Question

If you are a retiree, which of the following risks associated with the bonds are you most concerned about?

	a	Price Risk
	b.	Interest Rate Risk
	c.	Default Risk
	d.	Reinvestment Risk

2.

Preferred stock is considered hybrid between bond and stock because the company must pay dividend every year to holders of preferred stock.

True

False

3.

A bond has a $1,900 par value, 10 years to maturity, and 7% annual coupon and sells for $1,800. (2 pts.)

1. What is its YTM?

Assume YTM remains constant for the next 3 years. What will be its price 3 years from now?

	a.	7.78 & $5798.23 respectively
	b.	4.34 & $1826.15 respectively
	c.	7.78 & $1949.17 respectively
	d.	7.78 & $1822.36 respectively

4.Of the following bond ratings, which option is likely to require highest rate of return?

a.	AA
	b.	A
	c.	BBB
	d.	BB
	e.	B

Answer 1

Question 1

Option A is correct.

• The growth of a person's retirement fund depends, in part, to the way interest rates move.
• While low-interest-rate environments may be great for those looking to borrow, they aren't so good for people who are looking to save.
• Banks and other financial institutions usually pay low returns for investments when interest rates are low.

Question 2

True

• They offer more predictable income than common stock and are rated by the major credit rating agencies.
• Unlike with bondholders, failing to pay a dividend to preferred shareholders does not mean a company is in default.

Question 3

YTM =

YTM = [ ( 7% * 1900 ) + (1900 - 1800)/10 ] / [ (1900 + 1800 ) / 2 ]

        = [ 133 + 10 ] / 1850

        = 143 / 1850

        = 7.78 % Answer

Price at year 3

Price = Coupen Amount * PVAF (r, n) + Face Value * PVIF (r, n)

         = [ ( 1900 * 7%) * PVAF (7.78%, 7) + 1900 * PVIF (7.78%, 7)

          = 133 * [ 1/1.0778 + 1/1.07782 + ..... + 1/1.07787 ] + 1900 * [1/1.0778]7

        = 133 * 5.2458 + 1900 * 0.5919

       = 1822.36 Answer

The option D is correct.

Question 4

> Rule - The lower the rating, greater the risk and hence higher rate of required returns.

> Among the option, B rating is the lowest and hence higher returns will require in this case.

> Answer - The option E is correct.

Hope you understand the solution.