Deck 5: Bonds, bond Valuation, and Interest Rates

Question 1

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.

Answer 1

False

Question 2

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.

Answer 2

False
The callable bond will be called if rates fall far enough below the coupon rate,but it will not be called otherwise.Thus,the call provision can only harm bondholders.Therefore,callable bonds sell at higher yields than noncallable bonds,regardless of the slope of the yield curve.

Question 3

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

Answer 3

True

Question 4

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 5

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

Question 6

Junk bonds are high risk,high yield debt instruments.They are often used to finance leveraged buyouts and mergers,and to provide financing to companies of questionable financial strength.

Question 7

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 8

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.

Question 9

If the required rate of return on a bond (r_d)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 10

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 11

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 12

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 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

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 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

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 17

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 18

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 19

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 20

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%.

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

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.

Question 23

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 24

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 25

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

Question 26

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.

Question 27

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 28

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 29

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 30

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 31

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 32

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 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

Which of the following statements is CORRECT?

A) An indenture is a bond that is less risky than a mortgage bond.
B) The expected return on a corporate bond will generally exceed the bond's yield to maturity.
C) If a bond's coupon rate exceeds its yield to maturity, then its expected return to investors exceeds the yield to maturity.
D) Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated.
E) All else equal, senior debt generally has a lower yield to maturity than subordinated debt.

Question 35

If its yield to maturity declined by 1%,which of the following bonds would have the largest percentage increase in value?

A) A 1-year bond with an 8% coupon.
B) A 10-year bond with an 8% coupon.
C) A 10-year bond with a 12% coupon.
D) A 10-year zero coupon bond.
E) A 1-year zero coupon bond.

Question 36

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 37

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 38

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 39

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 40

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 41

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 42

Which of the following statements is CORRECT?

A) If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.
B) Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.
C) If the maturity risk premium (MRP) equals zero, the yield curve must be flat.
D) The yield curve can never be downward sloping.
E) If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the yield curve will have an upward slope.

Question 43

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 44

Bonds A,B,and C all have a maturity of 15 years and a yield to maturity of 9%.Bond A's price exceeds its par value,Bond B's price equals its par value,and Bond C's price is less than its par value.Which of the following statements is CORRECT?

A) Bond A has the most interest rate risk.
B) If the yield to maturity on the three bonds remains constant, the prices of the three bonds will remain the same over the next year.
C) If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline.
D) Bond C sells at a premium over its par value.
E) If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its price.

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

Which of the following statements is CORRECT?

A) A 10-year, 10% coupon bond has less reinvestment rate risk than a 10-year, 5% coupon bond (assuming all else equal).
B) The total return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year.
C) The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10% bond.
D) A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%.
E) 10-year, zero coupon bonds have higher reinvestment rate risk than 10-year, 10% coupon bonds.

Question 47

You are considering three different bonds for your portfolio.Each bond has a 10-year maturity and a yield to maturity of 10%.Bond X has an 8% annual coupon,Bond Y has a 10% annual coupon,and Bond Z has a 12% annual coupon.Which of the following statements is CORRECT?

A) Bond X has the greatest reinvestment rate risk.
B) If market interest rates decline, all of the bonds will have an increase in price, and Bond Z will have the largest percentage increase in price.
C) If market interest rates remain at 10%, Bond Z's price will be 10% higher one year from today.
D) If market interest rates increase, Bond X's price will increase, Bond Z's price will decline, and Bond Y's price will remain the same.
E) If the bonds' market interest rates remain at 10%, Bond Z's price will be lower one year from now than it is today.

Question 48

Which of the following statements is CORRECT?

A) All else equal, long-term bonds have less interest rate price risk than short-term bonds.
B) All else equal, low-coupon bonds have less interest rate price risk than high-coupon bonds.
C) All else equal, short-term bonds have less reinvestment rate risk than long-term bonds.
D) All else equal, long-term bonds have less reinvestment rate risk than short-term bonds.
E) All else equal, high-coupon bonds have less reinvestment rate risk than low-coupon bonds.

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

Which of the following statements is CORRECT?

A) Liquidity premiums are generally higher on Treasury than corporate bonds.
B) The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
C) Default risk premiums are generally lower on corporate than on Treasury bonds.
D) Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.
E) If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.

Question 51

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 52

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 53

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 54

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 55

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 56

Which of the following statements is CORRECT?

A) If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where r_d = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.
B) Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.
C) Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.
D) Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon.
E) If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where r_d = YTM = 5%, the bond would sell at a premium over its $1,000 par value.

Question 57

Which of the following statements is CORRECT?

A) Long-term bonds have less interest rate price risk but more reinvestment rate risk than short-term bonds.
B) If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less interest rate risk.
C) Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more interest rate price risk but less reinvestment rate risk.
D) Long-term bonds have less interest rate price risk and also less reinvestment rate risk than short-term bonds.
E) One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold.

Question 58

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 59

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 60

Which of the following statements is NOT CORRECT?

A) All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.
B) If a bond is selling at its par value, its current yield equals its yield to maturity.
C) If a bond is selling at a premium, its current yield will be greater than its yield to maturity.
D) All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.
E) If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.

Question 61

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 62

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 63

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 64

Which of the following statements is NOT CORRECT?

A) The expected return on a corporate bond must be less than its promised return if the probability of default is greater than zero.
B) All else equal, senior debt has less default risk than subordinated debt.
C) A company's bond rating is affected by its financial ratios and provisions in its indenture.
D) Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off its debt according to the seniority of the debt as spelled out in the Act.
E) All else equal, secured debt is less risky than unsecured debt.

Question 65

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 66

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 67

Which of the following statements is CORRECT?

A) All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required return for bonds of similar risk is 8%.
B) The price of a discount bond will increase over time, assuming that the bond's yield to maturity remains constant.
C) For a given firm, its debentures are likely to have a lower yield to maturity than its mortgage bonds.
D) When large firms are in financial distress, they are almost always liquidated, whereas smaller firms are generally reorganized.
E) The total return on a bond during a given year consists only of the coupon interest payments received.

Question 68

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 69

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 70

Which of the following statements is CORRECT?

A) Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.
B) Once a firm declares bankruptcy, it must then be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and lawyer fees.
C) Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds.
D) A firm with a sinking fund that gave it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.
E) One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the debt until the bonds mature.

Question 71

Which of the following statements is CORRECT?

A) If their maturities and other characteristics were the same, a 5% coupon bond would have more interest rate price risk than a 10% coupon bond.
B) A 10-year coupon bond would have more reinvestment rate risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of reinvestment rate risk.
C) A 10-year coupon bond would have more interest rate price risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of interest rate price risk.
D) If their maturities and other characteristics were the same, a 5% coupon bond would have less interest rate price risk than a 10% coupon bond.
E) A zero coupon bond of any maturity will have more interest rate price risk than any coupon bond, even a perpetuity.

Question 72

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 73

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 74

Which of the following statements is CORRECT?

A) The most likely explanation for an inverted yield curve is that investors expect inflation to increase.
B) The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.
C) If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
D) Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.
E) The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.

Question 75

Assuming all else is constant,which of the following statements is CORRECT?

A) For any given maturity, a 1.0 percentage point decrease in the market interest rate would cause a smaller dollar capital gain than the capital loss stemming from a 1.0 percentage point increase in the interest rate.
B) From a corporate borrower's point of view, interest paid on bonds is not tax-deductible.
C) Price sensitivity as measured by the percentage change in price due to a given change in the required rate of return decreases as a bond's maturity increases.
D) For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (r_d) causes a larger dollar capital loss than the capital gain stemming from a 1.0 percentage point decrease in the interest rate.
E) A 20-year zero coupon bond has more reinvestment rate risk than a 20-year coupon bond.

Question 76

Assume that the current corporate bond yield curve is upward sloping.Under this condition,then we could be sure that

A) The economy is not in a recession.
B) Long-term bonds are a better buy than short-term bonds.
C) Maturity risk premiums could help to explain the yield curve's upward slope.
D) Long-term interest rates are more volatile than short-term rates.
E) Inflation is expected to decline in the future.

Question 77

Bonds for two companies were just issued: Short Corp.'s bonds will mature in 5 years,and Long Corp.'s bonds will mature in 15 years.Both bonds promise to pay a semiannual coupon,they are not callable or convertible,and they are equally liquid.Further,assume that the Treasury yield curve is based only on expectations about future inflation,i.e.,that the maturity risk premium is zero for T-bonds.Under these conditions,which of the following statements is correct?

A) If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield.
B) If the yield curve for Treasury securities is upward sloping, Long's bonds must under all conditions have a higher yield than Short's bonds.
C) If the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as Long's bonds.
D) If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal.
E) If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have the lower yield.

Question 78

Which of the following statements is CORRECT?

A) Subordinated debt has less default risk than senior debt.
B) Convertible bonds have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.
C) Junk bonds typically provide a lower yield to maturity than investment-grade bonds.
D) A debenture is a secured bond that is backed by some or all of the firm's fixed assets.
E) Junior debt is debt that has been more recently issued, and in bankruptcy it is paid off after senior debt because the senior debt was issued first.

Question 79

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 80

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.