Deck 4: Bond Valuation

Question 1

Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts interest rate risk to companies, it offers no advantages to issuers.

Answer 1

False
Floating rates can benefit issuers if rates decline, so a company that thinks rates are likely to fall would want to issue such bonds.

Question 2

Which of the following statements is CORRECT?

A) most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature.
B) a sinking fund provision makes a bond more risky to investors at the time of issuance.
C) sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time.
D) if interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.
E) sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued.

Answer 2

E

Question 3

A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if interest rates are below 10% and at a discount if interest rates are greater than 10%.

Answer 3

True

Question 4

Kessen Inc.'s bonds mature in 7 years, have a par value of $1,000, and make an annual coupon payment of $70. The market interest rate for the bonds is 8.5%. What is the bond's price?

A) $923.22
B) $946.30
C) $969.96
D) $994.21
E) $1,019.06

Question 5

Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?

A) adding a call provision.
B) the rating agencies change the bond's rating from baa to aaa.
C) making the bond a first mortgage bond rather than a debenture.
D) adding a sinking fund.
E) adding additional restrictive covenants that limit management's actions.

Question 6

A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond.

Question 7

Nicholas Industries can issue a 20-year bond with a 6% annual coupon. This bond is not convertible, is not callable, and has no sinking fund. Alternatively, Nicholas could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Nicholas would have to pay on the convertible, callable bond?

A) it could be less than, equal to, or greater than 6%.
B) greater than 6%.
C) exactly equal to 8%.
D) less than 6%.
E) exactly equal to 6%.

Question 8

You are considering 2 bonds that will be issued tomorrow. Both are rated triple B (BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10% coupon, neither can be called except for sinking fund purposes, and both are offered to you at their $1,000 par values. However, Bond SF has a sinking fund while Bond NSF does not. Under the sinking fund, the company must call and pay off 5% of the bonds at par each year. The yield curve at the time is upward sloping. The bond's prices, being equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would generally be expected to have a higher yield than Bond NSF.

Question 9

Ranger Inc. would like to issue new 20-year bonds. Initially, the plan was to make the bonds non-callable. If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return?

A) there is no reason to expect a change in the required rate of return.
B) the required rate of return would decline because the bond would then be less risky to a bondholder.
C) the required rate of return would increase because the bond would then be more risky to a bondholder.
D) it is impossible to say without more information.
E) because of the call premium, the required rate of return would decline.

Question 10

You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.

Question 11

The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present.

Question 12

If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.

Question 13

The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.

Question 14

Noncallable bonds that mature in 10 years were recently issued by Sternglass Inc. They have a par value of $1,000 and an annual coupon of 5.5%. If the current market interest rate is 7.0%, at what price should the bonds sell?

A) $829.21
B) $850.47
C) $872.28
D) $894.65
E) $917.01

Question 15

A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells initially) at par. These bonds provide compensation to investors in the form of capital appreciation.

Question 16

Sinking funds are devices used to force companies to retire bonds on a scheduled basis prior to their maturity. Many bond indentures allow the company to acquire bonds for a sinking fund by either purchasing bonds in the market or selecting the bonds to be acquired by a lottery administered by the trustee through a call at face value.

Question 17

For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures.

Question 18

Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds.

Question 19

The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

A) since the bonds have the same ytm, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
B) bond c sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
C) bond a sells at a discount (its price is less than par), and its price is expected to increase over the next year.
D) over the next year, bond a's price is expected to decrease, bond b's price is expected to stay the same, and bond c's price is expected to increase.
E) bond a's current yield will increase each year.

Question 20

A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates.

Question 21

Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?

A) market interest rates rise sharply.
B) market interest rates decline sharply.
C) the company's financial situation deteriorates significantly.
D) inflation increases significantly.
E) the company's bonds are downgraded.

Question 22

A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is NOT CORRECT?

A) the bond's yield to maturity is 9%.
B) the bond's current yield is 9%.
C) if the bond's yield to maturity remains constant, the bond will continue to sell at par.
D) the bond's current yield exceeds its capital gains yield.
E) the bond's expected capital gains yield is positive.

Question 23

If the required rate of return on a bond (rd) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)

Question 24

McCurdy Co.'s Class Q bonds have a 12-year maturity, $1,000 par value, and a 5.75% coupon paid semiannually (2.875% each 6 months), and those bonds sell at their par value. McCurdy's Class P bonds have the same risk, maturity, and par value, but the P bonds pay a 5.75% annual coupon. Neither bond is callable. At what price should the annual payment bond sell?

A) $943.98
B) $968.18
C) $993.01
D) $1,017.83
E) $1,043.28

Question 25

An 8-year Treasury bond has a 10% coupon, and a 10-year Treasury bond has an 8% coupon. Both bonds have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?

A) both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.
B) the prices of both bonds would increase by the same amount.
C) one bond's price would increase, while the other bond's price would decrease.
D) the prices of the two bonds would remain constant.
E) the prices of both bonds will decrease by the same amount.

Question 26

A 25-year, $1,000 par value bond has an 8.5% annual coupon. The bond currently sells for $875. If the yield to maturity remains at its current rate, what will the price be 5 years from now?

A) $839.31
B) $860.83
C) $882.90
D) $904.97
E) $927.60

Question 27

Rogoff Co.'s 15-year bonds have an annual coupon rate of 9.5%. Each bond has face value of $1,000 and makes semiannual interest payments. If you require an 11.0% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

A) $891.00
B) $913.27
C) $936.10
D) $959.51
E) $983.49

Question 28

Assume that a 10-year Treasury bond has a 12% annual coupon, while a 15-year T-bond has an 8% annual coupon. Assume also that the yield curve is flat, and all Treasury securities have a 10% yield to maturity. Which of the following statements is CORRECT?

A) if interest rates decline, the prices of both bonds will increase, but the 10-year bond would have a larger percentage increase in price.
B) the 10-year bond would sell at a discount, while the 15-year bond would sell at a premium.
C) the 10-year bond would sell at a premium, while the 15-year bond would sell at par.
D) if the yield to maturity on both bonds remains at 10% over the next year, the price of the 10-year bond would increase, but the price of the 15-year bond would fall.
E) if interest rates decline, the prices of both bonds will increase, but the 15-year bond would have a larger percentage increase in price.

Question 29

CMS Corporation's balance sheet as of today is as follows:
The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is the current market value of the firm's debt?

A) $5,276,731
B) $5,412,032
C) $5,547,332
D) $7,706,000
E) $7,898,650

Question 30

Which of the following statements is CORRECT?

A) the time to maturity does not affect the change in the value of a bond in response to a given change in interest rates.
B) you hold two bonds. one is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. the same market rate, 6%, applies to both bonds. if the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline.
C) the shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates.
D) the longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates.
E) you hold two bonds. one is a 10-year, zero coupon, issue and the other is a 10-year bond that pays a 6% annual coupon. the same market rate, 6%, applies to both bonds. if the market rate rises from the current level, the zero coupon bond will experience the larger percentage decline.

Question 31

A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?

A) if the yield to maturity remains at 8%, then the bond's price will decline over the next year.
B) the bond's coupon rate is less than 8%.
C) if the yield to maturity increases, then the bond's price will increase.
D) if the yield to maturity remains at 8%, then the bond's price will remain constant over the next year.
E) the bond's current yield is less than 8%.

Question 32

A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?

A) the bond is selling below its par value.
B) the bond is selling at a discount.
C) if the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.
D) the bond's current yield is greater than 9%.
E) if the yield to maturity remains constant, the bond's price one year from now will be higher than its current price.

Question 33

Stephenson Co.'s 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?

A) the bond's current yield exceeds its yield to maturity.
B) the bond's yield to maturity is greater than its coupon rate.
C) the bond's current yield is equal to its coupon rate.
D) if the yield to maturity stays constant until the bond matures, the bond's price will remain at $850.
E) the bond's coupon rate exceeds its current yield.

Question 34

Haswell Enterprises' bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond's price?

A) 1,063.09
B) 1,090.35
C) 1,118.31
D) 1,146.27
E) 1,174.93

Question 35

Which of the following statements is CORRECT?

A) on an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.
B) on an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest.
C) if a coupon bond is selling at par, its current yield equals its yield to maturity.
D) the current yield on bond a exceeds the current yield on bond b; therefore, bond a must have a higher yield to maturity than bond b.
E) if a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity.

Question 36

Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?

A) the prices of both bonds will remain unchanged.
B) the price of bond a will decrease over time, but the price of bond b will increase over time.
C) the prices of both bonds will increase by 7% per year.
D) the prices of both bonds will increase over time, but the price of bond a will increase by more.
E) the price of bond b will decrease over time, but the price of bond a will increase over time.

Question 37

A 15-year bond has an annual coupon rate of 8%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 6%. Which of the following statements is CORRECT?

A) the bond is currently selling at a price below its par value.
B) if market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.
C) the bond should currently be selling at its par value.
D) if market interest rates remain unchanged, the bond's price one year from now will be higher than it is today.
E) if market interest rates decline, the price of the bond will also decline.

Question 38

Which of the following statements is CORRECT?

A) if a bond's yield to maturity exceeds its coupon rate, the bond will sell at par.
B) all else equal, if a bond's yield to maturity increases, its price will fall.
C) if a bond's yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.
D) all else equal, if a bond's yield to maturity increases, its current yield will fall.
E) a zero coupon bond's current yield is equal to its yield to maturity.

Question 39

One year ago Lerner and Luckmann Co. issued 15-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 14 years to maturity?

A) $1,077.01
B) $1,104.62
C) $1,132.95
D) $1,162.00
E) $1,191.79

Question 40

Reinegar Corporation is planning two new issues of 25-year bonds. Bond Par will be sold at its $1,000 par value, and it will have a 10% semiannual coupon. Bond OID will be an Original Issue Discount bond, and it will also have a 25-year maturity and a $1,000 par value, but its semiannual coupon will be only 6.25%. If both bonds are to provide investors with the same effective yield, how many of the OID bonds must Reinegar issue to raise $3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.

A) 4,228
B) 4,337
C) 4,448
D) 4,562
E) 4,676

Question 41

Sentry Corp. bonds have an annual coupon payment of 7.25%. The bonds have a par value of $1,000, a current price of $1,125, and they will mature in 13 years. What is the yield to maturity on these bonds?

A) 5.56%
B) 5.85%
C) 6.14%
D) 6.45%
E) 6.77%

Question 42

Bonds A and B are 15-year, $1,000 face value bonds. Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT?

A) one year from now, bond a's price will be higher than it is today.
B) bond a's current yield is greater than 8%.
C) bond a has a higher price than bond b today, but one year from now the bonds will have the same price.
D) both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.
E) bond b has a higher price than bond a today, but one year from now the bonds will have the same price.

Question 43

Which of the following statements is CORRECT?

A) a callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.
B) corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.
C) two bonds have the same maturity and the same coupon rate. however, one is callable and the other is not. the difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.
D) the actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.
E) two bonds have the same maturity and the same coupon rate. however, one is callable and the other is not. the difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.

Question 44

A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?

A) the bond has a current yield greater than 8%.
B) the bond sells at a discount.
C) the bond's required rate of return is less than 7.5%.
D) if the yield to maturity remains constant, the price of the bond will decline over time.
E) the bond sells at a price below par.

Question 45

Which of the following statements is CORRECT?

A) if a coupon bond is selling at a discount, then the bond's expected capital gains yield is negative.
B) if a bond is selling at a discount, the yield to call is a better measure of the expected return than the yield to maturity.
C) the current yield on bond a exceeds the current yield on bond b. therefore, bond a must have a higher yield to maturity than bond b.
D) if a coupon bond is selling at par, its current yield equals its yield to maturity.
E) if a coupon bond is selling at a premium, then the bond's current yield is zero.

Question 46

Field Industries' outstanding bonds have a 25-year maturity and $1,000 par value. Their nominal yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $850. What is the bond's nominal (annual) coupon interest rate?

A) 6.27%
B) 6.60%
C) 6.95%
D) 7.32%
E) 7.70%

Question 47

Which of the following statements is CORRECT?

A) a bond is likely to be called if its market price is below its par value.
B) even if a bond's ytc exceeds its ytm, an investor with an investment horizon longer than the bond's maturity would be worse off if the bond were called.
C) a bond is likely to be called if its market price is equal to its par value.
D) a bond is likely to be called if it sells at a discount below par.
E) a bond is likely to be called if its coupon rate is below its ytm.

Question 48

Which of the following statements is CORRECT?

A) the total yield on a bond is derived from dividends plus changes in the price of the bond.
B) bonds are riskier than common stocks and therefore have higher required returns.
C) bonds issued by larger companies always have lower yields to maturity (less risk) than bonds issued by smaller companies.
D) the market value of a bond will always approach its par value as its maturity date approaches, provided the bond's required return remains constant.
E) if the federal reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices.

Question 49

Which of the following statements is CORRECT?

A) if a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.
B) if interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.
C) if a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium.
D) if a coupon bond is selling at a premium, its current yield equals its yield to maturity.
E) if a coupon bond is selling at par, its current yield equals its yield to maturity.

Question 50

Currently, Bruner Inc.'s bonds sell for $1,250. They pay a $120 annual coupon, have a 15-year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM.)

A) 2.11%
B) 2.32%
C) 2.55%
D) 2.80%
E) 3.09%

Question 51

Which of the following statements is CORRECT?

A) the market value of a bond will always approach its par value as its maturity date approaches. this holds true even if the firm has filed for bankruptcy.
B) rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices.
C) the yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.
D) on an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.
E) the yield to maturity for a coupon bond that sells at a premium consists entirely of a positive capital gains yield; it has a zero current interest yield.

Question 52

Which of the following statements is CORRECT?

A) all else equal, an increase in interest rates will have a greater effect on the prices of short-term than long-term bonds.
B) all else equal, an increase in interest rates will have a greater effect on higher-coupon bonds than it will have on lower-coupon bonds.
C) if a bond's yield to maturity exceeds its coupon rate, the bond's price must be less than its maturity value.
D) if a bond's yield to maturity exceeds its coupon rate, the bond's current yield must be less than its coupon rate.
E) if two bonds have the same maturity, the same yield to maturity, and the same level of risk, the bonds should sell for the same price regardless of the bond's coupon rates.

Question 53

Perry Inc.'s bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and a par value of $1,000. What is their current yield?

A) 7.39%
B) 7.76%
C) 8.15%
D) 8.56%
E) 8.98%

Question 54

Which of the following statements is CORRECT?

A) a bond's current yield must always be either equal to its yield to maturity or between its yield to maturity and its coupon rate.
B) if a bond sells at par, then its current yield will be less than its yield to maturity.
C) if a bond sells for less than par, then its yield to maturity is less than its coupon rate.
D) a discount bond's price declines each year until it matures, when its value equals its par value.
E) assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. the premium bond must have a lower current yield and a higher capital gains yield than the par bond.

Question 55

Curtis Corporation's noncallable bonds currently sell for $1,165. They have a 15-year maturity, an annual coupon of $95, and a par value of $1,000. What is their yield to maturity?

A) 6.20%
B) 6.53%
C) 6.87%
D) 7.24%
E) 7.62%

Question 56

Which of the following statements is CORRECT?

A) if rates fall after its issue, a zero coupon bond could trade at a price above its par value.
B) if rates fall rapidly, a zero coupon bond's expected appreciation could become negative.
C) if a firm moves from a position of strength toward financial distress, its bonds' yield to maturity would probably decline.
D) if a bond is selling at a premium, this implies that its yield to maturity exceeds its coupon rate.
E) if a coupon bond is selling at par, its current yield equals its yield to maturity.

Question 57

Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, and an 8% yield to maturity. Which of the following statements is CORRECT?

A) bond a trades at a discount, whereas bond b trades at a premium.
B) if the yield to maturity for both bonds remains at 8%, bond a's price one year from now will be higher than it is today, but bond b's price one year from now will be lower than it is today.
C) if the yield to maturity for both bonds immediately decreases to 6%, bond a's bond will have a larger percentage increase in value.
D) bond a's current yield is greater than that of bond b.
E) bond a's capital gains yield is greater than bond b's capital gains yield.

Question 58

Sommers Co.'s bonds currently sell for $1,080 and have a par value of $1,000. They pay a $100 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,125. What is their yield to maturity (YTM)?

A) 8.56%
B) 9.01%
C) 9.46%
D) 9.93%
E) 10.43%

Question 59

Meacham Enterprises' bonds currently sell for $1,280 and have a par value of $1,000. They pay a $135 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,050. What is their yield to call (YTC)?

A) 6.39%
B) 6.72%
C) 7.08%
D) 7.45%
E) 7.82%

Question 60

Gilligan Co.'s bonds currently sell for $1,150. They have a 6.75% annual coupon rate and a 15-year maturity, and are callable in 6 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds, the YTC or the YTM?

A) 3.92%
B) 4.12%
C) 4.34%
D) 4.57%
E) 4.81%

Question 61

Squire Inc.'s 5-year bonds yield 6.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Squire's bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t ? 1) × 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Squire's bonds?

A) 0.49%
B) 0.55%
C) 0.61%
D) 0.68%
E) 0.75%

Question 62

"Restrictive covenants" are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.

Question 63

Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds.

Question 64

Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.

Question 65

Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?

A) a 1-year bond with a 15% coupon.
B) a 3-year bond with a 10% coupon.
C) a 10-year zero coupon bond.
D) a 10-year bond with a 10% coupon.
E) an 8-year bond with a 9% coupon.

Question 66

A bond that had a 20-year original maturity with 1 year left to maturity has more interest rate price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates, and they cannot be called.)

Question 67

Suppose International Digital Technologies decides to raise a total of $200 million, with $100 million as long-term debt and $100 million as common equity. The debt can be mortgage bonds or debentures, but by an iron-clad provision in its charter, the company can never raise any additional debt beyond the original $100 million. Given these conditions, which of the following statements is CORRECT?

A) if the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of debentures.
B) in this situation, we cannot tell for sure how, or whether, the firm's total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. the interest rate on each of the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result might well be such that the firm's total interest charges would not be affected materially by the mix between the two.
C) the higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures.
D) if the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds.
E) the higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm's total dollar interest charges will be.

Question 68

Assume that interest rates on 15-year noncallable Treasury and corporate bonds with different ratings are as follows:
The differences in rates among these issues were most probably caused primarily by:

A) tax effects.
B) default risk differences.
C) maturity risk differences.
D) inflation differences.
E) real risk-free rate differences.

Question 69

5-year Treasury bonds yield 5.5%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year bonds is 0.4%. What is the real risk-free rate, r*?

A) 2.59%
B) 2.88%
C) 3.20%
D) 3.52%
E) 3.87%

Question 70

Which of the following bonds has the greatest interest rate price risk?

A) a 10-year, $1,000 face value, zero coupon bond.
B) a 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
C) all 10-year bonds have the same price risk since they have the same maturity.
D) a 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.

Question 71

Cornwall Corporation is planning to raise $1,000,000 to finance a new plant. Which of the following statements is CORRECT?

A) if debt is used to raise the million dollars, but $500,000 is raised as first mortgage bonds on the new plant and $500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds.
B) if two tiers of debt are used (with one senior and one subordinated debt class), the subordinated debt will carry a lower interest rate.
C) if debt is used to raise the million dollars, the cost of the debt would be lower if the debt were in the form of a fixed-rate bond rather than a floating-rate bond.
D) if debt is used to raise the million dollars, the cost of the debt would be higher if the debt were in the form of a mortgage bond rather than an unsecured term loan.
E) the company would be especially eager to have a call provision included in the indenture if its management thinks that interest rates are almost certain to rise in the foreseeable future.

Question 72

The Gergen Group's 5-year bonds yield 6.85%, and 5-year T-bonds yield 4.75%. The real risk-free rate is r* = 2.80%, the default risk premium for Gergen's bonds is DRP = 0.85% versus zero for T-bonds, the liquidity premium on Gergen's bonds is LP = 1.25%, and the maturity risk premium for all bonds is found with the formula MRP = (t ? 1) × 0.1%, where t = number of years to maturity. What is the inflation premium (IP) on 5-year bonds?

A) 1.40%
B) 1.55%
C) 1.71%
D) 1.88%
E) 2.06%

Question 73

As a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.

Question 74

Chandler Co.'s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Chandler's bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t ? 1) × 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Chandler's bonds?

A) 0.99%
B) 1.10%
C) 1.21%
D) 1.33%
E) 1.46%

Question 75

If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?

A) 1.90%
B) 2.09%
C) 2.30%
D) 2.53%
E) 2.78%

Question 76

Listed below are some provisions that are often contained in bond indentures. Which of these provisions, viewed alone, would tend to reduce the yield to maturity that investors would otherwise require on a newly issued bond?
1) Fixed assets are used as security for a bond.
2) A given bond is subordinated to other classes of debt.
3) The bond can be converted into the firm's common stock.
4) The bond has a sinking fund.
5) The bond has a call provision.
6) The indenture contains covenants that prevent the use of additional debt.

A) 1, 4, 6
B) 1, 2, 3, 4, 6
C) 1, 2, 3, 4, 5, 6
D) 1, 3, 4, 5, 6
E) 1, 3, 4, 6

Question 77

Jerome Corporation's bonds have 15 years to maturity, an 8.75% coupon paid semiannually, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,050. What is the bond's nominal yield to call?

A) 5.01%
B) 5.27%
C) 5.54%
D) 5.81%
E) 6.10%

Question 78

There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower.

Question 79

Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?

A) 20-year, 10% coupon bond.
B) 20-year, 5% coupon bond.
C) 1-year, 10% coupon bond.
D) 20-year, zero coupon bond.
E) 10-year, zero coupon bond.

Question 80

The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant.