# 1. If a firm could sell a mortgage bond at an 8% interest rate, it could sell an otherwise...

## Question:

1. If a firm could sell a mortgage bond at an 8% interest rate, it could sell an otherwise identical debenture at:

i. a rate less than 8%

ii. 8%

iii. a rate greater than 8%

iv. cannot be determined

2. Two years ago, Trans-Atlantic Airlines sold $250 million worth of bonds at$1,000 each. The bonds had a maturity of 12 years and a coupon rate of 12%. Today these bonds are selling for $910. Determine the yield-to-maturity (to the nearest tenth of one percent). i.13.2% ii. 5.6% iii. 13.7% iv. 12.0% 3. Assume that the dividend on Central Power Company's$4.68 preferred stock issue is paid annually at the end of the year. Determine the value of this preferred stock to an investor who requires a 12 percent rate of return.

i. $3.25 ii.$39

iii. $12 iv.$27.08

Maturity risk is the risk associated with investing in an investment that has a long duration. All else the same, an investment with a longer duration is subject to a higher risk, and hence must command a higher return.

Question 1

A debenture has a shorter term to maturity than a mortgage bond. All else the same, a bond with a longer term to maturity will have a higher yield because of the maturity risk premium. Therefore, a debenture will have a lower interest rate than an otherwise identical bond.

Question 2

The yield to maturity is the discount rate that equates the present value of the bond to its current price. The bond has 1000 par value, 1000*12% = 120 annual coupon, and current price of 910. The bond has 10 years to maturity. The yield to maturity is the solution to the following equation:

• {eq}\displaystyle \frac{120*(1 - (1 + y)^{-10})}{y} = 910 {/eq}

which yields:

• {eq}y = 13.71\% {/eq}

Question 3

The price of a preferred stock is calculated as follows:

• price per share = dividend per share / required return
• price per share = 4.68 / 12%
• price per share = 39 