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1. Consider a convertible bond that is trading at a conversion premium of 20 percent. If the
value of the underlying stock rises by 25 percent, the value of the bond will:
A. rise by less than 25%.
B. rise by 25%.
C. rise by more than 25%.
D. remain unchanged.
Correct answer: A
The convertible bond implicitly gives bondholders a call option on the underlying stock.
The delta of this option will vary between 0 (when the option is extremely out of the
money) and 1 (when the option is extremely in the money). In this case, the bond is trading
at a conversion premium of 20% so the delta must be somewhere between zero and one,
and hence the price of the convertible bond will rise by less than the price of the
underlying stock.
2. If a cash flow of $10,000 in two years time has a PV of $8,455, the annual percentage rate,
assuming continuous compounding is CLOSEST to:
A. 8.13%.
B. 8.39%.
C. 8.75%.
D. 8.95%.
Correct answer: B
Continuously compounded rate = ln(FV/PV)/N = ln(10000 / 8455) / 2 = 8.39%.
3. The current values of a firms assets and liabilities are 200 million and 160 million
respectively. If the asset values are expected to grow by 40 million and liability values by
30 million within a year and if the annual standard deviation of these values is 50 million,
the distance from default in the KMV model would be closest to:
A. 0.8 standard deviations.
B. 1.0 standard deviations.
C. 1.2 standard deviations.
D. Cannot not be determined.
Correct answer: B
Distance from default = (Expected value of assets - Expected value of liabilities) /
Standard deviation = (240 - 190)/50 = 1.0.
4. What is the semiannual-pay bond equivalent yield on an annual-pay bond with a yield to
maturity of 12.51 percent?
A. 12.00%.
B. 11.49%.
C. 12.51%.
D. 12.14%.
Correct answer: D:
The semiannual-pay bond equivalent yield of an annual-pay bond = 2 * [(1 +
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