close solutoin list

BOND VALUATION Robert Black and Carol Alvarez are vice presidents of Western Money Management and codirectors of the company's pension fund management division. A major new client, the California League of Cities, has requested that Western present an investment seminar to the mayors of the represented cities. Black and Alvarez, who will make the presentation, have asked you to help them by answering the following questions: a. What are a bond's key features? b. What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky? c. How is the value of any asset whose value is based on expected future cash flows determined? d. How is a bond’s value determined? What is the value of a 10-year, $1,000 par value bond with a 10% annual coupon if its required return is 10%? e. 1. What is the value of a 13% coupon bond that is otherwise identical to the bond described in part d? Would we now have a discount or a premium bond? 2. What is the value of a 7% coupon bond with these characteristics? Would we now have a discount or premium bond? 3. What would happen to the values of the 7%, 10%, and 13% coupon bonds over time if the required return remained at 10%? (Hint: With a financial calculator, enter PMT, I/YR, FV, and N; then change (override) N to see what happens to the PV as it approaches maturity.) f. 1. What is the yield to maturity on a 10-year, 9% annual coupon, $1,000 par value bond that sells for $887.00? That sells for $1,134.20? What does the fact that it sells at a discount or at a premium tell you about the relationship between r d and the coupon rate? a. 2. What are the total return, the current yield, and the capital gains yield for the discount bond? Assume that it is held to maturity, and the company does not default on it. (Hint: Refer to footnote 6 for the definition of the current yield and to Table 7.1.) g. What is price risk? Which has more price risk, an annual payment 1-year bond or a 10-year bond? Why? h. What is reinvestment risk ? Which has more reinvestment risk, a 1-year bond or a 10-vear bond? i. How does the equation for valuing a bond change if semiannual payments are made? Find the value of a 10-year, semiannual payment. 10% coupon bond if nominal r d = 13% j. Suppose for $1,000 you could buy a 10%, 10-year, annual payment bond or a 10%, 10-year, semiannual payment bond. They are equally risky. Which would you prefer? If $1,000 is the proper price for the semiannual bond, what is the equilibrium price for the annual payment bond? k. Suppose a 10-year, 10% semiannual coupon bond with a par value of $1,000 is currently selling for $1,135.90, producing a nominal yield to maturity of 8%. However, it can be called after 4 years for $1,050. 1. What is the bond's nominal yield to call (YTC) ? 2. If you bought this bond, would you be more likely to earn the YTM or the YTC? Why? l. Does the yield to maturity represent the promised or expected return on the bond? Explain. m. These bonds were rated AA – by S&P. Would you consider them investment-grade or junk bonds? n. What factors determine a company’s bond rating? o. If this firm were to default on the bonds, would the company be immediately liquidated? Would the bondholders be assured of receiving all of their promised payments? Explain.

BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250
BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250

Solutions

Chapter
Section
Chapter 7, Problem 20IC
Textbook Problem

BOND VALUATION Robert Black and Carol Alvarez are vice presidents of Western Money Management and codirectors of the company's pension fund management division. A major new client, the California League of Cities, has requested that Western present an investment seminar to the mayors of the represented cities. Black and Alvarez, who will make the presentation, have asked you to help them by answering the following questions:

  1. a. What are a bond's key features?
  2. b. What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
  3. c. How is the value of any asset whose value is based on expected future cash flows determined?
  4. d. How is a bond’s value determined? What is the value of a 10-year, $1,000 par value bond with a 10% annual coupon if its required return is 10%?
  5. e. 1. What is the value of a 13% coupon bond that is otherwise identical to the bond described in part d? Would we now have a discount or a premium bond?

2. What is the value of a 7% coupon bond with these characteristics? Would we now have a discount or premium bond?

3. What would happen to the values of the 7%, 10%, and 13% coupon bonds over time if the required return remained at 10%? (Hint: With a financial calculator, enter PMT, I/YR, FV, and N; then change (override) N to see what happens to the PV as it approaches maturity.)

  1. f. 1. What is the yield to maturity on a 10-year, 9% annual coupon, $1,000 par value bond that sells for $887.00? That sells for $1,134.20? What does the fact that it sells at a discount or at a premium tell you about the relationship between rd and the coupon rate?
  2. a. 2. What are the total return, the current yield, and the capital gains yield for the discount bond? Assume that it is held to maturity, and the company does not default on it. (Hint: Refer to footnote 6 for the definition of the current yield and to Table 7.1.)
  3. g. What is price risk? Which has more price risk, an annual payment 1-year bond or a 10-year bond? Why?
  4. h. What is reinvestment risk? Which has more reinvestment risk, a 1-year bond or a 10-vear bond?
  5. i. How does the equation for valuing a bond change if semiannual payments are made? Find the value of a 10-year, semiannual payment. 10% coupon bond if nominal rd = 13%
  6. j. Suppose for $1,000 you could buy a 10%, 10-year, annual payment bond or a 10%, 10-year, semiannual payment bond. They are equally risky. Which would you prefer? If $1,000 is the proper price for the semiannual bond, what is the equilibrium price for the annual payment bond?
  7. k. Suppose a 10-year, 10% semiannual coupon bond with a par value of $1,000 is currently selling for $1,135.90, producing a nominal yield to maturity of 8%. However, it can be called after 4 years for $1,050.
  8. 1. What is the bond's nominal yield to call (YTC)?
  9. 2. If you bought this bond, would you be more likely to earn the YTM or the YTC? Why?
  10. l. Does the yield to maturity represent the promised or expected return on the bond? Explain.
  11. m. These bonds were rated AA – by S&P. Would you consider them investment-grade or junk bonds?
  12. n. What factors determine a company’s bond rating?
  13. o. If this firm were to default on the bonds, would the company be immediately liquidated? Would the bondholders be assured of receiving all of their promised payments? Explain.

Expert Solution

Want to see this answer and more?

Experts are waiting 24/7 to provide step-by-step solutions in as fast as 30 minutes!*

See Solution

*Response times vary by subject and question complexity. Median response time is 34 minutes and may be longer for new subjects.

Chapter 7 Solutions

Fundamentals of Financial Management (MindTap Course List)
Show fewer chapter solutions
Ch. 7 - A sinking fund can be set up in one of two ways:...Ch. 7 - Can the following equation be used to find the...Ch. 7 - The values of outstanding bonds change whenever...Ch. 7 - If interest rates rise after a bond issue, what...Ch. 7 - Discuss the following statement: A bonds yield to...Ch. 7 - If you buy a callable bond and interest rates...Ch. 7 - Assume that you have a short investment horizon...Ch. 7 - Indicate whether each of the following actions...Ch. 7 - Why is a call provision advantageous to a bond...Ch. 7 - Are securities that provide for a sinking fund...Ch. 7 - Whats the difference between a call for sinking...Ch. 7 - Why are convertibles and bonds with warrants...Ch. 7 - Explain whether the following statement is true or...Ch. 7 - Would the yield spread on a corporate bond over a...Ch. 7 - A bonds expected return is sometimes estimated by...Ch. 7 - Which of the following bonds has the most price...Ch. 7 - Which of the bonds has the most reinvestment risk?...Ch. 7 - BOND VALUATION Madsen Motorss bonds have 23 years...Ch. 7 - YIELD TO MATURITY AND FUTURE PRICE A bond has a...Ch. 7 - BOND VALUATION Nesmith Corporations outstanding...Ch. 7 - YIELD TO MATURITY A firms bonds have a maturity of...Ch. 7 - BOND VALUATION An investor has two bonds in his...Ch. 7 - BOND VALUATION An investor has two bonds in her...Ch. 7 - INTEREST RATE SENSITIVITY .An investor purchased...Ch. 7 - YIELD TO CALL Seven years ago the Templeton...Ch. 7 - YIELD TO MATURITY Harrimon Industries bonds have 6...Ch. 7 - CURRENT YIELD, CAPITAL GAINS YIELD, AND YIELD TO...Ch. 7 - BOND YIELDS Last year Carson Industries issued a...Ch. 7 - YIELD TO CALL It is now January 1, 2018, and you...Ch. 7 - PRICE AND YIELD A 7% semiannual coupon bond...Ch. 7 - EXPECTED INTEREST RATE Lourdes Corporations 12%...Ch. 7 - BOND VALUATION Bond X is noncallable and has 20...Ch. 7 - BOND VALUATION You are considering a 10-year,...Ch. 7 - BOND RETURNS Last year Janet purchased a 1,000...Ch. 7 - YIELD TO MATURITY AND YIELD TO CALL Kempton...Ch. 7 - BOND VALUATION Clifford Clark is a recent retiree...Ch. 7 - BOND VALUATION Robert Black and Carol Alvarez are...

Additional Business Textbook Solutions

Find more solutions based on key concepts
Show solutions
Identify and describe the three steps in the delegation process.

Foundations of Business (MindTap Course List)

Describe a plant asset.

College Accounting, Chapters 1-27

Define the term product

MKTG 12:STUDENT ED.-TEXT

What are economic agents?

Accounting Information Systems

To get information about Apples dividend policy, enter its ticker quote (AAPL) and select OVERVIEW FULL REPOR...

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)

What is a base year?

Macroeconomics