 # Bond Questions

1. Which of the following would result in the lowest cash flow from operating activities over the life of the bond (assume that the bond is paid off at maturity at par, same market yield, same term to maturity)? A. Issuing a bond at par B. Issuing a bond at a premium C. Issuing a bond at a discount D. Issuing a zero-coupon bond -------- 2) Two years ago a frim issued three bonds with ten-year maturities. All three had the same par and all traded at the same yield-to-maturity when they were issued. But, one was issued at a premium, one at par, and one at a discount. Which bond will have the largest liability balance today (two years after issuance)? A. The bond issued at par B. The bond issued at a premium C. The bond issued at a discount D. Recorded liability will be the same for all three ----- 3) Two years ago a firm issued 3 bonds with 10-year maturities. All three had the same par and all traded at the same yield-to-maturity when they were issued. But, one was issued at a premium, one at par, and one at a discount. Which bond will have the largest interest expense for the second year post issuance? A. The bond issued at par B. The bond issued at a premium C. The bond issued at a discount D. Recorded interest expense will be the same for all three

B B C

D, B B

1. D) Zero coupon bond has no coupon so no CFO 2. B) Bond at premium after 2 years will still be at a premium to par, slowly amortizing the premium as you move to maturity 3. B) Bond at premium. Since interest expense is calculated as YTM * liability, and we established in the last question that the bond at the premium will have the higher liability, I’m going to premium.

answer?

Ok the Answers I have are: 1) B - The bond issued at a premium is making a coupon payment above that of any of the other bonds. This coupon is the amount that is reflected in the cash flow from operations. Therefore, premium bonds have the lowest cash flow from operations, relative to other bonds (par, discount, and zero-coupon). Remember, the offset is that premium bonds will have higher cash flows from financing activities 2) B - The net liability recorded for each bond is the bond payable less the unamortized bond discount (or plus premium). Another way to rationalize this is to think of which of the bonds would have raised the most cash at time of issue, which is the premium bond. It will continue to have the largest liability balance until the date all the bonds mature. 3) B - Interest expense is based on the yield-to-maturity times the net book value of the bond (bond payable adjusted for premium or discount). As the net book value of the premium bond is the largest, its interest expense will be the largest.

D, B, B

I dont get why the first one is B!

Zero coupon will have the lowest CFO. And when the bond matures, the CFF will get hit, not CFO. I disagree with the answer B. The correct answer should be Zero coupon bond is best for CFO (infact that’s what firms do, to enhance liquidity ratios, issue zero coupon bonds)

Yea me neither. I was hoping someone here could explain it

If you look at the FSA financial liabilites book, premium bonds have a lower IE then discount bonds, I have no idea how only 2 years into matury the IE on premium would already be higher than discount bonds

pepp, the questions asked what bond would have the lowest CFO, in issuing zero coupon bonds the IE is zero because it does not pay interest. Therefore is has the highest CFO

getterdone Wrote: ------------------------------------------------------- > pepp, the questions asked what bond would have the > lowest CFO, in issuing zero coupon bonds the IE is > zero because it does not pay interest. Therefore > is has the highest CFO Opps… WTF… I got confused here…thanks for the cooperations getterdone! anytime

getterdone Wrote: ------------------------------------------------------- > pepp, the questions asked what bond would have the > lowest CFO, in issuing zero coupon bonds the IE is > zero because it does not pay interest. Therefore > is has the highest CFO I see what you mean. But the question is not very clear then. There would be no interest expense, hence CFO will be highest under zero coupon. I was thinking lowest amount of money being taken out of CFO. TRICKY!!!

I really hate questions about ‘lowest CFO’ and 'highest CFF"… … I always get it screwed up… regarding what they’re looking for…

The third question is also tricky then, Scenario 1 if IE is simply to be taken as book value of liabilities x market rate during issue, then yeah premium bond will have the highest interest since it has the highest of book value hence the answer is B Scenario 2 However, if IE is taken as the Coupon - Amort for premium bond IE is taken as the coupon + Amort for the discount bond, then yeah discount bond will have the highest IE. So please clarify, what measure of IE do you take???

It’s questions like this that make me OVERanalyze all the other questions… Should have taken more English classes in college!

I think you’re safest to default to ‘interest expense’ meaning book value x market rate. That’s how the debt chapter in FSA defines it.

Yeah, I think that a question like this on the actual CFA exam would be worded a little more clearly… I hope anyway.