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provisions that are often contained in bond indentures:

[i]. Listed below are some provisions that are often contained in bond indentures:

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  1. Fixed assets may be used as security.

 

  1. The bond may be subordinated to other classes of debt.

 

  1. The bond may be made convertible.

 

  1. The bond may have a sinking fund.

 

  1. The bond may have a call provision.

 

  1. The bond may have restrictive covenants in its indenture.

 

Which of the above provisions, each viewed alone, would tend to reduce the yield to maturity investors would otherwise require on a newly issued bond?

 

  1. 1, 2, 3, 4, 5, 6

 

  1. 1, 2, 3, 4, 6

 

  1. 1, 3, 4, 5, 6

 

  1. 1, 3, 4, 6

 

  1. 1, 4, 6

 

 

[ii]. Suppose a new company decides to raise its initial $200 million of capital as $100 million of common equity and $100 million of long-term debt. By an iron-clad provision in its charter, the company can never borrow any more money. Which of the following statements is most correct?

 

  1. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be absolutely certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of debentures.

 

  1. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be absolutely certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds.

 

  1. The higher the percentage of total debt represented by debentures, the greater the risk of, and hence the interest rate on, the debentures.

 

  1. The higher the percentage of total debt represented by mortgage bonds, the riskier both types of bonds will be, and, consequently, the higher the firm’s total dollar interest charges will be.

 

  1. In this situation, we cannot tell for sure how, or whether, the firm’s total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. Interest rates on the two types of bonds would vary as their percentages were changed, but the result might well be such that the firm’s total interest charges would not be affected materially by the mix between the two.

 

Multiple Choice: Problems

 

 

 

[iii]. Assume that you wish to purchase a bond with a 30-year maturity, an annual coupon rate of 10 percent, a face value of $1,000, and semiannual interest payments. If you require a 9 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

 

  1. $905.35

 

  1. $1,102.74

 

  1. $1,103.19

 

  1. $1,106.76

 

  1. $1,149.63

 

 

[iv]. A bond has an annual 8 percent coupon rate, a maturity of 10 years, a face value of $1,000, and makes semiannual payments. If the price is $934.96, what is the annual nominal yield to maturity on the bond?

 

  1. 8%

 

  1. 9%

 

  1. 10%

 

  1. 11%

 

  1. 12%

 

[v]. A bond has an annual 11 percent coupon rate, an annual interest payment of $110, a maturity of 20 years, a face value of $1,000, and makes annual payments. It has a yield to maturity of 8.83 percent. If the price is $1,200, what rate of return will an investor expect to receive during the next year?

 

  1. -0.33%

 

  1. 8.83%

 

  1. 9.17%

 

  1. 11.00%

 

  1. None of the above

 

 

[vi]. You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6 months. If your nominal annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay for this bond?

 

  1. $ 826.31

 

  1. $1,086.15

 

  1. $ 957.50

 

  1. $1,431.49

 

  1. $1,124.62

 

 

 

[vii]. Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

 

  1. $619

 

  1. $674

 

  1. $761

 

  1. $828

 

  1. $902

 

 

[viii]. A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If your nominal annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond?

 

  1. $ 941.36

 

  1. $1,051.25

 

  1. $1,115.57

 

  1. $1,391.00

 

  1. $ 825.49

 

 

[ix]. Consider a $1,000 par value bond with a 7 percent annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10 percent?

 

  1. 10.00%

 

  1. 8.46%

 

  1. 7.00%

 

  1. 8.52%

 

  1. 8.37%

 

 

 

[x]. Rollincoast Incorporated issued BBB bonds two years ago that provided a yield to maturity of 11.5 percent. Long-term risk-free government bonds were yielding 8.7 percent at that time. The current risk premium on BBB bonds versus government bonds is half what it was two years ago. If the risk-free long-term governments are currently yielding 7.8 percent, then at what rate should Rollincoast expect to issue new bonds?

 

  1. 7.8%

 

  1. 8.7%

 

  1. 9.2%

 

  1. 10.2%

 

  1. 12.9%

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