Reference no: EM132771971

In the midst of World War II, the U.S. government began issuing defense bonds, later calling them war bonds once the country entered the war. Although the citizens who purchased the bonds could have received a better return on their investments elsewhere, they took comfort in knowing that their investment would help with their country's war efforts and there would be a guaranteed return. Even through the deadliest and most costly war in history, people felt assured in the security that was provided through the purchase of bonds. Even today, investors and organizations can rely on the same security that bonds provide. Organizations may also consider the option of issuing bonds in order to raise money for projects and operations. Therefore, it is important for financial managers to understand aspects of bonds, such as how sensitive they are to interest rates and how some features benefit issuers, while others benefit investors.

Problem 1: How are the price and the Yield-to-Maturity (YTM) of a bond related?

Problem 2: What is the main reason why long-term bonds are subject to greater interest rate risk than short-term bonds?

Problem 3: A company is contemplating issuing a bond and is debating whether or not to include a call provision. What are the costs? How do these answers change for a put provision?

Problem 4: How does a company that issues a bond decide on the appropriate coupon rate to set? Also, could you please explain the difference between the coupon rate and the required rate of return on the bond?

Problem 5: Could you then please explain why some bonds sell at a premium over their par value while other bonds sell at a discount? Also, could you please discuss the relationship between the coupon rate and the YTM for premium bonds. What about for discount bonds and bonds selling at par value?

Problem 6: What is the relationship between the current yield and YTM for premium bonds, discount bonds, and bonds selling at par value?