Bonds and their valuation (Difficulty: e = Easy, m = Medium, and t = Tough) Multiple Choice: Conceptual
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- 40. Bond concepts Answer: d Diff: M N
39. Bond concepts Answer: d Diff: MStatements a and c are correct; therefore, statement d is the correct choice. Statement a is correct. From the information given, we can solve for the price of the bond = $887. Current yield = $100/$887 = 11.274%. Statement b is incorrect; since the bond is selling at a discount its YTC > YTM. The YTC = 14.05%. Statement c is correct. From the information given, since the coupon rate < YTM we know the bond is selling at a discount. VB = $887.00. 40. Bond concepts Answer: d Diff: M NThe correct answer is statement d. Bonds with a lower coupon have a lower reinvestment rate risk. Bonds with longer maturities have a lower reinvestment rate risk. Since all three bonds have the same maturity, the one with the highest coupon will have the highest reinvestment rate risk. Bond Z has the highest coupon, so statement a is false. If market interest rates remain unchanged, discount bonds (CPN < YTM) will go up in price, while premium bonds (CPN > YTM) will go down in price. Bond Z is selling at a premium, so its price will decline (if interest rates are unchanged). Therefore, statement b is false. If market interest rates increase, the prices of all bonds will decrease, therefore, statement c is incorrect. Statement d is correct from the information given above in response to statement b. If market interest rates decline, all bonds will have an increase in price. The one with the largest percentage increase will be the one with the most price risk. As maturity increases, price risk increases. As coupon decreases, price risk increases. Since all three bonds have the same maturity, the one with the lowest coupon will have the greatest price risk. Therefore, Bond X will have the largest percentage increase in price, so statement e is false. |