FIN2102: Key Features of Bond - Financial Management Assessment Answer

Code: FIN2102

Financial Management Assessment Answer

1. What are the key features of a bond?
2. What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
3. How is the value of any asset whose value is based on expected future cash flows determined?
4. How is the value of a bond determined? What is the value of a 10-year, $1,000 par value bond with a 10 percent annual coupon if its required rate of return is 10 percent?
5. What would be the value of the bond described in part D, if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13 percent return? Would we now have a discount or premium bond?
6. What would happen to the bond’s value if inflation fell, and r_d declined to 7 percent? Would we now have a premium or discount bond?
7. What is the yield to maturity on a10-year, 9 percent, annual coupon, $1,000 par value bond that sells for $887.00? Does that sell for $1,134.20? What does the fact that a bond sells at a discount or at a premium tell you about the relationship between r_d and the bond’s coupon rate?
8. What is the interest rate (or price) risk? Which bond has more interest rate risk, an annual payment 1-year bond or a 10-year bond? Why?
9. What is the reinvestment rate risk? Which has more reinvestment rate risk, a 1-year bond or a 10-year bond?
10. How does the equation for valuing a bond change if semiannual payments are made? Find the value of a 10-year, semiannual payment, 10 percent coupon bond if nominal r_d = 13%.
11. Suppose you could buy, for $1,000, either a 10 percent, 10-year, annual payment bond or a 10 percent, 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?
12. Proton’s bonds were issued with a yield to maturity of 7.5 percent. Does the yield to maturity represent the promised or expected return on the bond?
13. Proton’s bonds were rated AA by S&P (Standard and Poor). Would you consider these bonds investment grade or junk bonds? Explain.
14. What factors determine a company’s bond rating?
15. If the 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?

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