. Bond concepts Answer: a Diff: E

12. Bond concepts Answer: c Diff: E

Statement c is correct; the other statements are false. If a bond’s YTM > annual coupon, then it will trade at a discount. If interest rates increase, the 10-year zero coupon bond’s price change is greater than the 10-year coupon bond’s.

13. Bond concepts Answer: e Diff: E

All the statements are true; therefore, the correct choice is statement e. Since the bond is selling at par, its YTM = coupon rate. The current yield is calculated as $90/$1,000 = 9%. If YTM = coupon rate, the bond will sell at par. So, if the bond’s YTM remains constant the bond’s price will remain at par.

14. Bond concepts Answer: a Diff: E

If the bond is selling at a discount, the coupon rate must be less than the required yield on the bond. So statement a is correct. Statement b is false, because the price will increase towards $1,000. Statement c can only be correct if the bond is trading at par, and it isn’t.

15. Bond concepts Answer: d Diff: E

The bond has a coupon rate higher than the YTM, so it must be trading at a price above its par value. Statement a is incorrect; its current yield = Coupon/Price, which will be less than 8 percent because the price is greater than par. Statement b is correct. Statement c is also correct; the price of the bond will decline over time because it is currently trading above par. Therefore, statement d is the best answer.

16. Bond concepts Answer: a Diff: E

Since Bond B sells at par, then the coupon rate on Bond B equals its YTM. Therefore, its YTM is 10 percent. Since all the bonds have the same risk and the yield curve is steady, the YTM for Bonds A and C will also be 10 percent. Because Bond A has an 8 percent coupon, it must be trading at a discount and its price will increase over time towards the par value. Because Bond C has a coupon rate of 12 percent, it must be trading at a premium and its price will decline over time towards the par value. The only correct answer is statement a.

17. Bond concepts Answer: d Diff: E

Statement a is false. If the YTM is 8 percent, and A’s coupon payment is only 7 percent, investors will find A to be less valuable than a new par value bond with an 8 percent coupon. Therefore, A will be selling for less than its par value (at a discount). If the YTM is 8 percent and B’s coupon payment is 9 percent, investors will find B to be more valuable than a new par value bond with an 8 percent coupon. Therefore, B will be selling for more than its par value (at a premium). There-fore, B’s price must be higher than A’s. Statement b is false. The bonds will not have the same price until expiration, when the price of each will be its par value of $1,000. Statement c is false. Bond B is selling at a higher price than Bond A from the statements given in the problem. Statement d is correct. If a bond is selling at a discount, over time its price will increase until it reaches its par value at expiration. Since Bond A is selling at a discount this statement is true. Statement e is false. The total yield on the bond will be the sum of the capital gains yield and the current yield. If it has a positive capital gains yield, and it will since A is selling at a discount, its current yield must be less than 8 percent because the sum of the two yields must equal 8 percent.

18. Bond concepts Answer: c Diff: E

If the YTM is lower than the coupon rate, then this bond gives higher coupon payments than the “going rate.” Therefore, it is more valuable, and will sell at a premium. So, statement a is false. The current yield is the bond’s annual coupon payments divided by the bond’s price today: Current yield = Annual coupon payment/Current price. Since we know that the bond is selling at a premium, it will be selling for a higher price than $1,000. If the bond were selling at par ($1,000), then the current yield would be the same as the coupon rate. Since it is selling at a premium, the denominator of the current yield equation is larger, making the current yield smaller. Therefore, statement b is false. Since the bond is selling at a premium, its price will decrease through time until its price equals the par value, just at maturity. Remember the following diagram:

Therefore, statement c is the correct choice.

19. Bond concepts Answer: a Diff: E N

Statement a is correct. Statement b is incorrect; just the opposite is true. Bonds with higher coupons have less interest rate price risk but more reinvestment rate risk. Statement c is incorrect; the price of a discount bond will continue to change, based on years to maturity. As a discount bond approaches maturity, its price will increase to its par value. Clearly, then, statements d and e are also incorrect.

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