FINC 7110 Exam 2- Concepts || with 100% Error-free Answers.
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Course
FINC 7110
Institution
FINC 7110
Is it true that a U.S. Treasury security is risk-free? correct answers No. As interest rates ^ value of Treasury security ^. Long-term treasury securities have *substantial* interest rate risk.
Which has greater interest rate risk, a 30 year Treasury bond or 30 year BB corporate bond? correct an...
FINC 7110 Exam 2- Concepts || with 100% Error-free
Answers.
Is it true that a U.S. Treasury security is risk-free? correct answers No. As interest rates ^ value
of Treasury security ^. Long-term treasury securities have *substantial* interest rate risk.
Which has greater interest rate risk, a 30 year Treasury bond or 30 year BB corporate bond?
correct answers All else the same, treasury security will have lower coupons because of its lower
default risk, so it will have greater interest rate risk.
How does a bond issuer decide on the appropriate coupon rate to set on its bonds? correct
answers Bond issuers look at outstanding bonds of similar maturity and risk. These yields are
used to establish coupon rate for issue to sell at par value. They also ask potential purchasers
what coupon rate would attract them.
Explain the difference between the coupon rate and the required return on a bond. correct
answers Coupon rate- fixed and determines what bonds coupon payments will be
Required return- what investors actually demand on the issue which fluctuates through time
Companies pay rating agencies such as Moody's and S&P to rate their bonds, and the costs can
be substantial. However, companies are not requires to have their bonds rated in the first place;
doing so is strictly voluntary. Why do you think they do it? correct answers Companies pay to
have their bonds rated because unrated bonds can be difficult to sell; many large investors are
prohibited from investing in unrated issues.
U.S. Treasury bonds are not rated. Why? Often, junk bonds are not rated. Why? correct answers
Treasury bonds have no credit risk since they are backed by the US government so a rating is not
necessary.
Junk bonds are not rated because there would be no point in an issuer paying a rating agency to
assign its bonds a low rating.
What are the implications for bond investors of the lack of transparency in the bond market?
correct answers Lack of transparency means that a buyer or seller can't see recent transactions, so
it is much harder to determine what the best bid and ask prices are at any point in time.
What is the relationship between the price of a bond and its YTM? correct answers Bond price is
the present value of the cash flows from a bond. The YTM is the interest rate used in valuing the
cash flows from a bond.
Explain why some bonds sell at a premium while others sell at a discount. What do you know
about the relationship between the coupon rate and the YTM for premium bonds? Discount
bonds? Par value? correct answers If the coupon rate is higher than the required return on a bond,
the bond will sell at premium since it provides periodic income in the form of coupon payments
in excess of that required by investors on similar bonds.
, If the coupon rate is lower than required return, bond sells at discount because it provides
insufficient coupon payments compared to that required by investors on similar bonds.
Premium= coupon rate exceeds YTM
Discount= YTM exceeds coupon rate
Par= YTM is coupon rate
What is the relationship between current yield and YTM for premium bonds? Discount bods? Par
Value? correct answers Current yield is the annual coupon payment divided by current bond
price.
Premium- current yield > YTM
Discount- YTM > current yield
Par- current yield = YTM
All else being the same, which has more interest rate risk:
1. Long term or short term bond?
2. Low coupon bond or high coupon bond
3. Long-term high coupon bond or short-term low coupon bond correct answers 1. Long term
2. Low coupon
3. Unsure but normally the maturity of the bond is more important determinant so long term has
more
Why does the value of a share of stock depend on the dividends? correct answers The value of
any investment depends on the present value of its cash flows. The cash flows from a share of
stock ARE the dividends
A substantial percentage of the companies listed on the NYSE and the NASDAQ don't pay
dividends, but investors are nonetheless willing to buy shares in them. How is this possible given
your answer to the previous question? correct answers Investors believe the company will
eventually start paying dividends
Referring to the previous question (about the substantial percentage of companies that don't pay
dividends), under what circumstances might a company choose not to pay dividends? correct
answers In general, companies that need the cash will forgo dividends since they are a cash
expense. Young companies and companies in financial distress tend to do this.
Suppose a company has a preferred stock issue and a common stock issue. Both have just paid a
$2 dividend. Which do you think will have a higher price, a share of the preferred or a share of
the common? correct answers The common stock probably has a higher price because the
dividend can grow whereas it is fixed on the preferred. However, the preferred is less risky
because of the dividend and liquidation preference. Really just depends on circumstances.
Based on the dividend growth model, what are the two components of the total return on a share
of stock? Which do you think is typically larger? correct answers The two components are the
dividend yield and the capital gains yield. For most companies, the capital gains yield is larger.
This is easy to see for companies that pay no dividends. For companies that do pay dividends,
the dividend yields are rarely over five percent and are often much less.
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