CFA Practice Question

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CFA Practice Question

A three-year, annual-pay, 5% coupon bond with par value \$1,000 currently sells for \$975. A three-year, annual-pay, step-up bond with scheduled coupon rates of 5%, 5.5% and 6% is also available from the same bond issuer.

A. The price of \$1,000 par value of the step-up bond is greater than \$975.
B. The price of \$1,000 par value of the step-up bond is less than \$975.
C. The price of \$1,000 par value of the step-up bond is equal to \$975.

The price of the step-up bond will be greater because the promised cash flows are greater.

User Comment
mtcfa This assumes that both bonds are of identical risk.
Eglovismenos They are issued by the same issuer, so it is a fact that both bonds have the same risk and not an assumption
shawnryu what if step up bond is so risk bond as CMO, CDO and so on despite the same issuer.
nike If not given you should assume the risk is the same. Don't think too much.
fedha good point nike
antihead 50 * 1,0593 ^-1 + 55 * 1,0593 ^ -2 + 60 * 1,0593 ^-3 + 1000 * 1,0593 ^-3 = 987, 95 (rounded).
hyperinflation oh my gosh people... STOP OVER-ANALYZING.
gulfa99 there is no need for caculation. bonds are normally issued at par and the question is not referring to zero coupon bond. so 1000 is greater than 975 simple.
johntan1979 Yet another wrong assumption from gulfa99.

The price of the step up bond is greater because of the higher promised cash flows. If the 3 rates had been anything less than 5%, then it won't be greater.
gill15 I wonder if Gulfa passed. Maybe he'll use his assumptions and luckily be right and breeze through the exams.
CJPerugini Step up bonds are often times callable by the firm, making them more risky than a traditional bond. Increased risk = decreased bond price
Inaganti6 Comments are dangerous. Way too many people pontificating without enough basis the confidence and adamance is almost arrogant .
sshetty2 Bonds with coupon payments, in general, bear less interest rate risk and therefore are sold with a lower risk premium