Chapter 16 Assignment

Bond yields
(LO16-2)
1. The Pioneer Petroleum Corporation has a bond outstanding with an $85 annual interest payment, a market price of $800,
and a maturity date in five years. Find the following:
a) The coupon rate.
$85 Interest / $1,000 Par = 8.5% Coupon rate
b) The current rate.
$85 Interest / $800 Market price = 10.625% Current yield
c) The yield to maturity.
N=5 I/Y=CPT I/Y 14.3788 PV= –800 PMT=85 FV=1,000 Answer: 14.38

Bond yields
(LO16-2)
4. An investor must choose between two bonds: Bond A pays $72 annual interest and has a market value of $925. It has 10
years to maturity. Bond B pays $62 annual interest and has a market value of $910. It has 2 years to maturity. Assume the
par value of the bonds is $1,000.

a) Compute the current yield on both bonds.

92.5% and 91%.
b) Which bond should she select based on your answer to part a?
Bond B
c) A drawback of current yield is that it does not consider the total life of the bond. For example, the yield to
maturity on Bond A is 8.33 percent. What is the yield to maturity on Bond B?
(1000/910)(1/2)=5.49%
d) Has your answer changed between parts b and c of this question in terms of which bond to select?
No

Secured vs. unsecured debt

(LO16-1)
5. Match the yield to maturity in column 2 with the security provisions (or lack thereof) in column 1. Higher returns tend to
go with greater risk.
(1) (2)

Security Provision Yield to Maturity

a. Debenture c a. 6.85%

b. Secured debt a b. 8.20%

c. Subordinated debenture b c. 7.76%

 Bond value
(LO16-2)
6. The Florida Investment Fund buys 58 bonds of the Gator Corporation through a broker. The bonds pay 10 percent annual
interest. The yield to maturity (market rate of interest) is 12 percent. The bonds have a 10-year maturity.
Using an assumption of semiannual interest payments:
a) Compute the price of a bond (refer to “Semiannual Interest and Bond Prices” in Chapter 10 for review if
necessary).
PVA = $50 × 11.470 = $573.50
PV = $1,000 × .312 = $312.00
573.50+312.00=885.50
b) Compute the total value of the 58 bonds.
885.50 x 58=$51,359

Interest rates and bond ratings

(LO16-2)
9. Twenty-five-year B-rated bonds of Parker Optical Company were initially issued at a 12 percent yield. After 10 years the
bonds have been upgraded to Aa2. Such bonds are currently yielding 10 percent to maturity. Use Table 16-2 to determine
the price of the bonds with 15 years remaining to maturity. (You do not need the bond ratings to enter the table; just use
the basic facts of the problem.)
12 percent initial coupon rate, 10 percent yield to maturity, 15 years remaining to maturity: =
$1,153.32

Interest rates and bond ratings

(LO16-2)
10. A previously issued A2, 15-year industrial bond provides a return three-fourths higher than the prime interest rate of 11
percent. Previously issued A2 public utility bonds provide a yield of three-fourths of a percentage point higher than
previously issued A2 industrial bonds of equal quality. Finally, new issues of A2 public utility bonds pay three-fourths of
a percentage point more than previously issued A2 public utility bonds.

What should be the interest rate on a newly issued A2 public utility bond?
A2 15-year industrial bonds 8% × 1.25 = 10.000%
Additional return on A2 15-year public utility bond + .375%
Additional return on new issues + .250%
Anticipated return on newly issued A2 public utility bonds 10.625%

Zero-coupon rate bond

(LO16-2)
11. A 17-year, $1,000 par value zero-coupon rate bond is to be issued to yield 7 percent.

a) What should be the initial price of the bond? (Take the present value of $1,000 for 17 years at 7 percent.)
PV= FV / (1 + i)n= $1,000 / (1.07)17= $316.57
b) If immediately upon issue, interest rates dropped to 6 percent, what would be the value of the zero-coupon rate
bond?
PV= FV / (1 + i)n= $1,000 / (1.06)17= $371.36
c) If immediately upon issue, interest rates increased to 9 percent, what would be the value of the zero-coupon
rate bond?
PV= FV / (1 +i)n= $1,000 / (1.09)17= $231.07

Effect of inflation on purchasing power of bond

(LO16-2)
14. Seventeen years ago, the Archer Corporation borrowed $6,500,000. Since then, cumulative inflation has been 65 percent
(a compound rate of approximately 3 percent per year).

a) When the firm repays the original $6,500,000 loan this year, what will be the effective purchasing power of the
$6,500,000? (Hint: Divide the loan amount by one plus cumulative inflation.)
6,500,000/1.65=3,939,394
b) To maintain the original $6,500,000 purchasing power, how much should the lender be repaid? (Hint: Multiply
the loan amount by one plus cumulative inflation.)
6,500,00 x 1.65 = 10,725,000
c) If the lender knows he will receive only $6,500,000 in payment after 17 years, how might he be compensated
for the loss in purchasing power? A descriptive answer is acceptable.
A $10,725,000 loan repayment in a 65 percent cumulative inflationary environment will provide
$6,500,000 in purchasing power to the original lender.

Loss exposure and profit potential

(LO16-2)
16. A $1,000 par value bond was issued 20 years ago at a 9 percent coupon rate. It currently has 5 years remaining to
maturity. Interest rates on similar debt obligations are now 10 percent.

a) Compute the current price of the bond using an assumption of semiannual payments.
PVA= 35 × 11.470 = $401.45
PV = $1,000 × .312 = $312.00
Present value of interest payments $401.45
 Present value of payment at maturity312.00
Total present value or price of the bond$713.45
b) If Mr. Robinson initially bought the bond at par value, what is his percentage loss (or gain)?
Purchase price $1,000.00
Current value713.45
Dollar loss$ 286.55
c) Now assume Mrs. Pinson buys the bond at its current market value and holds it to maturity, what will her
percentage return be?
Maturity value $1,000.00
Purchase price 713.45
Dollar gain$ 286.55
d) Although the same dollar amounts are involved in part b and c, explain why the percentage gain is larger than
the percentage loss.
Because it was a smaller investment and the same amount of dollar loss

Finance lease or operating lease

(LO16-4)
20. Krawczek Company will enter into a lease agreement with Heavy Equipment Co. where Krawczek will make lease
payments over the next 5 years. The lease is noncancelable and requires equal annual payments of $20,000 per year
beginning on January 1 of the first year. The last payment will be January 1 of year 5, and Krawczek will continue to use
the asset until December 31 of that year. Other important information includes the following:
 The fair value of the equipment is $140,000.
 The applicable discount rate is an 8 percent annual rate.
 The economic life of the asset is 10 years.
 Krawczek does not guarantee the residual value of the asset at the end of the lease, and it does not expect to keep the asset at
the end of the term.
 The asset is a standard piece of equipment.

a) Is the lease an operating lease or a finance lease?

Operating
b) What will be the lease expense shown on the income statement at the end of year 1?
20,000
c) What will be the interest expense shown on the income statement at the end of year 1?
1600
d) What will be the amortization expense shown on the income statement at the end of year 1?
125000