Managerial Finance

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Chapter 5 Questions

(5-2)  “Short-term interest rates are more volatile than long-term interest rates, so short-term

bond prices are more sensitive to interest rate changes than are long-term bond prices.”

Is this statement true or false? Explain.

(5-3)  The rate of return on a bond held to its maturity date is called the bond’s yield to maturity.

If interest rates in the economy rise after a bond has been issued, what will happen to the

bond’s price and to its YTM? Does the length of time to maturity affect the extent to which

a given change in interest rates will affect the bond’s price? Why or why not?

(5-4)  If you buy a callable bond and interest rates decline, will the value of your bond rise by as

much as it would have risen if the bond had not been callable? Explain.

(5-5)  A sinking fund can be set up in one of two ways. Discuss the advantages and

disadvantages of each procedure from the viewpoint of both the firm and its bondholders.

Chapter 5 Problems

(5-1)  Jackson Corporation’s bonds have 12 years remaining to maturity. Interest is paid

annually, the bonds have a $1,000 par value, and the coupon interest rate is 8%. The

bonds have a yield to maturity of 9%. What is the current market price of these bonds?

(5-2)  Wilson Wonders’s bonds have 12 years remaining to maturity. Interest is paid annually,

the bonds have a $1,000 par value, and the coupon interest rate is 10%. The bonds sell at a

price of $850. What is their yield to maturity?

(5-5)  A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has

a yield of 9%. Assume that the liquidity premium on the corporate bond is 0.5%. What is

the default risk premium on the corporate bond?

(5-6)  The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-year

Treasury security yields 6.3%. What is the maturity risk premium for the 2-year security?

(5-7)  Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually.

The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity of 8.5%.

What is the price of the bonds?

(5-8)  Thatcher Corporation’s bonds will mature in 10 years. The bonds have a face value of

$1,000 and an 8% coupon rate, paid semiannually. The price of the bonds is $1,100.

The bonds are callable in 5 years at a call price of $1,050. What is their yield to maturity?

What is their yield to call?

(5-10) The Brownstone Corporation’s bonds have 5 years remaining to maturity.

Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest

rate is 9%.

            a. What is the yield to maturity at a current market price of (1) $829 or (2) $1,104?

            b. Would you pay $829 for one of these bonds if you thought that the appropriate rate

                 of interest was 12%—that is, if rd = 12%? Explain your answer.

 (5-14)  A bond that matures in 7 years sells for $1,020. The bond has a face value of $1,000 and a

yield to maturity of 10.5883%. The bond pays coupons semiannually. What is the bond’s

current yield?

(5-18)  The real risk-free rate is 2%. Inflation is expected to be 3% this year, 4% next year, and

then 3.5% thereafter. The maturity risk premium is estimated to be 0.0005 × (t − 1), where

t = number of years to maturity. What is the nominal interest rate on a 7-year Treasury

security?

(5-21)  Suppose Hillard Manufacturing sold an issue of bonds with a 10-year maturity, a $1,000

par value, a 10% coupon rate, and semiannual interest payments.

            a. Two years after the bonds were issued, the going rate of interest on bonds such as

                 these fell to 6%. At what price would the bonds sell?

            b. Suppose that 2 years after the initial offering, the going interest rate had risen to 12%.

                 At what price would the bonds sell?

            c. Suppose that 2 years after the issue date (as in part a) interest rates fell to 6%.

                Suppose further that the interest rate remained at 6% for the next 8 years. What

                would happen to the price of the bonds over time?

 

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