Deck 6: Bonds Debtcharacteristics and Valuation

Question 1

Eurocredits are bank loans that are denominated in the currency of a country other than where the lending bank is located.

Answer 1

True

Question 2

Eurobonds are typically issued as registered bonds rather than bearer bonds.

Answer 2

False

Question 3

In general, long-term unsecured debts are less costly than long-term secured debts for a particular firm.

Answer 3

False

Question 4

As junk bonds are such high-risk instruments, the returns on such bonds aren't very high.

Question 5

Issuing zero coupon bonds might appeal to a company that is considering investing in a long-term project that will not generate positive cash flows for several years.

Question 6

Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise.

Question 7

Call provisions on corporate bonds are generally included to protect the issuer against large increases in interest rates. They affect the actual maturity of the bond but not its price.

Question 8

Foreign debt is debt sold in a country other than the one in whose currency the debt is denominated

Question 9

A call provision gives bondholders the right to demand, or "call for," the 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 10

LIBOR is the acronym for London Interbank Offer Rate, which is an average of interest rates offered by London banks to U.S. corporations.

Question 11

One of the disadvantages of issuing zero coupon bonds is that the tax shield associated with the bonds' appreciation cannot be claimed until the bond matures.

Question 12

If a bond is callable and if interest rates in the economy decline, then the company can sell a new issue of low-interest-rate bonds and use the proceeds to "call" the old bonds in and have effectively refinanced at a lower rate.

Question 13

Foreign debt is a debt instrument sold by a foreign borrower that is denominated in the currency of the country in which it is sold.

Question 14

Eurobonds have a higher level of required disclosure than normally applies to bonds issued in domestic markets, particularly in the United States.

Question 15

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

Question 16

The motivation for floating-rate bonds arose out of the costly experience of the early 1980s when inflation pushed interest rates to very high levels, causing sharp declines in the prices of long-term bonds.

Question 17

Restrictive covenants are designed to protect both the bondholder and the issuer even though they may constrain the actions of the firm's managers. Such covenants are contained in the bond's indenture.

Question 18

The financial pages of the local newspaper helped Mary in identifying that she can buy a bond ($1,000 par) for $800. If the coupon rate is 10 percent, the annual interest payments equal $80.

Question 19

Typically, debentures have higher interest rates than mortgage bonds primarily because mortgage bonds are backed by assets while debentures are unsecured.

Question 20

Although common stock represents a riskier investment to an individual than do bonds, bonds represent a riskier method of financing to a corporation than does common stock.

Question 21

A(n) _____ can be exchanged for shares of equity at the owner's discretion.

A) debenture
B) indenture
C) callable bond
D) convertible bond
E) putable bond

Question 22

If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be selling at a discount; i.e., the bond's market price should be less than its face (maturity) value.

Question 23

If there are two bonds with a simple interest rate yield of 9%, and one bond is compounded quarterly while the other bond is compounded monthly, then the bond compounded quarterly will have a higher effective annual yield.

Question 24

Regardless of the size of the coupon payment, the price of a bond moves in the opposite direction to interest rate movements. For example, if interest rates rise, bond prices fall.

Question 25

In the event of liquidation, a(n) _____ has a claim on assets only after the senior debt has been paid off.

A) debenture
B) income bond
C) indenture
D) subordinated debenture
E) mortgage bond

Question 26

A debt backed by some form of specific property is known as a:

A) debenture.
B) mortgage bond.
C) subordinated debt.
D) government bond.
E) term loan.

Question 27

There is an inverse relationship between bond ratings and the required return on a bond. The required return is lowest for AAA rated bonds, and required returns increase as the ratings get lower (worse).

Question 28

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

Question 29

A bond with a $100 annual interest payment and $1,000 face value with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates were greater than 11%.

Question 30

If a bond is selling for less than its face, or maturity, value and the market interest rate remains unchanged during the life of the bond, then the price (value) of the bond will increase as the maturity date nears.

Question 31

Other things held constant, if a bond indenture contains a call provision, the yield to maturity (YTM) on the bond that would exist without such a call provision will be _____ the YTM with the call provision.

A) higher than
B) lower than
C) the same as
D) moving with
E) unrelated to

Question 32

A bond's value will increase with increases in interest rate over time.

Question 33

A bond differs from a term loan in that:

A) a bond issue is negotiated between a financial institution and an investor.
B) a bond is sold to a financial institution only.
C) a bond is offered to the public at a variable coupon rate.
D) a bond has a high issuance cost.
E) a bond involves minimal formal documentation.

Question 34

A bond that only pays interest if the firm has sufficient earnings to cover the interest payments is called a(n):

A) callable bond.
B) putable bond.
C) convertible bond.
D) income bond.
E) indexed bond.

Question 35

A contract that is negotiated directly with a bank and under which the borrower agrees to make a series of interest and principal payments to the bank on specific dates is called:

A) preferred stock.
B) commercial paper.
C) convertible debt.
D) a term loan.
E) a bond issue.

Question 36

The longer the maturity of the bond, the more significantly its price changes in response to a given change in interest rates.

Question 37

The terms and conditions of a bond are set forth in its:

A) debenture.
B) underwriting agreement.
C) indenture.
D) restrictive covenants.
E) call provision.

Question 38

Which of the following is generally considered an advantage of term loans over publicly issued bonds?

A) Higher flotation costs
B) Speed, or how long it takes to bring the issue to the market
C) Fixed bond terms after the bond has been issued
D) Regular interest and principal payments on specified dates
E) Standard terms of issue requiring no negotiation between the borrowing firm and the financial institution

Question 39

Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10 percent currently have a yield to maturity (YTM) equal to 8 percent. Based on this information, it is understood that BB&C's bonds must currently be selling at a premium in the financial markets.

Question 40

A 20-year original maturity bond 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.)

Question 41

The principal value of debt:

A) is added to the interest payments to get the maturity value of the debt.
B) must be repaid at some point during the life of the debt to the investors.
C) is always half of the maturity value of the debt.
D) is equal to the market value of the debt.
E) always yields positive returns for investors.

Question 42

The principal value is also referred to as the maturity value because:

A) it is always repaid at maturity in one installment.
B) it is written on the face of the debt contract.
C) it is repaid at the maturity date.
D) it is added to interest payments to be repaid at the maturity date.
E) it is issued at a value below par value to generate a positive capital gain.

Question 43

The date on which the principal amount of a debt is due is the:

A) maturity date.
B) reinvestment date.
C) issue date.
D) repurchase date.
E) priority date.

Question 44

When the market value of debt is the same as its par value, it is:

A) refinanced at a lower interest rate.
B) a par bond selling at its face value
C) issued at a premium
D) repaid at the maturity date
E) selling at a discount

Question 45

The face value of a debt is:

A) the principal value written on the face, or outside cover, of a debt contract.
B) always equal to the market value of the debt.
C) equal to the principal value minus the interest payments to investors.
D) always greater than the maturity value of the debt.
E) added to the interest payments to find the maturity value of the debt.

Question 46

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

A) An increase in interest rates
B) A decrease in interest rates
C) An increase in the price of outstanding convertible bonds
D) A decrease in call premium
E) An increase in the maturity value of callable bonds

Question 47

Which of the following statements is true about foreign bonds?

A) The interest rate on foreign bonds is annually adjusted for inflation.
B) Foreign bonds are bonds sold in a foreign country and are denominated in the currency of the country in which the issue is sold.
C) Foreign bonds are bonds sold by a foreign borrower but convertible to bonds issued in the foreign country.
D) The term Eurobond specifically applies to any foreign bonds denominated in U.S. dollars.
E) The interest rate on foreign bonds is adjusted annually for exchange rate fluctuations.

Question 48

Which of the following types of investor would be most likely to purchase zero coupon bonds?

A) Retired individuals seeking income for current consumption
B) Individuals in high tax brackets
C) Tax-free investors such as pension funds
D) Risk-averse individuals anticipating increases in interest rates
E) Individuals with no interest income

Question 49

The principal value generally is written on the outside cover of the debt contract, so it is sometimes called the:

A) maturity value.
B) premium value.
C) yield value.
D) face value.
E) discounted value.

Question 50

A bond that can be redeemed for cash at the bondholder's option is called a(n):

A) convertible bond.
B) putable bond.
C) callable bond.
D) debenture.
E) income bond.

Question 51

A debt is said to be selling at par when:

A) investors' required rate of return from debt is equal to the coupon rate.
B) the market rate of return is more than the coupon rate of return.
C) the borrower pays the interest at the maturity of the debt.
D) the current market price of the debt is more than the face value of the debt.
E) the market value is equal to the face value of the debt.

Question 52

For installment loans, the maturity date is:

A) the date on which the last installment payment is due.
B) the date on which the market interest rate rises above the coupon rate.
C) the date on which the coupon rate rises above the market interest rate.
D) the date on which the first installment payment is due.
E) the date on which the last coupon interest payment is made to the bondholders.

Question 53

When the market value of debt is the same as its face value, it is said to be selling at the:

A) yield value.
B) par value.
C) discounted value.
D) premium value.
E) maturity value.

Question 54

The principal value of debt is:

A) the amount added to interest payments to be repaid at the maturity date.
B) the amount owed to the lender.
C) the sum of all interest payments during the life of the debt.
D) the amount of adjustment in the maturity value of the debt due to interest rate fluctuations.
E) the sum of interest and inflation adjusted par value of debt.

Question 55

Which of the following statements is true about a zero coupon bond?

A) A zero coupon bond is taxed as a capital gain at the time the bond matures.
B) A zero coupon bond is issued at a substantial discount below its par value.
C) A zero coupon bond is issued at a coupon rate that adjusts for inflation.
D) The interest received every year on a zero coupon bond is taxed as interest income.
E) The discount on the issue of a zero coupon bond is written off over its life in the investor's financial statement.

Question 56

A debt is said to be selling at par, when the _____ of the debt is equal to the _____.

A) par value; discounted value of the interest payments
B) principal value; discount on the issue of a zero coupon bond
C) face value; premium payment on the exercise of a call provision
D) market value; face value of the debt
E) maturity value; par value of the debt

Question 57

High-risk, high-yield bonds used to finance mergers, leveraged buyouts, and troubled companies are referred to as:

A) callable bonds.
B) junk bonds.
C) convertible bonds.
D) floating-rate bonds.
E) putable bonds.

Question 58

Which of the following bonds pays interest based on an inflation index?

A) Floating-rate bonds
B) Income bonds
C) Treasury bills
D) Purchasing power bonds
E) Zero coupon bonds

Question 59

A bond that pays no annual interest and is sold at a discount below its par value is called a:

A) mortgage bond.
B) callable bond.
C) convertible bond.
D) putable bond.
E) zero coupon bond.

Question 60

Which of the following types of bonds protects a bondholder against increases in interest rates?

A) Floating-rate bonds
B) Income bonds
C) Bonds with call provisions
D) Municipal bonds
E) Mortgage bonds

Question 61

Commercial paper is a type of:

A) promissory note.
B) credit note.
C) debit note.
D) bond indenture.
E) T-bill.

Question 62

When liquidating a traditional certificate of deposit (CD) prior to maturity, the owner:

A) must repay the interest due on the CD.
B) must return it to the issuing institution.
C) must refund the difference in the face value and market value of the CD to the issuing institution.
D) must claim the interest earned by the bank by investing the CD amount.
E) must deposit the amount equivalent to the CD amount in a savings account with the same bank.

Question 63

General obligation bonds are backed:

A) by the revenue generated from the project in which the bond proceeds are invested.
B) by the government's ability to tax its citizens.
C) by the penalty collected from the earlier repayment of a certificate of deposit.
D) by the increase in the coupon rate due to inflation adjustment.
E) by the additional principal received from exchange rate fluctuations.

Question 64

On the maturity date, _____.

A) the maturity value of the debt is to be repaid
B) the first installment of the installment loan is due
C) the interest payment is due
D) the market interest rate rises above the coupon rate
E) the market price of the bond rises above the face value of the debt

Question 65

Commercial paper is issued in denominations of:

A) $10.
B) $100.
C) $1,000.
D) $100,000.
E) $1,000,000.

Question 66

The maturity date is the date:

A) on which the market interest rate equals the coupon rate on a bond.
B) the principal amount of debt is due.
C) on which investors make no capital gain or loss on an investment.
D) the interest payment is due.
E) on which the market value of a bond is more than the face value of the bond.

Question 67

A _____ is assigned to represent the bondholders and to guarantee that the terms of the indenture are carried out.

A) federal government agent
B) trustee
C) liquidator
D) negotiator
E) rating agency

Question 68

Federal funds represent:

A) funds collected from federal tax payment by banks.
B) loans from the federal government to banks.
C) loans from one bank to another bank.
D) funds with banks for the repayment of loans to the federal government.
E) funds collected from investors for investment in federal securities.

Question 69

The maturity of commercial paper varies from:

A) six to twelve months.
B) one to five months.
C) one to nine months.
D) five to ten months.
E) four to eight months.

Question 70

A certificate of deposit represents:

A) a promissory note of payment by a bank borrowing reserves from another bank.
B) a deposit in a savings account in a bank.
C) a promissory note of payment by the issuing institution to the investor.
D) a time deposit of a state government with the federal government.
E) a time deposit at a bank or other financial intermediary.

Question 71

Revenue bonds are used to:

A) raise funds to repay loans borrowed from the federal government.
B) raise funds for projects that will generate revenues.
C) raise funds to pay interest on T-bills issued by the state government.
D) raise funds to repay loans borrowed by the local government.
E) raise funds for projects that require additional funding by increasing tax rates.

Question 72

A(n) _____ certificate of deposit (CD) can be redeemed by whoever owns it at maturity.

A) exchangeable
B) jumbo
C) negotiable
D) mature
E) commercial

Question 73

Municipal bonds are issued by:

A) financial institutions.
B) state and local governments.
C) commercial banks.
D) the federal government.
E) non-governmental organizations.

Question 74

Banks that need additional funds to meet the reserve requirements of the Federal Reserve:

A) borrow from the state government of the state where their headquarters are located.
B) borrow from banks with excess reserves.
C) issue treasury bills to investors.
D) decrease the coupon interest rate on the bonds issued to raise funds.
E) exercise the call option on the loans extended to small businesses.

Question 75

The two principal types of municipal bonds are:

A) general obligation bonds and income bonds.
B) income bonds and putable bonds.
C) revenue bonds and general obligation bonds.
D) floating-rate bonds and indexed bonds.
E) floating-rate bonds and revenue bonds.

Question 76

Banks generally use the federal funds market to:

A) repay loans to investors.
B) adjust their reserves.
C) make interest payments on loans.
D) make security deposits with other banks.
E) repay loans to the federal government.

Question 77

Which of the following is true of a traditional certificate of deposit (CD)?

A) Money in traditional CDs must be kept at the issuing institution for a specified time period.
B) Traditional CDs pay no periodic interest.
C) Traditional CDs are repaid in installments by the issuing bank.
D) Traditional CDs have a floating rate of interest.
E) Traditional CDs are discounted when their market price is more than issue price.

Question 78

Which of the following statements is true about federal funds?

A) Federal funds offer loans at a coupon rate that is two times the market interest rate.
B) Federal funds have very long maturities, often 3 years or more.
C) Federal funds offer loans to the state government to meet the reserve requirements of the federal government.
D) Federal funds are used to repay the T-bills issued by the federal government.
E) Federal funds are used by banks to meet the reserve requirements of the Federal Reserve.

Question 79

Which of the following statements is true about commercial paper?

A) Commercial paper always matures in two months.
B) Commercial paper is issued by bankrupt firms.
C) Commercial paper pays annual interest.
D) Commercial paper is issued at a discount.
E) Commercial paper is issued in denominations of $100.

Question 80

The indentures for publicly traded bonds are approved by:

A) the state government.
B) the Securities and Exchange Commission.
C) the federal government.
D) the Public Company Accounting Oversight Board.
E) the local government.