Question

QUESTION 55

1. Which of the following is/are correct regarding the reasons an investor might consider investing in corporate bonds? (1) They have lower default risk than Treasuries. (2) They generally pay higher interest than Treasuries. (3) They generally offer some inflation protection via the semi-annual payment of coupons. (4) They offer higher security of principal than equities. (5) Convertible bonds may participate if the company’s shares rise in value.

   		a. 1, 2 and 3.
   		b. 2, 3 and 4.
   		c. 2 and 4.
   		d. 2, 4 and 5.

QUESTION 56

1. Which of the following would likely cause a bond to have a lower market value? (1) The issuer’s credit rating changed from A to AA. (2) The issuer’s credit rating changed from AA to A. (3) The YTM of comparable securities rose. (4) The YTM of comparable securities declined. (5) The bond included a call feature.

   		a. 1, 3 and 4.
   		b. 2 and 4.
   		c. 2, 3 and 5.
   		d. 2, 4 and 5.

Answer 1

Ans 55 : option "D" is the correct choice

Lets discuss each option in detail:

(1) They have lower default risk than Treasuries.

this is incorrect. corporate bonds have higher default risk

(2) They generally pay higher interest than Treasuries.

this is correct and higher interest is paid to compensate the investor for assuming higher default risk

(3) They generally offer some inflation protection via the semi-annual payment of coupons.

this statement is incorrect as inflation protection is proved by TIPS not corporate bonds

(4) They offer higher security of principal than equities.

this statement is correct as bondholders are paid back first in case of liquidation

(5) Convertible bonds may participate if the company’s shares rise in value.

this is correct as the convertible bonds can be converted to equity shares.

Ans 56: "C" is the correct answer

Lets discuss each option in detail:

(1) The issuer’s credit rating changed from A to AA.

incorrect : rating change from A to AA is an upgrade of credit rating. this way investors credit risk in going down. this will increase the value of bond

(2) The issuer’s credit rating changed from AA to A.

this statement is correct.In case of a rating downgrade investors will demand a higher return in compensation of higher credit risk. when desired rate of return increases the market value of the bond will fall. Price and interest rate are inversely related.

(3) The YTM of comparable securities rose.

when YTM rises makes value falls so this is correct.

(4) The YTM of comparable securities declined.

incorrect as decline in YTM will increase market value.

(5) The bond included a call feature.

call option is an advantage to the issuer. for buying callable bonds investors demand higher return which causes market value to decline.