Question

pany 1 ny 2 are comparable companies. Bond 1 was issued by Company 1 and Bond 2 mpany 2. Bond 1 and Bond 2 both currently trade a, par andare yielding 5.0%. Bond i is and Compa ssued by Company 2. Bond 1 and Bond ble at $105 $2,000 $1,800 $1,600 o while Bond 2 is puttable at $950. The graph below can be used for question 12. Bond Price (Y-Axis) vs. Yield to Maturity (X-Axis) $1,37975 51,40117104 $1,270.68 $1,194.61 1,12.07 1092 22 $1.8843 $1000.003 $ $1,171.69 $1,200 $1,000 $800 $600 $400 $200 6-83 $878.34 $841.75 $806.9 6 6 6.0% 7.0% 8.0% 9.0% 10.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% BOND 1 BOND 2 12. Bond 1's YTM instantaneously falls to 4.0% while Bond 2's YTM instantaneously increases to 6.0%. Which of the following is statements is (are) most likely TRUE: I. Bond 1's credit rating was just downgraded by a credit rating agency Il. Bond 2's credit rating was just upgraded by a credit rating agency IlI. Company 1 will buy the bond back from the creditors IV. Company 1's creditors will buy the bond back from the company V. Company 2's creditors will sell the bond back to the company E. IV 13. Assume that ROE is the only factor which impacts a stock's price; the higher a stock's ROE, the better the stock will perform. You are considering buying only one of the following: a defensive company with low debt, a defensive company with high debt, a cyclical company with low debt, or a cyclical company with high debt. Given the position in the business cycle, which statement is most accurate? A. When entering a recession, buy a cyclical company with low leverage B. When entering a recession, buy a defensive company with low leverage C. During the expansion phase of a business cycle, buy a defensive company with high leverage D. During the expansion phase of a business cycle, buy a cyclical company with low leverage E. During the expansion phase of a business cycle, buy a cyclical company with high leverage

Answer 1

12. Answer C. III

Reason: When there is a buyback of the bond by the company, there is rush and a higher demand for bonds. Because of the higher demand, the prices rise and the YTM falls as is the case. Hence the answer is Option C

13. Answer E. During the expansion phase of a business cycle, buy a cyclical company with high leverage

Reason: When there is an expansion phase, the interest rates tend to be lower and the interest on debt will reduce,. A cyclical company will also have a higher growth in this phase. Such companies are called high beta plays and that would be the best approach