Financial Planning Problems

Question # 00005327 Posted By: spqr Updated on: 12/14/2013 05:52 AM Due on: 12/30/2013
Subject Finance Topic Finance Tutorials:
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8-21. Consider a four-year, default-free security with annual coupon payments and a face value of $1000 that is issued at par. What is the coupon rate of this bond?

8-22. Consider a five-year, default-free bond with annual coupons of 5% and a face value of $1000.

a. Without doing any calculations, determine whether this bond is trading at a premium or at a discount. Explain.

b. What is the yield to maturity on this bond?

c. If the yield to maturity on this bond increased to 5.2%, what would the new price be?


8-23. Prices of zero-coupon, default-free securities with face values of $1000 are summarized in the following table:

Suppose you observe that a three-year, default-free security with an annual coupon rate of 10% and a face value of $1000 has a price today of $1183.50. Is there an arbitrage opportunity? If so, show specifically how you would take advantage of this opportunity. If not, why not?

8-24. Assume there are four default-free bonds with the following prices and future cash flows:

Do these bonds present an arbitrage opportunity? If so, how would you take advantage of this opportunity? If not, why not?

8-25. Suppose you are given the following information about the default-free, coupon-paying yield curve:

a. Use arbitrage to determine the yield to maturity of a two-year, zero-coupon bond.

b. What is the zero-coupon yield curve for years 1 through 4?

Less: one-year zero ($120 face value)


Less: two-year zero ($120 face value)


Less: three-year zero ($120 face value)


Four-year zero ($1120 face value)



8-26. Explain why the expected return of a corporate bond does not equal its yield to maturity.

8-27. Grummon Corporation has issued zero-coupon corporate bonds with a five-year maturity. Investors believe there is a 20% chance that Grummon will default on these bonds. If Grummon does default, investors expect to receive only 50 cents per dollar they are owed. If investors require a 6% expected return on their investment in these bonds, what will be the price and yield to maturity on these bonds?

8-28. The following table summarizes the yields to maturity on several one-year, zero-coupon securities:

a. What is the price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a AAA rating?

b. What is the credit spread on AAA-rated corporate bonds?

c. What is the credit spread on B-rated corporate bonds?

d. How does the credit spread change with the bond rating? Why?


8-29. Andrew Industries is contemplating issuing a 30-year bond with a coupon rate of 7% (annual coupon payments) and a face value of $1000. Andrew believes it can get a rating of A from Standard and Poor’s. However, due to recent financial difficulties at the company, Standard and Poor’s is warning that it may downgrade Andrew Industries bonds to BBB. Yields on A-rated, long-term bonds are currently 6.5%, and yields on BBB-rated bonds are 6.9%.

a. What is the price of the bond if Andrew maintains the A rating for the bond issue?

b. What will the price of the bond be if it is downgraded?

8-30. 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 (annualpay) 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? Are they junk bonds?


8-31. A BBB-rated corporate bond has a yield to maturity of 8.2%. A U.S. Treasury security has a yield to maturity of 6.5%. These yields are quoted as APRs with semiannual compounding. Both bonds pay semiannual coupons at a rate of 7% and have five years to maturity.

a. What is the price (expressed as a percentage of the face value) of the Treasury bond?

b. What is the price (expressed as a percentage of the face value) of the BBB-rated corporate bond?

c. What is the credit spread on the BBB bonds?

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Tutorials for this Question
  1. Tutorial # 00005143 Posted By: spqr Posted on: 12/14/2013 06:05 AM
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    Why? a. The price of this bond will be b. ...
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