow funds consider issuing variable-rate bonds if it expects that interest rates will decrease? Explain

14. Bond Downgrade Explain how the downgrading of bonds for a particular corporation affects the prices of those bonds, the return to investors that currently hold these bonds, and the potential return to other investors who may invest in the bonds in the near future.

15. Junk Bonds Merrito, Inc., is a large U.S. firm that issued bonds several years ago. Its bond ratings declined over time and, about a year ago, the bonds were rated in the junk bond classification. Never- the less, investors were buying the bonds in the secondary market because of the attractive yield they offered. Last week, Merrito defaulted on its bonds, and the prices of most other junk bonds declined abruptly on the same day. Explain why news of Merrito’s financial problems could cause the prices of junk bonds issued by other firms to decrease, even when those firms had no business relationships with Merrito. Explain why the prices of those junk bonds with less liquidity declined more than those with a high degree of liquidity.

1. Inflation-Indexed Treasury Bond An inflation- indexed Treasury bond has a par value of $1,000 and a coupon rate of 6 percent. An investor purchases this bond and holds it for one year. During the year, the consumer price index increases by 1 percent every six months. What are the total interest payments the investor will receive during the year?

2. Inflation-Indexed Treasury Bond Assume that the U.S. economy experienced deflation during the year and that the consumer price index decreased by 1 percent in the first six months of the year and by 2 percent during the second six months of the year. If an investor had pur- chased inflation-indexed Treasury bonds with a par value of $10,000 and a coupon rate of 5 percent, how much would she have received in interest during the year?

  

Chapter 8: Questions and Applications 1 and 10; Problems 1, 3, and 12

1. Bond Investment Decision Based on your forecast of interest rates, would you recommend that investors purchase bonds today? Explain.

10. Inflation Effects Assume that inflation is expected to decline in the near future. How could this affect future bond prices? Would you recommend that financial institutions increase or decrease their concentration in long-term bonds based on this expectation? Explain

1. Bond Valuation Assume the following information for an existing bond that provides annual coupon payments:

a. What is the present value of the bond?

b. If the required rate of return by investors were 14 percent instead of 11 percent, what would be the present value of the bond?

c. If the required rate of return by investors were 9 percent, what would be the present value of the bond?

3. Valuing a Zero-Coupon Bond Assume that you require a 14 percent return on a zero-coupon bond with a par value of $1,000 and six years to maturity. What is the price you should be willing to pay for this bond?

12. Bond Valuation You are interested in buying a $1,000 par value bond with 10 years to maturity and an 8 percent coupon rate that is paid semiannually. How much should you be willing to pay for the bond if the investor’s required rate of return is 10 percent?