Exam 8: The Risk Structure of Interest Rates: Defaults, Prepayments, Taxes, and Other Rate-Determining Factors

If the following events happened to Alvernon Way Corporation what is likely to happen to the company's stock price, all other factors held constant?

The yield differential between callable and non-callable securities is normally smallest when interest rates are expected to rise.

Junk bonds have been used to finance mergers.

What does convertibility refer to in Finance? Why are convertibles sometimes called hybrid securities?

What exactly is prepayment risk? What factors lead to an increase in prepayment risk?

Credit swaps are a form of credit derivative.

A 10-year corporate bond issued January 1, 1992 and sold to investors at par ($1,000) with a 10 percent coupon rate is called on January 1, 1995 at par plus one year's coupon income. At time of call prevailing rates on comparable securities were 8 percent. If the bond's holder reinvested the call price at 8 percent for 7 years, what is his 10-year holding-period yield?

A Aaa-rated municipal bond carries a market yield of 5.25 percent today while Aaa-rated corporate bonds have 11.50 percent market yields. What is the break-even tax rate that would make a taxable investor indifferent between these two types of bonds?

Marketability is primarily an advantage to the issuer of new securities.

To the learned observer, it is not surprising that both Moody's and Standard & Poor's often issue the same ratings for a company, since credit ratings are completely objective.

What are credit derivatives? What are their principal advantages and disadvantages?

The floor which, normally, is the lowest value to which a convertible bond can fall is known as the conversion value of that bond.

While an investor in callable bonds does not know exactly when his or her bonds will be called (if ever), he or she does know that the reinvestment rate will be at time of call because this is specified in the bond's indenture.

Please explain the meaning of the phrase default risk. What factors appear to have the most influence upon the degree of default risk displayed by a security, loan or other financial asset?

Orange County's default was most closely associated with trading in risky state and local government bonds.

A risky bond has a market yield of 14.50 percent and the risk-free rate is 9.25 percent. What is the default-risk premium?

Orange County, California in 1994 and 1995 provided an example of marketability risk in its security offerings.