Question

Graph/Chart 1 1,500 1,400 1,200- 1,100- 1,000 E 900- 800- 700 60 500 6 7 89 10 11 12 13 Required return (%) PrintDone

Answer 1

a(1) The value of bond if required rate of return is 9% is $1,000

a(2) The value of bond if required rate of return is 13% is $750

a(3) The value of bond if required rate of return is 6% is $ 1,300

b(1) When the required return is less than the coupon rate, the market value is more than the par value, the bond therefore sells at a premium

b(2) When the required return is equal to the coupon rate, the market value is equal to the par value, the bond therefore sells at par

b(3) When the required return is greater than the coupon rate, the market value is less than the par value, the bond therefore sells at a discount

The required return on the bond is likely to differ from the coupon interest rate because either (1) economic conditions have changed, causing a shift in the basic cost of long-term funds, or (2) the firm’s risk has changed

Answer : Option D: firm’s risk has changed