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 thatthe bond has a larger YTM (discount rate that will equate the PV ofthe 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 10years but has a ﬁrst put date in 4 years at the par value of $1,000. Whichof 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 sevenyears to maturity. Which of the following is closest to the yield tomaturity (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 forthe 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 tothe current yield on the bond? A) 7.65%. B) 7.53%.C) 7.75% Explanation (A) — The current yield is computed as: (Annual CashCoupon 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 onethat results in a lower yield. The YTM on a discount bond will alwaysbe 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 nowand 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= 3.910543.91054 × 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 theyield-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 rategoes above the coupon rate and the bond's price falls below par. Thecurrent yield is the coupon rate / price, so as price falls below 1000the current yield rises above the coupon rate. The YTM considers thecurrent 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 iscallable 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 bondcould be called in the future. Because the bond is callable using yieldto maturity would give a falsely increased rate of return