Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 25 points for this homework assignment.
1. Ranger Inc. would like to issue new 20-year bonds. Initially, the plan was to make the bonds non-callable. If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return?
a. There is no reason to expect a change in the required rate of return.
b. The required rate of return would decline because the bond would then be less risky to a bondholder.
c. The required rate of return would increase because the bond would then be more risky to a bondholder.
d. It is impossible to say without more information.
e. Because of the call premium, the required rate of return would decline.
2. Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?
a. Adding a call provision.
b. The rating agencies change the bond’s rating from Baa to Aaa.
c. Making the bond a first mortgage bond rather than a debenture.
d. Adding a sinking fund.
e. Adding additional restrictive covenants that limit management’s actions.
3. Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?
a. 20-year, 10% coupon bond.
b. 20-year, 5% coupon bond.
c. 1-year, 10% coupon bond.
d. 20-year, zero coupon bond.
e. 10-year, zero coupon bond.
4. Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?
a. A 1-year bond with a 15% coupon.
b. A 3-year bond with a 10% coupon.
c. A 10-year zero coupon bond.
d. A 10-year bond with a 10% coupon.
e. An 8-year bond with a 9% coupon.
5. Which of the following bonds has the greatest interest rate price risk?
a. A 10-year, $1,000 face value, zero coupon bond.
b. A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
c. All 10-year bonds have the same price risk since they have the same maturity.
d. A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.