Question

5. Suppose you buy a Baa rated corporate bond today for $1,000 with a maturity of ten years and a yield to maturity of 7%, and sell it one year from now for $1,150. Which of the following is (are) true? A. Your holding period return will be less than the yield to maturity B. Your holding period return will be equal to the yield to maturity C. Your holding period return will be greater than the yield to maturity D. Insufficient information to determine which will be higher E. Both A and D 6. Why is it best to hold zero coupon bonds in a tax-deferred account like a 401K? A. Zero coupon bonds are tax exempt I B. The IRS requires the holders of zero coupon bonds to pay taxes on the interest that accrues, even though they aren't receiving coupon payments C. The IRS allows investors to defer paying taxes on all zero coupon bonds D. The SEC mandates are zero coupon bonds be held in tax deferred accounts E. Both C and D 7. Why do corporate bonds pay a higher risk premium than municipal bonds? A. Neither corporations nor state and local governments can levy taxes B. State and local governments can print money, whereas corporations cannot C. Corporations can levy higher taxes than state and local governments D. State and local governments can levy taxes, whereas corporations cannot E. None of the above 8. According to the Dividend Discount Model, if the growth rate of a company's dividends increases, holding all else equal, then the value of the company's stock will A. Increase B. Decrease C. Stay the same D. Insufficient information E. None of the above

Answer 1

Q5) C) Holding period return will be equal to yield to maturity

Explanation: Using financial calculator to find the coupon rate

Inputs: N= 9

I/y= 7%

Pv= -1,150

Fv= 1,000

Pmt= compute

We get, coupon payment as 93.023

Using the coupon payment to find the present value of bond at time 0

Inputs: N= 10

I/y= 7%

Pmt= 93.023

Fv= 1,000

Pv= compute

We get, present value of the bond at initiation is $1,161.7037

Holding period return = Ending value - beginning value + income / beginning value

= 1,150 - 1,161.7037 + 93.023 / 1,161.7037

= -11.7037 + 93.0230 / 1,161.7037

= 81.3193 / 1,161.7037

= 7%

So, ytm is equal to holding period return.

Q6) The IRS requires the holders zero coupon bonds to pay taxes on the interest that accrues, even though they aren't receiving any coupon payments.

Explanation: The imputed interest on the zero coupon bond is taxable so it should be held in 401(k), so that the taxes can be deferred at a later date.

Q7) E) None of the above

Explanation: Corporate bonds pay higher risk premium because thay are slightly more risky than municipal bonds.

Q8) A) Increase

Explanation: The value of stock will increase as the dividend increases, all else remaining constant because their is a positive relationship between price and dividend. As dividend increases price increases.