A bond pays semi-annual interest of $50.  They mature in 15 years, and
have a par value of $1,000.  The market rate of interest is 8%.  The
market value of the bonds is: (round to nearest dollar)
a)$1,173
b)$743
c)$1,000
d)$827

Bondholders ahve a priority claim on assets ahead of:
a)common stockholders
b)preferred stockholders
c)both A and B
d)none of the above

Bond ratings are usually NOT affected by:
a)the companys fiscal year end
b)profitable operations
c)variability in earnings
d)firm size

An example of growth factor in common stock is:
a)acquiring a loan to fund an investment in East Germany
b)retaining profits in order to reinvest into the firm
c)issuing new stock to provide capital for future growth
d)increasing the dividend per share that is paid to common
stockholders

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Request for Question Clarification by nauster-ga on 11 Feb 2003 16:02 PST

I can provide you with enough information and explanation that you
will be able to answer these questions on your own. Do you consider
that to be a satisfactory form of answer?

---

Clarification of Question by k9queen-ga on 11 Feb 2003 16:12 PST

No

Hi k9queen-ga,

I have a University Degree in Accounting and have been working in my
Accounting field for years. so I feel that I am quite capable of
answering your questions.

1)The answer is (d)

Here is the formula and the workings

V= I(PVIFA kd/2n) + M(PVIF kd/2,n)

Semi annual amount is $50
 
M= $1000

kd=8%

n=15



V= 50(26.772/2) + 1000( 1/(1+.08)15)
  =50(13.386) + 1000(.315241705/2)
  =669.3 + 1000(.157620853)
   =669.3 +157.620853
   =826.92085
   =827
 



2)Bondholders have priority claim over both the Preferred and Common
Share holders which is answer (c)

This is so because bondholders are outside lenders to the company and
they expect repayment from the business. A bond holder has a greater
claim on an issuer's income than a shareholder in the case of
financial distress.

I have listed a couple websites that gives the definition of
Bondholders and also explains their position



Definition

Bondholder
The owner of a bond. In addition to receiving regular interest
payments and the return of principal, bondholders are given precedence
over stockholders in case of asset liquidation.
http://www.investorwords.com/cgi-bin/getword.cgi?528

Equity Securities( includes common and preferred stock)
Any security that represents an ownership stake rather than an IOU.
Equity securities include common and preferred stock. Bonds are not
equity securities; they are simply loans to the company. Bondholders
can expect repayment of principal from the business, while
stockholders hope for dividends and price appreciation. In the event
the business goes bad, the bondholders have a claim on the company's
assets that supersedes the claims of equity holders.

http://moneycentral.msn.com/investor/glossary/glossary.asp?TermID=159


3)Bond rates are not affected by (a) a company's fiscal year

There are many other factors that affect bond rates and they are
interest rate risk, credit risk, repayment risk, balancing risk.  Also
note that profitable operations, variablility in earnings and firm
size falls within these areas.  A firms size is risky because if the
firm is small or downsizing they would not be able to take as much
risk as a large firm  and in doing so would affect the bond rates.

This website goes in more detail with regards to the size of a firm
http://www.hwwa.de/Publikationen/Discussion_Paper/2000/113.pdf

This websites dicusses what affect bond rates
http://www.mfea.com/NewsCommentary/FundFocus/BondFunds/Fidelity2.asp
http://207.228.247.118/debtfaq.asp#4



4) An example of growth factor in common stock is (d) the increasing
of dividend per share to common stockholders.

This is so because common stockholders are paid a dividend per year
based on the stock sold and if more stock sold then the dividend would
increase.

This website also goes in detail with the explanation
Why Do Companies Issue Stock to the Public?
http://www.usboomers.com/stock_basics.htm


Hope this helps.  If you have any further questions please contact me.

Best regards


jeanwil-ga

Thank you for the clarification and very detailed!  Very fast response also.

i'm sorry to disagree with the offered response but the offered
response is incorrect. in the first question regarding the current
valuation of the bond, without doing any math a simple logical
analysis of the proposition makes $827 an incorrect response.

the question states that the bond holder receives semi-annual payments
of $50.00. so our bondholder collects $100.00 per year on his bond.
the question further states that the par value of this bond is
$1000.00. clearly the nominal, stated or coupon rate, which are
synonomous terms, for this issue is 10%. the market rate of interest
is quoted as 8%. in order for an investor to obtain a yield on this
bond of less than the coupon rate the bond must be selling at a
premium to par. therefore, doing no math, given the choices offered,
only amounts greater than par can possibly be a correct solution. as
there is only one such choice, $1173 is in fact the only possible
answer.

an investor purchasing this bond at a market price of $873.00 would
have a current yield of 12.06% and a yield to maturity of 12.59%.
obviously neither of those are the 8% indicated as the yield in the
question.

current yield is a simple calculation. divide the number of dollars
you receive in interest by the amount you pay for the bond. yield to
maturity is a bit more involved as it takes into account the
difference between the par or maturity value, the current price of the
bond (more or less than par) and the time left till maturity.

in simpliest, albeit, only fairly accurate terms, yield to maturity
can be calculated thusly:

subtract
the current market price:    1173
from
the par or redemption value  1000
                             ----
                              173

the 173 is the number of dollars the investor expects to lose at
maturity. remember you paid 1173 to get $100.00 per year for 15 years
but at maturity you only get back $1000.00.

divide the expected loss (or gain if buying at a discount) by the time
till maturity, in this case exactly 15 years.  173/15 = 11.53

the $11.53 represents an estimate of the annual loss you will absorb
versus the 100 interest payment. subtract the expected loss from the
interest payment leaves: 100.00
         11.53
        ------
         88.47  this is the simple but theoretical per year benefit
you will realize through ownership of this bond.

you now divide the 88.47 by the average of the redemption proceeds
plus your acqusition cost. in the problem the redemption is 1000, the
acquistion is 1173 and the average is 1000 + 1173 / 2 = 2173/2 =
1086.50

88.47/1086.50 = .0814

unfortunately that method is not used among bond traders and while in
the ball park is not a yield to maturity you will ever see quoted. the
next step up the ladder adds a small refinement to the calculation.
while this calculation is more accurate it is also not accurate enough
to be used in trading. the actual formula used in calculating ytm is
quite complex. it begins by recognizing that the gain or loss does not
occur in equal annual installments. ytm is calculated considering each
payment period as a seperate compounding period and calculates a
present value for each. meaning in this case there would be 15
seperate compounding periods to calculate to arrive at a yield to
maturity. the sum of the present values would equal the purchase
price. even then, the most accurate ytm calculations will cause
multiple iterations of the formula until the differences in
calculations become insignificant. that is your yield to maturity.

luckily for those who need to know these things you don't have to know
the formula or sharpen your pencil and do the math. business
calculators are usually programmed top calculate a yield to maturity
or a market price based on a yield to maturity if you have the basic
information. before calculators most bond traders kept books of
printed precalculated tables in front of them. they didn't do the math
either, they just looked it up. as a final aside, bonds in fact do not
trade between dealers based on a dollar price. bonds between dealers
are almost always quoted and traded on a ytm basis and the dollar
price is just a function of that yield.

the problem in the instant case also fails to be specific in its 8%
market quote. while it is usual that the 8% is a ytm, and if
confronted with this question i would consider it as such, the
question in fact fails to specify it as such. so just to overkill this
response, if the 8% is a ytm then the answer is $1173. if the 8% is a
current yield then the price of the bond would be $1250. the 1250
price would consequently push the ytm down to 7.24%.

so, without indication to the contrary i would always assume the 8% is
a ytm. if it is a ytm then the current value of a 10% coupon, $1000
par value bond with 15 years to maturity and an 8% ytm will calculate
to $1173. but all that is way too much work. the answer 1173 was the
only choice based on my second paragraph alone. i believe that simple
concept outlined in that paragraph is the point of this question and
no calculations were expected of you at all.

I teach an econ course, and agree that the answer needs to be 
$1173.  

The accountant had the right idea, he just made a simple mistake when
applying the formula -- as pointed out by elwtee above --
the interest is not $50/yr -- instead it is $50/6-months

The value of the bond is a sum of 1.04^-n * payment at half-year n

It is fairly easy to put all this in a table in excel and add it up.

Potentially, if these are homework problems, learning excel and making
such tables would be a good thing to do.