Name:_________________________ FINN 200 - Quiz 2

LUMS ID: _____________________ Tuesday, Feb 28, 2023

Duration: 75 Min Total Marks -50

Each question carries equal marks. For calculation questions space has been given to show your
working as well. Half of the score will be allocated to correct working to get to the answer

Q1) Which of the following is most likely correct regarding Bond Provisions?

A. Call features give the lender the opportunity to replace higher than market coupon bonds
with lower coupon issues
B. A callable but not refundable bond can be called for any reason other than refunding
C. Prepayment option brings additional certainty regarding cash flows to investor

Q2) Which of the following is least likely correct about zero coupon bonds?

A. Zero coupon bonds are issued at a discount to par value

B. Zero coupon bonds have lower reinvestment risk than coupon bonds
C. Investors do not earn interest in zero coupon bonds as such bonds make no interest
payments

Q3) A firm has just issued five year fixed rate bonds. What is the current yield of the bond if the
coupon rate is 6% and price of bond is $1,010?

A. 2.97%
B. 5.94%
C. 6.00%

Q4) Compared to an otherwise similar non-convertible bond, a convertible bond is usually offered at
what type of yield to the issuer of the bond?

A. A yield advantage
B. A yield disadvantage
C. Either a yield advantage or disadvantage

Q5) Which of the following is least accurate with respect to floating rate notes?

A. The spread is reset periodically; thus as spread changes, coupon rates change accordingly
B. The spread is constant and is set when the bond is issued based on issuer’s creditworthiness
C. The reference rate is reset periodically; thus as reference rate changes coupon rate changes

Q7) XYZ bond has a market price of $98.76 per $100 of par value. It is a quarterly pay bond with
three years to maturity and a stated coupon rate of 7.5%. The yield to maturity of the bond is closest
to?

A. 8.5%
B. 7.00%
C. 7.96%
Name:_________________________ FINN 200 - Quiz 2
LUMS ID: _____________________ Tuesday, Feb 28, 2023
Duration: 75 Min Total Marks -50
Q8) A 5% semi annual coupon paying bond has an original maturity of 6 years. The bond is first
callable three years from today and thereafter annually on coupon payment dates. The bond is
currently priced at $104 per $100 of par value. The exhibit presents the schedule of call prices?

Years to Call Date Call price per $100 of par value

3 104
4 103
5 101
6 100

The yield to third call is closest to?

A. 2.14%
B. 4.28%
C. 4.81%

Q11) An investor has purchased a five year, 7% annual coupon bond that is first callable in 3 years. If
the issuer’s credit quality has deteriorated, after the call protection period the:

A. Issuer would be willing to exercise the call option if the market interest rates have increased
B. Investor would be willing to exercise the call option irrespective of the market interest rate
change
C. Issuer would not be willing to exercise the call option if there is no change in market
interest rates

Q14) A 4% annual coupon paying bond has an original maturity of 6 years. The bond is first callable
in 2 years. The bond is currently priced at $102 per $100 of par value. The bond is first callable at a
price of $106 on the coupon payment date in 2 years, callable at $104 in 3 years and at par value on
the coupon payment dates till maturity. The yield to second call is closest to?

A. 4.38%
B. 4.55%
C. 4.83%

Q15) The major concern for an investor who has a long term time horizon relative to the time to
maturity of the bond is:

A. Market price risk

B. Credit spread risk
C. Coupon reinvestment risk

Q17) A buy and hold investor purchased a 6 year 10% annual coupon bond at $91. Before the first
coupon is received, market interest rates go down by 1.5%. the future value for reinvested coupons
per $100 of face value is closest to:

A. 68
B. 78
C. 84
Name:_________________________ FINN 200 - Quiz 2
LUMS ID: _____________________ Tuesday, Feb 28, 2023
Duration: 75 Min Total Marks -50

HMK Enterprises would like to raise $10 million to invest in capital expenditures. The company plans
to issue five-year bonds with a face value of $1000 and a coupon rate of 6.5% (annual payments).
The following table summarizes the yield to maturity for five-year (annual-pay) coupon corporate
bonds of various ratings:

a. Assuming the bonds will be rated AA, what will the price of the bonds be?

b. How much total principal amount of these bonds must HMK issue to raise $10 million today,
assuming the bonds are AA rated? (Because HMK cannot issue a fraction of a bond, assume that all
fractions are rounded to the nearest whole number.)

c. What must the rating of the bonds be for them to sell at par?

d. Suppose that when the bonds are issued, the price of each bond is $959.54. What is the
likely rating of the bonds?
a. The price will be
65 65 + 1000
P= + ... + = $1, 008.36.
(1 + 0.063) (1 + 0.063)5

$10,000,000
b. Each bond will raise $1008.36, so the firm must issue: = 9,917.13  9,918 bonds.
$1,008.36

This will correspond to a principle amount of 9,918  $1,000 = $9,918,000.

c. For the bonds to sell at par, the coupon must equal the yield. Since the coupon is 6.5%, the yield
must also be 6.5%, or A rated.
d. First, compute the yield on these bonds:
65 65 + 1000
959.54 = + ... +  YTM = 7.5%.
(1 + YTM ) (1 + YTM )5

Given a yield of 7.5%, it is likely these bonds are BB rated. Yes, BB-rated bonds are junk bonds.

Consider the following bonds:

Name:_________________________ FINN 200 - Quiz 2
LUMS ID: _____________________ Tuesday, Feb 28, 2023
Duration: 75 Min Total Marks -50
a. What is the percentage change in the price of each bond if its yield to maturity falls from 6% to
5%?

b. Which of the bonds A–D is most sensitive to a 1% drop in interest rates from 6% to 5% and
why? Which bond is least sensitive? Provide an intuitive explanation for your answer.
The results are shown in the table below.
Bond Coupon Rate Maturity Price at Price at Percentage Change
(annual payments) (years) 6% YTM 5% YTM
A 0% 15 $41.73 $48.10 15.3%
B 0% 10 $55.84 $61.39 9.9%
C 4% 15 $80.58 $89.62 11.2%
D 8% 10 $114.72 $123.17 7.4%
b. Bond A is most sensitive, because it has the longest maturity and no coupons. Bond D is the least
sensitive. Intuitively, higher coupon rates and a shorter maturity typically lower a bond’s interest
rate sensitivity.

Bond value Answer: a Diff: M

i. If the required rate of return on a bond is greater than its coupon interest rate (and rd remains
above the coupon rate), the market value of that bond will always be below its par value until
the bond matures, at which time its market value will equal its par value. (Accrued interest
between interest payment dates should not be considered when answering this question.)

a. True

b. False

Bond value - annual payment Answer: a Diff: M

. You have just noticed in the financial pages of the local newspaper that you can buy a $1,000
par value bond for $800. If the coupon rate is 10 percent, with annual interest payments, and there
are 10 years to maturity, you should make the purchase if your required return on investments of
this type is 12 percent.

a. True

b. False

Prices and interest rates Answer: a Diff: M

. The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates
than low-coupon bonds, other things equal and held constant.

a. True

b. False
Name:_________________________ FINN 200 - Quiz 2
LUMS ID: _____________________ Tuesday, Feb 28, 2023
Duration: 75 Min Total Marks -50
Current yield and capital gains yield Answer: c Diff: M

ii. Meade Corporation bonds mature in 6 years and have a yield to maturity of 8.5 percent. The
par value of the bonds is $1,000. The bonds have a 10 percent coupon rate and pay interest
on a semiannual basis. What are the current yield and capital gains yield on the bonds for this
year? (Assume that interest rates do not change over the course of the year).

a. Current yield = 8.50%, capital gains yield = 1.50%

b. Current yield = 9.35%, capital gains yield = 0.65%

c. Current yield = 9.35%, capital gains yield = -0.85%

d. Current yield = 10.00%, capital gains yield = 0.00%

e. None of the answers above is correct.

iii. You have just been offered a $1,000 par value bond for $847.88. The coupon rate is 8 percent,
payable annually, and annual interest rates on new issues of the same degree of risk are 10
percent. You want to know how many more interest payments you will receive, but the party
selling the bond cannot remember. Can you determine how many interest payments remain?

a. 14

b. 15

c. 12

d. 20

e. 10

Yield to call Answer: b Diff: M

iv. McGriff Motors has bonds outstanding which will mature in 12 years. The bonds pay a 12
percent semiannual coupon and have a face value of $1,000 (i.e., the bonds pay a $60 coupon
every six months). The bonds currently have a yield to maturity of 10 percent. The bonds are
callable in 8 years and have a call price of $1,050. What are the bonds' yield to call?

a. 8.89%

b. 9.89%

c. 9.94%

d. 10.00%

e. 12.00%
Name:_________________________ FINN 200 - Quiz 2
LUMS ID: _____________________ Tuesday, Feb 28, 2023
Duration: 75 Min Total Marks -50

i. Bond value Answer: a Diff: M

ii. Current yield and capital gains yield Answer: c Diff: M

First, calculate the price of the bond as follows: N = 6  2 = 12, I

= 8.5/2 = 4.25, PMT = 10%/2  1,000 = 50, FV = 1,000, and PV =
? = -$1,069.3780. The current yield (CY) is then $100/$1,069.3780 =
9.35%. Recognizing that the CY and capital gains yield (CG) constitute
the total return (YTM) on the bond or CY + CG = YTM, solve for CG in
the following equation 9.35% + CG = 8.5%, CG = -0.85%.

iii. Interest payments remaining Answer: b Diff: M

Time Line:
0 10% 1 2 n = ? Years
. . .
| | | |
PMT = 80 80 80
VB = 847.88 FV = 1,000

Financial calculator solution:

Inputs: I = 10; PV = -$847.88; PMT = 80; FV = 1,000.
Output: N = 15 years.
iv. Yield to call Answer: b Diff: M

First we need to find the price of the bond:

N = 12  2 = 24
I = 10/2 = 5
PMT = 60
FV = 1,000
Solve for PV = -$1,137.99.
Name:_________________________ FINN 200 - Quiz 2
LUMS ID: _____________________ Tuesday, Feb 28, 2023
Duration: 75 Min Total Marks -50

Now use the price of the bond to figure the YTC:

N = 8  2 = 16
PV = -1,137.99
PMT = 60
FV = 1,050
Solve for I = 4.9441%  2 = 9.8883%  9.89%.