Testbank of Foundations of Financial Markets and Institutions, 4e (Fabozzi/Modigliani/Jones)

In: Business and Management

Submitted By linda12
Words 3420
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Answers to Concepts Review and Critical Thinking Questions

1. No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury securities have substantial interest rate risk.

2. All else the same, the Treasury security will have lower coupons because of its lower default risk, so it will have greater interest rate risk.

3. No. If the bid were higher than the ask, the implication would be that a dealer was willing to sell a bond and immediately buy it back at a higher price. How many such transactions would you like to do?

4. Prices and yields move in opposite directions. Since the bid price must be lower, the bid yield must be higher.

5. There are two benefits. First, the company can take advantage of interest rate declines by calling in an issue and replacing it with a lower coupon issue. Second, a company might wish to eliminate a covenant for some reason. Calling the issue does this. The cost to the company is a higher coupon. A put provision is desirable from an investor’s standpoint, so it helps the company by reducing the coupon rate on the bond. The cost to the company is that it may have to buy back the bond at an unattractive price.

6. Bond issuers look at outstanding bonds of similar maturity and risk. The yields on such bonds are used to establish the coupon rate necessary for a particular issue to initially sell for par value. Bond issuers also simply ask potential purchasers what coupon rate would be necessary to attract them. The coupon rate is fixed and simply determines what the bond’s coupon payments will be. The required return is what investors actually demand on the issue, and it will fluctuate through time. The coupon rate and required return are equal only if the bond sells for exactly par.

7. Yes. Some investors have obligations that are denominated in dollars; i.e., they are nominal.…...

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