Irwin Enterprises 12% Each band has 10 years until maturity and has the same ris

Question

Irwin Enterprises 12% Each band has 10 years until maturity and has the same risk. Ther yied to maturity MM) is 9%. Interest rates are assurmed to remain constant over the rext 10 years. Label the curves on the following graph to indicate the peth that band's price, or value, is expected ta follow. BOND VALUE S IrwinY B00 600 YEARS TO MATURITY Based on the preceding information, which of the following statements are true? check all that a The epected capita gains Yield for Johnson's bonds is greater than 12% The bonds have the same expected total return. The expected capital gains yield for Johnson's bonds is negatwe. Irwin's bonds have the highest expected total return. Smith's bonds have exhoited a substantial trading Volume i the past few years.Its bonds would be referred to as a

Explanation / Answer

Before I answer this question, let me explain a basic bond concept - this is relationship between coupon rate, YTM, bond price and par value.

When Coupon rate > YTM of bond, price of bond is higher than the par value of bond. This is a premium bond.

When Coupon rate < YTM of bond, price of bond is lower than the par value of bond. This is a discount bond.

When Coupon rate = YTM of bond, price of bond is equal to the par value of bond

Also, as the bond mover towards maturity, its' price moves towards par value. SO, the value of a premium bond declines, and value of a discount bond increases.

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Now, lets move to answer the question.

YTM is 9%.

Now, for Johnson Inc.,Coupon rate is 12%, higher than YTM. So it is a premium bond, represented by ORANGE LINE (which decreases and moves towards par value as it approaches maturity).

For Smith Metalworks,Coupon rate is 9%, equal to YTM. So it is a bond valued at par, represented by GREEN LINE (which remains constant in value as it approaches maturity)

For Irwin Enterprise,Coupon rate is 6%, lower than YTM. So it is a discount bond, represented by BLUE LINE (which increases and moves towards par value as it approaches maturity).

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Multiple choice question:

Statement 2 and 3 are correct. All the 3 bonds have same expected rate of return which is the YTM.

Also, since Johnson's is a premium bond, its price will decrease as it moves to maturity, so the capital gains yield would be negative.

Statement 1 is false as capital gains yield for any of these bonds would be less than the YTM which is 9% in this question. Statement 4 is false as all 3 bonds have same expected rate of return.

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Fill in the blanks:

Answer is SEASONED ISSUE. the hint is in question which mentions it has been traded in volumes since 'few years', which implies it has been issued earlier and is not a new issue.

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