CFA Level 1 - Fixed Income Session 16 - Reading 66 - LOS b

CFA Level 1 - Fixed Income Session 16 - Reading 66 - LOS b (Notes, Practice Questions, Sample Questions) 1. A bond is selling at a discount relative to its par value. Which of the following relationships holds? A) yield to maturity < coupon rate < current yield. B) current yield < coupon rate < yield to maturity. C) coupon rate < current yield < yield to maturity Explanation (C) — When a bond is selling at a discount, it means that the bond has a larger YTM (discount rate that will equate the PV of the bond's cash flows to its current price) than its current yield (coupon payment/current market bond price) and coupon payment 2. PG&E has a bond outstanding with a 7% semiannual coupon that is currently priced at $779.25. The bond has remaining maturity of 10 years but has a first put date in 4 years at the par value of $1,000. Which of the following is closest to the yield to first put on the bond? A) 14.46%. B) 7.73%. C) 14.92% Explanation (A) — To compute yield to first put, enter: FV = $1,000; N = 2 × 4 = 8; PMT = $35; PV = -$779.25; CPT → I/Y = 7.23%, annualized as (7.23)(2) = 14.46% 3. Suppose that IBM has a $1,000 par value bond outstanding with a 12% semiannual coupon that is currently trading at 102.25 with seven years to maturity. Which of the following is closest to the yield to maturity (YTM) on the bond? A) 11.52%. B) 11.21%. C) 11.91% Explanation (A) — To find the YTM, enter PV = –$1,022.50; PMT = $60; N = 14; FV = $1,000; CPT → I/Y = 5.76%. Now multiply by 2 for the semiannual coupon payments: (5.76)(2) = 11.52% 4. A five-year bond with a 7.75% semiannual coupon currently trades at 101.245% of a par value of $1,000. Which of the following is closest to the current yield on the bond? A) 7.65%. B) 7.53%. C) 7.75% Explanation (A) — The current yield is computed as: (Annual Cash Coupon Payment) / (Current Bond Price). The annual coupon is: ($1,000)(0.0775) = $77.50. The current yield is then: ($77.50) / ($1,012.45) = 0.0765 = 7.65% 5. The yield to call is a less conservative yield measure than the yield to maturity whenever the price of a callable bond is quoted at a value: A) equal to or greater than par value plus one year's interst. B) equal to par value less one year's interest. C) more than par Explanation (B) — The more conservative yield measure is the one that results in a lower yield. The YTM on a discount bond will always be less than its yield to call 6. Consider a 5-year, semiannual, 10% coupon bond with a maturity value of 1,000 selling for $1,081.11. The first call date is 3 years from now and the call price is $1,030. What is the yield-to-call? A) 7.28%. B) 7.82%. C) 3.91% Explanation (B) — N = 6; PMT = 50; FV = 1,030; PV = $1,081.11; CPT → I = 3.91054 3.91054 × 2 = 7.82 7. A 12% coupon bond with semiannual payments is callable in 5 years. The call price is $1,120. If the bond is selling today for $1,110, what is the yield-to-call? A) 11.25%. B) 10.25%. C) 10.95% Explanation (C) — PMT = 60; N = 10; FV = 1,120; PV = 1,110; CPT → I = 5.47546 (5.47546)(2) = 10.95 8. If a bond sells at a discount its: A) coupon rate is less than the market rate of interest. B) current yield is greater than its YTM. C) coupon rate is greater than its current yield. Explanation (A) — When a bond sells at a discount, the market rate goes above the coupon rate and the bond's price falls below par. The current yield is the coupon rate / price, so as price falls below 1000 the current yield rises above the coupon rate. The YTM considers the current yield plus the capital gain associated with the discount 9.1 Consider the purchase of an existing bond selling for $1,150. This bond has 28 years to maturity, pays a 12% annual coupon, and is callable in 8 years for $1,100. What is the bond's yield to call (YTC)? A) 10.55%. B) 10.05%. C) 9.26%. Explanation (B) — N = 8; PMT = 120; PV = -1,150; FV = 1,100; CPT → I/Y. 9.2 What is the bond's yield to maturity (YTM)? A) 10.55%. B) 9.26%. C) 10.34%. Explanation (C) — N = 28; PMT = 120; PV = -1,150; FV = 1,000; CPT → I/Y. 9.3 What rate should be used to estimate the potential return on this bond? A) 10.34%. B) the YTC. C) the YTM. Explanation (B) — The yield to call should be used since the bond could be called in the future. Because the bond is callable using yield to maturity would give a falsely increased rate of return