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Solutions to Bonds and Discounts

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Submitted By lawston52
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Chapter 4

Answers to Concept Review Questions

1. Managers need to understand how bonds and stocks are priced because (1) firms regularly issue stocks and bonds to raise money for investment (2) understanding how securities are priced is helpful when conducting an acquisition or a divestiture, (3) the stock price is an objective signal of how managers are performing, and (4) finance theory teaches that the goal of the manager should be to maximize the firm’s stock price.

5. The coupon rate equals the annual coupon payment divided by par value. The coupon yield equals the annual coupon payment divided by the bond’s market price.

6. A bond sells at a discount when the bond’s coupon rate is lower than the market’s required rate of return on the bond.

11. An issuer benefits from an option to call a bond, because such an option allows the issuer to lock in a more favorable interest rate if rates should fall.. The option to convert bonds into common stock benefits bondholders. Once the stock price rises high enough, the value of the bonds starts to behave like the stock’s value—the prices start to rise. So convertible bonds offer investors some minimal level of return plus a lot of upside potential.

13. The price of a Treasury note quoted as 98:10 is 98 10/32 percent of par value or $983.125.

Answers to End-of-Chapter Questions

Q4-1. What is the relationship between the price of a financial asset and the return that investors require on that asset, holding other factors constant?

A4-1. Holding an asset’s cash flows constant, if investors pay a higher price for the asset, then their return from holding the asset will be lower. In general, asset prices are inversely correlated with returns.

Q4-2. Define the following terms commonly used in bond valuation: (a) par value, (b) maturity date, (c) coupon, (d) coupon rate, (e) coupon yield,

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