Question

1. When bond rating companies rate a bond, which are qualities they evaluate?

I. Profitability of the bond issuer

II. Default probability of the bond issuer

III. Management team of the bond issuer

IV. Protection offered to bond investors in the event of default

a. II and III

b. I and IV

c. I and II

d. I, II and III

e. II and IV

2. Wolverine Corp. issued 13-year bonds 2 years ago at a coupon rate of 9.4 percent. The bonds make semiannual payments and carry a face value of $1,000. If these bonds currently sell for $980, what is the YTM?

a. 4.85%

b. 11.64%

c. 10.67%

d. 8.73%

e. 9.70%

3. A Treasury bond is quoted as 111:18 ask and 111:10 bid. What is the bid-ask spread in dollars on a $1,000 face value bond?

a. $25.00

b. $8.00

c. $2.50

d. $0.80

e. $5.00

Answer 1

1. When bond rating companies rate a bond, which are qualities they evaluate?

Bond rating companies rate a bond, the qualities they evaluate are the financial soundness of the company and its capacity to repay interest and principal on time. Therefore they evaluate default probability of the bond issuer as well as protection offered to bond investors in the event of default. Although they look at the financial strength of the company but not necessarily profitability of the bond issuer and management team of the bond issuer is not a major focus of bond evaluation.

Therefore correct answer is option: e. II and IV

2. Wolverine Corp. issued 13-year bonds 2 years ago at a coupon rate of 9.4 percent. The bonds make semiannual payments and carry a face value of $1,000. If these bonds currently sell for $980, what is the YTM?

Current Yield to maturity (YTM) of the bond is can be calculated in following manner

Face value or par value of bond is M= $1,000

Price of bond P0 = $980

Coupon payment C =9.4%/2 * $1,000 = $47 semiannual

Number of remaining payments n = (13 -2) years * 2 = 11 *2 = 22

And Yield to maturity (YTM) =?

Formula for calculation the YTM

Bond price P0 = C* [1- 1/ (1+YTM) ^n] /YTM + M / (1+YTM) ^n

Now putting the values into formula, we get

$980 = $47 * [1 – 1 / (1+YTM) ^22] /YTM + $1,000/ (1+YTM) ^22

Or YTM = 4.85 % semiannual

Or annual YTM = 2 * 4.85% = 9.70% per year

Therefore correct answer is option: e. 9.70%

3. A Treasury bond is quoted as 111:18 ask and 111:10 bid. What is the bid-ask spread in dollars on a $1,000 face value bond?

Bid-Ask spread is the difference between Bid and asked price

Bid-Ask spread = Asked price - Bid price

A Treasury bond is quoted in increment of 1/32;

Therefore, quote 111:18 mean (111 + 18/32) = 111.5625% of face value

= 111.5625% * $1000 = $1,115.625

And quote 111:10 mean (111 + 10/32) = 111.3125% of face value

= 111.3125% * $1000 = $1,113.125

Therefore,

Bid-Ask spread = $1,115.625 - $1,113.125

= $2.50

Therefore correct answer is option: c. $2.50