1. A $1000 face value bond purchased for $965.00, with an annual coupon of $40,
ID: 1093924 • Letter: 1
Question
1. A $1000 face value bond purchased for $965.00, with an annual coupon of $40, and 20 years to maturity has:
A) A current yield equal to 4.00%.
B) A current yield equal to 6.22%.
C) A coupon rate equal to 4.00%.
D) A yield to maturity less than 4.00%.
2. Suppose we observe interest rates are risng in general in debt markets, this could be due to
A) less government borrowing.
B) rising inflationary expectations.
C) rising bond demand.
D) none of the above.
3. An investor in a 20% marginal tax bracket, earning $10 in interest annually for a $100 U.S. Treasury bond:
A) Earns a 10% after-tax return because interest on U.S. Treasury bonds is tax exempt at the federal level.
B) Earns a 7% return after-tax.
C) Assuming the same default risk, would be indifferent between this bond and a municipal bond offering $8 annually per $100 of face value.
D) b and c
Explanation / Answer
Correct answers are highlighted and explained below:
1. A $1000 face value bond purchased for $965.00, with an annual coupon of $40, and 20 years to maturity has:
A) A current yield equal to 4.00%.
B) A current yield equal to 6.22%.
C) A coupon rate equal to 4.00%. Coupon rate is $40/$1000 = 4%. The yield is $40/$965 = 4.14%
D) A yield to maturity less than 4.00%.
2. Suppose we observe interest rates are risng in general in debt markets, this could be due to
A) less government borrowing.
B) rising inflationary expectations. Inflation will cause debt markets to raise rates.
C) rising bond demand.
D) none of the above.
3. An investor in a 20% marginal tax bracket, earning $10 in interest annually for a $100 U.S. Treasury bond:
A) Earns a 10% after-tax return because interest on U.S. Treasury bonds is tax exempt at the federal level.
B) Earns a 7% return after-tax.
C) Assuming the same default risk, would be indifferent between this bond and a municipal bond offering $8 annually per $100 of face value. These are the same since the Bond is getting 8% return after taxes
D) b and c
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