Fixed Income Characteristics and Valuation

B is correct. Current yield is calculated as annual coupon payment divided by current market price. A 5% coupon on a $1,000 par bond pays $50 annually. $50 ÷ $950 = 0.0526 or 5.26%.

A (5.00%) is incorrect because that's the nominal yield (coupon rate), not the current yield. C (5.50%) is incorrect and appears to be a calculation error. D (4.75%) is incorrect and would result from dividing the coupon rate by an incorrect price figure.

C is correct. Bond prices and interest rates have an inverse relationship. When market interest rates rise, existing bonds with lower fixed coupon rates become less attractive, causing their prices to fall. This is one of the most fundamental principles in fixed income investing.

A (Prices increase) is incorrect because this describes what happens when rates fall, not rise. B (Unchanged) is incorrect because existing bond prices are immediately affected by rate changes. D (Only new bonds affected) is incorrect because existing bonds must adjust their prices to remain competitive with new bonds issued at higher rates.

C is correct. Zero-coupon bonds have the highest duration because they pay no interest until maturity, and duration equals maturity for zeros. A 30-year zero has duration of 30 years, making it extremely sensitive to rate changes. The longer the duration, the greater the price volatility when rates change.

A (30-year 6% coupon) is incorrect because while it has a long maturity, the coupon payments reduce duration below the maturity. B (10-year 6% coupon) is incorrect because shorter maturity means lower duration. D (10-year 8% coupon) is incorrect because higher coupons and shorter maturities both reduce duration.

B is correct. BBB is the lowest investment grade rating from S&P. Investment grade bonds are rated BBB or higher (AAA, AA, A, BBB). These bonds have adequate capacity to meet financial commitments but may be more vulnerable to adverse economic conditions than higher-rated bonds.

A (High yield), C (Speculative), and D (Below investment grade) are all incorrect because these terms describe bonds rated BB or lower. The dividing line between investment grade and junk bonds is crucial: BBB/Baa and above is investment grade, BB/Ba and below is high yield or junk. Many institutional investors can only purchase investment grade securities.

D is correct. For a premium bond (trading above par), yield to call (YTC) is always the lowest yield because the bond will be called at the earliest opportunity, limiting price appreciation and total return. The yield hierarchy for premium bonds is: nominal > current > YTM > YTC.

A (Nominal yield) is incorrect because the coupon rate is the highest for premium bonds. B (Current yield) is incorrect because it's higher than YTM but lower than nominal for premiums. C (YTM) is incorrect because while lower than current yield, it's still higher than YTC. For premium bonds, YTC represents the worst-case scenario for investors.

A is correct. For discount bonds (trading below par), the yield hierarchy is: nominal (coupon) < current yield < YTM. Current yield is less than YTM because YTM includes both the annual interest and the gain from the bond appreciating to par at maturity.

B (Nominal > current) is incorrect because for discount bonds, the nominal yield is lower than current yield since you're dividing the same coupon by a lower market price. C (YTM < current) is incorrect because this reverses the relationship. D (Current = YTM) is incorrect because they're only equal at par, not for discount bonds.

D is correct. Credit spread measures the additional yield investors demand for taking on credit risk compared to risk-free Treasury securities. A wider spread indicates greater perceived credit risk or economic uncertainty. Credit spreads widen during recessions and narrow during economic expansions.

A (Current yield vs YTM) is incorrect because this relates to bond pricing relative to par, not credit quality. B (Short vs long rates) is incorrect because this describes the yield curve shape, not credit spreads. C (Coupon vs current yield) is incorrect because this simply reflects whether a bond trades at premium, discount, or par, not credit risk.

C is correct. First, calculate the conversion ratio: $1,000 par ÷ $40 conversion price = 25 shares. Then multiply by the stock price: 25 shares × $45 = $1,125. This is the parity or conversion value, representing what the bond is worth if converted to stock.

A ($888) is incorrect and would result from dividing rather than multiplying. B ($1,000) is incorrect because that's the par value, not the conversion value. D ($1,200) is incorrect and appears to be a calculation error. Remember: conversion ratio × stock price = parity.

B is correct as the exception. The current yield is actually LESS than 4%, not greater. For a premium bond (price above par), the current yield calculation is: $40 annual coupon ÷ $1,050 market price = 3.81%. When a bond trades at a premium, the current yield is always below the nominal (coupon) yield.

A (Trading at premium) is correct because $1,050 exceeds the $1,000 par value. C (YTM less than current) is correct because for premium bonds, the yield hierarchy is nominal > current > YTM. D (Price declines toward par) is correct because all bonds experience "pull to par" as they approach maturity, with premiums declining and discounts rising.

A is correct. To find the tax-equivalent yield, multiply the municipal yield by (1 minus the tax rate). However, we need to work backwards here: if the corporate bond yields 6%, we need to find what tax-free yield is equivalent. The after-tax corporate yield is 6% × (1 - 0.32) = 6% × 0.68 = 4.08%. Therefore, a municipal bond yielding 4.08% provides the same after-tax return.

B (6.00%) is incorrect because that's the pre-tax corporate yield, not the equivalent municipal yield. C (1.92%) is incorrect because that's the amount of taxes paid (6% × 32%), not the after-tax yield. D (8.82%) is incorrect because that would be the taxable equivalent yield of the municipal bond if you started with 6% muni yield: 6% ÷ (1 - 0.32) = 8.82%.