In: Finance

# 7.If Trumped Towers, Inc.bonds are downgraded from AAA –to BBB+, which of the following statements about...

7.If Trumped Towers, Inc.bonds are downgraded from AAA –to BBB+, which of the following statements about Trumped Towersbonds is (are) correct?

A.The current bond price will decrease.

B.The current bond price will increase

C.Interest rates required on new bond issues will decrease.

D.The current bond price will decrease and interest rates on new bonds issues will increase.

E.The current bond price will increase and interest rates on new bonds issues will decrease.

8.Which of the following statements is (are) correct?(x)Investors can follow the bond market prices by watching prevailing market interest rates because interest rates and bond prices move in opposite directions.(y)If a bond is selling at par value, then the current yield must equal the coupon rateand the current yield must equal the yield to maturity.(z)If acorporationwants to increase its debt ratioand interest rates have increased, then it is likely that the corporation will call its bonds.

A.(x), (y) and (z)

B.(x) and (y) only

C.(x) and (z) only

D.(y) and (z) only

E.(z) only

16.Terrific Towels. Inc. issued a bond with a $1,000 face value and a coupon rate of 6.5%. If the bond has a life of 19 years, pays semi-annual coupons, and the yield to maturity is 7.80%, what will the bond sell for? A.$794.45

B. $882.20 C.$872.28

D. $864.69 E.$404.93

17.Which of the following bonds will have the largest percentage increase in value if interest rates decrease by 1%?

A.2-year, 5% coupon bond

B.30-year, 10% coupon bond

C.10-year, zero coupon

D.30-year, zero coupon

E.It is the same for all of the coupon

## Solutions

##### Expert Solution

Answer 7    -   Option D is correct

As the rating of the trump towers Inc has been downgraded ( From AAA-   to BBB+ )so its prices will fall,

And new bonds issued by trump towers has to offer higher coupon rates, as rating has been downgraded.

Answer 8 :-    Option B is correct

x)Investors can follow the bond market prices by watching prevailing market interest rates because interest rates and bond prices move in opposite directions.

Correct :- Yes that is true that interest rate and Bond price move in opposite direction they are inversely proportional. As interest rate increase bond prices falls and viceversa.

(y)If a bond is selling at par value, then the current yield must equal the coupon rateand the current yield must equal the yield to maturity.

Correct :- Yes that is true that if Bond is selling at par the current yield must equal the coupon rate and yield will be equal to YTM. As you know that YTM is the rate at which discounting the future cash flows of the bonds should be equal to its current Value.

(z)If a corporation wants to increase its debt ratio and interest rates have increased, then it is likely that the corporation will call its bonds.

In Correct :- If interest rates increases the prices will fall and it will become less likely for a corporation to call as the valuation is low and they have to pay the call price which is higher.

Answer 16   :-    option C is correct

N = 19 years = 19 * 2 = 38 periods( semiannual payment)

Coupon rate = 6.5 % = 3.25% or 32.5$FV = 1000$

PMT = 32.5 $semiannually I/Y (Yield) = 7.8 % = 3.9 % (semiannually) PV = ? Putting the values in the calculator you will get PV = 872.28$

Answer 17 :-     option D is correct

% Change in Price of a Bond = - ( Duration * Change in YTM ) + 1/ 2 * ( Convexity * YTM^2)

Assuming convexity to be constant for all , as interest rates decreases by 1 % . So it depends on the bonds duration which will effect the % change in Price of a bond.

So the bond having the largest duration will effect the price most.

Now coupon bonds have the lowest duration as compared to zero coupon bonds so option A & B gets eliminated as compared to C & D .

Now for zero coupon bond duration = maturity, so bond having largest maturity will have the largest duration so option D have the maturity of 30 years will have the largest duration and will effect the price most.

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