Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 24, Problem 18PS
Call provisions
- a. If interest rates rise, will callable or noncallable bonds fall more in price?
- b. Sometimes you encounter bonds that can be repaid after a fixed interval at the option of either the issuer or the bondholder. If the exercise price of each option is the same and both the issuer and bondholder act rationally, what will happen when the options can be exercised? (Ignore refinements such as transactions or issue costs.)
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Which of the following sentences about bonds’ optional features is true? Explain
A.A borrower will be willing to pay a higher yield on a bond with a put option.
B.A callable bond allows the borrower to make an early repayment of the principal.
C.The yield on a puttable bond will be higher than the yield on a bond with similar characteristics but no optional features.
D.An investor will be willing to pay more for a bond with a call back provision.
Consider the investors who purchase callable bonds.
Usually, the investors will execute the call provision if interest rates rise so that they can get the face value amount back and reinvest it elsewhere at higher rates.
True or False
Which of the following is not an effect of a call provision?
A. Issuer can refund the bond issue if rates decline.
B. Requires the issuer to pay off the loan over its life rather than all at maturity.
C. Bond investors require higher yields on callable bonds
D. Upon calling bonds the issuer must pay call premium to bond holder
E. All of the above are effects of a call provision
Chapter 24 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 24 - Bond terms Select the most appropriate term from...Ch. 24 - Sinking funds For each of the following sinking...Ch. 24 - Security and seniority a. As a senior bondholder,...Ch. 24 - Prob. 4PSCh. 24 - Prob. 5PSCh. 24 - Private placements Explain the three principal...Ch. 24 - Prob. 7PSCh. 24 - Prob. 8PSCh. 24 - Convertible bonds True or false? a. Convertible...Ch. 24 - Prob. 10PS
Ch. 24 - Bond terms Bond prices can fall either because of...Ch. 24 - Prob. 13PSCh. 24 - Prob. 14PSCh. 24 - Security and seniority a. Residential mortgages...Ch. 24 - Prob. 16PSCh. 24 - Prob. 17PSCh. 24 - Call provisions a. If interest rates rise, will...Ch. 24 - Prob. 19PSCh. 24 - Covenants Alpha Corp. is prohibited from issuing...Ch. 24 - Prob. 21PSCh. 24 - Convertible bonds The Surplus Value Company had 10...Ch. 24 - Prob. 23PSCh. 24 - Convertible bonds Iota Microsystems 10%...Ch. 24 - Prob. 25PSCh. 24 - Convertible bonds Zenco Inc. is financed by 3...Ch. 24 - Tax benefits Dorlcote Milling has outstanding a 1...Ch. 24 - Convertible bonds This question illustrates that...Ch. 24 - Prob. 29PS
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- When a bond sells at a discount, the carrying value ________ after each amortization entry. A. increases B. decreases C. stays the same D. cannot be determinedarrow_forwardAn investor believes that a bond may temporarily increase in credit risk. Which of the following would be the most liquid method of exploiting this?a. The purchase of a credit default swap.b. The sale of a credit default swap.c. The short sale of the bond.arrow_forwardi. How would you expect the price of the callable bond to compare to that of the non-callable bond? Give an explanation for your answer, using a maximum of two sentences ii. If interest rates were to rise dramatically, how would you expect this to impact the price differences between the two bonds; increase, decrease or stay constant? Justify your response in a single sentence iii. Explain the advantage of issuing a callable bond compared to a non-callable?arrow_forward
- Which of the following statement is wrong? Group of answer choices a)the coupon rate of a newly issued bond is generally set equal to the required rate on bonds of equal risk. b)Since short-term interest is more volatile than the long-term interest rate, the price risk of short-term bond is more than that of the long-term bond c)The required rate of return for AAA bond is lower than that of an AA bond d)Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity.arrow_forwardWhich of the following is the best explanation of what the call premium is? Group of answer choices The amount above the face value an investor must pay to purchase the bond. The additional amount above the face value that the company must pay to repay the bond early. The additional amount above the market price that a company must pay to repay the bond early. The amount above the market price that an investor must pay to purchase the bond.arrow_forwardExplain how does a bond par value differs from its market value? Are variable rate bonds attractive to investors who expect the interest rates to decrease? Explain. Would a firm that needs to borrow funds consider issuing variable rate bonds if it expects interest rates to decrease in the future? Explain.arrow_forward
- The term structure of interest rates is A. None of the options are correct. B. the relationship between the interest rate on a security and its time to maturity. C. the relationship between the rates of interest on all securities. D. the relationship between the yield on a bond and its default rate. E. All of the options are correct.arrow_forwardWhat causes a gain or loss on the sale of a bond investment? Group of answer choices when the selling company negotiates a better price when the selling price of the bond differs from the book value (cost) of the bond when the selling company has unamortized discounts when the selling company has unamortized premiumsarrow_forwardWhich of the following statements is false? A. Other things being equal, an increase in a bond’s maturity will increase its interest rate risk. B. Other things being equal, an increase in the coupon rate of a bond will decrease its interest rate risk. C. Other things being equal, an increase in a bond’s YTM will decrease its interest rate risk. D. Effective duration is calculated as Macaulay duration divided by one plus the bond’s yield to maturity.arrow_forward
- Select all the correct statements. a. The no-arbitrage price of a bond is equal to its present value. b. If there is an arbitrage opportunity, it means one can make a risk-free profit. c. Small arbitrage opportunities may occasionally exist in real markets due to lack of information. d. The law of one price is based on the no-arbitrage assumption. e. Arbitrary investments and arbitrage generating investments are basically the samearrow_forward1)Which of the following is NOT true regarding bonds? Group of answer choices A)If a bond is selling at a discount, then the current yield is greater than the yield-to-maturity. B)An increase in market interest rates leads to a decrease in bond prices. C)If the coupon rate on a bond is lower than the yield-to-maturity, the bond sells at a discount. D)If the coupon rate on a bond equals the yield-to-maturity, then the bond sells at par. 2)When calculating free cash flows, which of the following statements is NOT true regarding the depreciation? Group of answer choices A)As an accrual, depreciation does not factor into free cash flow calculations. B)Depreciation is an accrual, not a cash flow. C)Depreciation create a tax shield. D)Depreciation is first removed and the subsequently added back in when calculating free cash flows.arrow_forward1. Under what conditions would the yield-to-maturity and current yield of a bond be equal? Group of answer choices a. The bond is priced at par b. The bond is priced at a discount c. Insufficient information d. The bond is priced at a premium 2. Which of the following is correct about the risk-free rate as used in valuing equity instruments? Group of answer choices a. The risk-free rate accounts for the rate of return or yield of a government instrument which does not carry any risk. b. The risk-free rate used for valuing equity instruments is normally the yield of a long-term government security. c. The risk-free rate used for valuing equity instruments is the same as that used for valuing short-term debt instruments. d. The risk-free rate accounts for the risks related to government securities which is composed of credit-spread, maturity risk premium and the real risk-free rate. 3. Berg Inc. has just paid a dividend of P2.00. Its stock is now selling…arrow_forward
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