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QUESTION 24 Questions 24 to 27: Bill Jennings made the following statements regarding zero coupon bonds...

QUESTION 24

  1. Questions 24 to 27:

    Bill Jennings made the following statements regarding zero coupon bonds and the term structure of interest rates.
    Statement 1: bond that sells at par consists entirely of an interest yield. However, if the bond sells at any
    price other than its par value, the YTM consists of the interest yield together with a positive or negative capital gains yield.

    Statement 2: A downward-sloping term structure of interest rates indicates long-term yield are higher than short-term yields.

    Statement 3: Zero coupon bonds provide an annual tax deduction to the investor and are issued at a deep discount.

    Statement 4: A 10-year zero coupon bond with face value of $1,000 and the 1-year interest rate is 5%. If the interest rate remains constant, the value of the zero coupon bond would be closed $632.

    Is Jennings correct with respect to?

    A.
    Statement   1 Statement 2
    YES NO
    B.
    YES YES


    C.
    NO NO


          

    D.
    NO YES


  2. QUESTION 25: Is Jennings correct with respect to?

  3. A.
    Statement   3 Statement 4
    NO YES
    B.
    YES NO


    C.
    YES    YES


    D.
    NO NO


  4. QUESTION 26: Today you are buying a $1,000 face value bond at an invoice price of $955. The bond has a 7% coupon and pays interest semiannually. There are 3 months until the next coupon date. What is the clean price of this bond?

  5. A.

    $937.50

    B.

    $885.00

    C.

    $943.33

    D.

    $955.00

  6. QUESTION 27: A bond has a 10-year maturity, a $1,000 face value, and a 7% coupon rate. If the market requires a yield of 8% on the bond, it will most likely trade at a:

  7. A.

    Discount.

    B.

    Premium.

    C.

    Discount or premium, depending on its duration.

Homework Answers

Answer #1

24. A

Negative and positive capital gains yields can change the selling price of a bond it the bond is selling at par it only includes Interest yield.

Downward- sloping indicates short term yield are higher than Long run yield.

25. D

According to IRS, the attributed interest on the bond is subject to income tax.

The price of a zero coupon bond can be calculated as:

= Face value/ (1 + r) ^n

= $1000/ (1 + 0.05) ^10

= $613.91 or $614

26. D. $955.00

The clean price is the value of a coupon bond excluding any accrued interest. The clean price is normally the invoiced price.

27. A

The original investment is counterbalance completely by reimbursement of the bond at maturity. Therefore, if YTM is elevated than the coupon rate, a bond is traded at discount.

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