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# Sinking funds and convertible bonds

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1) A sinking fund can be set up in one of two ways. Discuss the advantages and disadvantages of each procedure from the standpoint of both the firm and its bondholders.

2) Through the use of your own example, explain how a convertible bond works.

3) When will a bonds coupon rate, current yield and yield to maturity be equal to one another.

4) When should an issuing firm exercise a call provision on its' outstanding bonds? Why?

5) A stock rights offering allows existing shareholders the opportunity to do what? Why are the existing shareholders given this opportunity?

6) IBM has a bond issue outstanding with 14 years to maturity. When originally issued the bond had a par value of \$1,000, a stated coupon rate of 12% and 15 years to maturity. Currently, similar risk bonds in the market place are yielding 8%. What would you expect IBM's bond to sell for today? Additionally, at such a price is the bond selling at a discount or a premium? Why?

7) You are looking to purchase a zero coupon bond. The bond has 10 years until maturity and you require an 8% annual rate of return. What should you pay for this bond? In the past, what tax advantages did a zero coupon bond offer an investor? How are zero coupon bonds taxed today? That being the case, why buy a zero coupon bond?

8) You just purchased a bond for \$974.42 that matures in 5 Years. The bond was originally issued at par and had an annual coupon rate of 10%. Calculate the current yield and yield to maturity on the bond you just purchased.

9) The term structure of interest rates describes what? In addition, explain the difference between a normal yield curve and an inverted yield curve. Finally, use the expectation theory to explain a normal yield curve and an inverted yield curve.

#### Solution Preview

1) A sinking fund can be set up in one of two ways. Discuss the advantages and disadvantages of each procedure from the standpoint of both the firm and its bondholders.

A sinking fund allows a bond issuer an opportunity to purchase outstanding bonds from bondholders at a set rate with money from a sinking fund from the issuer's earnings and saved specifically for security setbacks. The disadvantage of a sinking fund, doubt will be raised by investors over the bond continuing to pay until its maturity date. An advantage of a sinking fund call is the yield is higher to counter the additional risk associated with holding them (The information was obtained at http://www.investopedia.com/terms/s/sinkingfundcall.asp). The second way to setup a sinking fund call is to call bonds at par (The information was obtained http://books.google.com/books?id=zepGuo84-8AC&pg=PA223&lpg=PA223&dq=two+ways+to+setup+a+sinking+fund+call&source=bl&ots=bm1l8Im7Ep&sig=yO1XU0w-20zQAdlA_BRaVStd1CI&hl=en&sa=X&ei=X9lkUb7dC8SJ2gWdgIGoCQ&ved=0CDYQ6AEwAQ#v=onepage&q=two%20ways%20to%20setup%20a%20sinking%20fund%20call&f=false).

2) Through the use of your own example, explain how a convertible bond works.

A convertible bond is issued by a corporation and can be converted to shares of the issuing company's stock at the bondholder's discretion. Convertible bonds have higher yields than common stock but lower yields than regular corporate binds. ...

#### Solution Summary

Sinking funds and convertible bonds are examined. The bonds coupon rates, current yields, and yields to maturity to equal to one another is determined.

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