Deck 6: Bonds Debt Characteristics and Valuation

Question 1

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

Answer 1

  D

Question 2

_____ bonds are high-risk, high-yield bonds that are often used to finance mergers, leveraged buyouts, and troubled companies. 

A)Callable
B)Junk
C)Convertible
D)Floating-rate
E)Putable

Answer 2

  B

Question 3

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

A)debenture.
B)mortgage bond.
C)subordinated debt.
D)U.S. government bond.
E)general obligation municipal bond.

Answer 3

  B

Question 4

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 always offered to the public at a variable coupon rate.
D)a bond has a higher issuance cost.
E)a bond involves minimal formal documentation.

Question 5

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 6

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)A decrease in the price of outstanding convertible bonds
D)A low call premium
E)A decrease in the call value

Question 7

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 8

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 9

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

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

Question 10

Which of the following statements is true about foreign bonds?

A)The interest rate on foreign bonds is adjusted annually 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 Eurodebt 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 11

A bond that pays no annual interest but 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 12

Which of the following is generally considered an advantage of term loans over corporate 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 13

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 14

A bond that pays interest only when a 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 15

The par 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 16

The par 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.
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 17

A contract that is negotiated directly between a borrowing firm and 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 18

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

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

Question 19

Which of the following types of investors 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 institutional investors such as pension funds
D)Risk-averse individuals anticipating increases in interest rates
E)Individuals with no interest income

Question 20

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

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

Question 21

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

A)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 22

A bond's maturity date is the date on which:

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

Question 23

The maturity of commercial paper varies from:

A)10 to 15 months.
B)two to three years.
C)one to nine months.
D)15 to 18 months.
E)three to five years.

Question 24

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 25

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 held at banks for the repayment of loans to the federal government.
E)funds collected from investors for investment in federal securities.

Question 26

Commercial paper is issued in denominations of:

A)$10 only.
B)$100 or less.
C)$1,000 only.
D)$100,000 or more.
E)$1,000,000 only.

Question 27

Commercial paper is a type of:

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

Question 28

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

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

Question 29

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 30

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 31

For installment loans, the maturity date is:

A)the date on which the last installment repayment of the principal amount 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 32

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 33

A bond's principal value is also referred to as the maturity value because:

A)it is always repaid at a discount prior to the bond's maturity.
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 that are repaid at the maturity date.
E)it is issued at a value below par value to generate a positive capital gain.

Question 34

A debt is said to be selling at par when:

A)investors' required rate of return from debt is greater than 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 35

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 36

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 three 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 37

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 38

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 39

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 40

The principal value of a bond 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 41

A(n) _____ is a provision that facilitates the orderly retirement of a bond issue. 

A)amortization fund
B)depreciation fund
C)redemption fund
D)conversion fund
E)sinking fund

Question 42

A sinking fund call on a bond:

A)requires the company to pay an early-payment penalty to investors.
B)does not require the company to pay a call premium.
C)requires the company to redeem bonds at market price.
D)does not require the company to pay a small percentage of the issue every year.
E)requires the company to claim back all the interest payments from the bondholders.

Question 43

Which of the following is an advantage of convertible bonds?

A)Investors can convert the bonds into higher coupon rate bonds.
B)Investors can choose to hold the company's bonds or convert the bonds into its common stock.
C)Investors are paid a penalty on the conversion of the bonds.
D)Investors are redeemed for the difference between the face value and the market price on redemption of the bonds.
E)Investors can claim interest for the remaining life of the bonds on the bonds' early conversion.

Question 44

A call provision for the redemption of a bond:

A)requires an advance payment of all of the interest that would be paid from the call date until the maturity of the bond.
B)allows the firm to refinance debt.
C)allows the firm to call the bonds for redemption at any time after the bond has been issued.
D)requires the redemption of the bonds at their market price.
E)requires bondholders to convert their bonds into lower coupon rate bonds.

Question 45

General obligation bonds are backed by the:

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

Question 46

Revenue bonds are used to:

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

Question 47

The conversion ratio is:

A)the number of new lower coupon rate bonds that the bondholder receives when old bonds are converted into the newer bonds.
B)the ratio of the face value of the bond to its market value.
C)the number of shares of stock that the bondholder receives upon conversion of a bond.
D)the ratio of the bond's old face value to its new face value.
E)the number of bonds in the company's new project received upon expansion.

Question 48

A bond sinking fund provision requires a firm to:

A)issue bonds every year to finance interest payment on bonds.
B)retire a portion of the bond issue each year.
C)increase the coupon rate by one percent every year.
D)use annual interest payments for the repayment of bonds.
E)gradually reduce the face value of debt to the level of market value of debt.

Question 49

Which of the following ratings by Standard & Poor's (S&P) is given to speculative bonds with extremely high credit risk?

A)A
B)B
C)BB
D)BBB
E)CCC

Question 50

The credit rating assigned to a bond reflects the probability that:

A)the bond's face value will increase above its market value.
B)the bond will go into default.
C)the company will earn extremely high returns on its bond's sinking fund investments.
D)the bond's maturity value will become lower than its principal value.
E)the firm will exercise a call provision on the bond.

Question 51

The conversion feature of a bond permits a:

A)company to convert a high coupon rate bond into a lower coupon rate bond.
B)bondholder to exchange his or her bonds for the company's common stock.
C)bondholder to redeem a small percentage of the bond every year.
D)company to convert the face value of the bond to the market price of the bond.
E)company to trade outstanding bonds with a term deposit in a financial institution.

Question 52

Which of the following ratings by Moody's is given to the bonds of companies that have the best credit risk?

A)Caa
B)Aaa
C)B
D)Ba
E)A

Question 53

A(n) _____ certificate of deposit (CD) can be traded to other investors prior to maturity. 

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

Question 54

The two principal types of municipal bonds are:

A)general obligation bonds and indexed 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 55

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 56

A certificate of deposit represents:

A)a promissory note of payment by a bank that borrows reserves from another bank.
B)a deposit in a checking 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 57

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.

Question 58

The Securities and Exchange Commission is required to verify that:

A)the coupon rate of debt is more than the market interest rate.
B)all previous indenture provisions have been met before allowing a company to sell new securities to the public.
C)the market price of debt is more than the principal value of debt.
D)the face value of debt is more than the maturity value of debt.
E)the new securities to be sold to the public have a higher coupon rate than all previous security issues.

Question 59

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 60

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 61

Per Standard & Poor's Corporation (S&P), a bond whose rating is BBB is considered:

A)a junk bond with low investment risk.
B)high quality with zero investment risk.
C)investment grade with medium investment risk.
D)substandard with high investment risk.
E)speculative with extremely high investment risk.

Question 62

Assume that an investor wishes to purchase a 20-year bond with a maturity value of $1,000 and semiannual interest payments of $40. If the investor requires a 10 percent simple yield to maturity on this investment, what is the maximum price she should be willing to pay for the bond?

A)$830
B)$674
C)$761
D)$828
E)$902

Question 63

Emily is contemplating the purchase of a 20-year bond that pays $50 interest every six months. The face value of the bond is $1,000. She plans to hold the bond for 10 years and sell it. She requires a 12 percent annual return but believes that the market will give only an 8 percent return when she sells the bond 10 years from now. Assuming she is a rational investor, how much should she be willing to pay for the bond today?

A)$1,126.85
B)$885.30
C)$737.50
D)$927.68
E)$856.91

Question 64

The greater a bond's default risk, the greater the:

A)maturity value of the bond.
B)chance the firm will exercise the call provision on the bond.
C)interest rate stability of the bond in the long run.
D)investment in the bond by risk-averse investors.
E)default risk premium (DRP) associated with the bond.

Question 65

The ratings of a firm's bonds are based on:

A)the firm's ratio of current liabilities to total assets.
B)the dividends paid in the last year by the firm.
C)the earnings per share of the shareholders of subsidiary firms.
D)exchange rate fluctuations of the U.S Dollar and Euro.
E)no precise formula.

Question 66

Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If an investor requires a simple annual rate of return of 12 percent with quarterly compounding, how much should the investor be willing to pay for this bond?

A)$1,204.33
B)$1,207.57
C)$986.43
D)$1,089.53
E)$438.10

Question 67

Rick bought a bond when it was issued by Macroflex Corporation 14 years ago. The bond, which has a $1,000 face value and a coupon rate equal to 10 percent, matures in six years. Interest is paid every six months; the next interest payment is scheduled for six months from today. Assuming the yield on similar risk investments is 14 percent, calculate the current market value (price) of the bond. 

A)$841.15
B)$1,238.28
C)$904.67
D)$757.26
E)$844.45

Question 68

JRJ Corporation issued 10-year bonds at a price of $1,000. These bonds pay $60 interest every six months. Their price has remained the same since they were issued; that is, the bonds still sell for $1,000. Due to additional financing needs, the firm wishes to issue new bonds that would have a maturity of 10 years and a par value of $1,000 and pay $40 interest every six months. If both bonds have the same yield, how many new bonds must JRJ issue to raise additional capital of $2 million? Fractions of bonds cannot be issued. (Round the number of bonds to the nearest whole number.)

A)2,404
B)2,596
C)3,073
D)5,282
E)4,275

Question 69

Because a bond's rating serves as an indicator of its default risk, the rating has a direct, measurable influence on the firm's:

A)earnings per share and thus the dividends it pays each year.
B)cost of using such debt and thus the bond's interest rate.
C)ability to procure raw material for production.
D)tax liability to the federal government.
E)current assets and the bond's maturity value.

Question 70

Devine Divots issued a bond a few years ago. The bond has a face value equal to $1,000 and pays investors $30 interest every six months. The bond has eight years remaining until maturity. If an investor requires a 7 percent rate of return to invest in this bond, what is the maximum price the investor should be willing to pay to purchase the bond?

A)$761.15
B)$939.53
C)$940.29
D)$965.63
E)$1,062.81

Question 71

Recently, Ohio Hospitals Inc. filed for bankruptcy. The firm was reorganized as American Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue of face value $1,000 to be put into effect. The issue has 10 years to maturity and a coupon rate of 10 percent, paid annually. The new agreement allows the firm to pay no interest for five years. Then, interest payments will be resumed for the next five years. Finally, at maturity (Year 10), the principal plus the interest that was not paid during the first five years will be paid. However, no interest will be paid on the deferred interest. If the required return is 20 percent, what should the bonds sell for in the market today?

A)$242.26
B)$281.69
C)$578.31
D)$362.44
E)$813.69

Question 72

Lower-rated bonds offer higher returns than higher-grade bonds because their:

A)coupon interest rates steadily increase throughout their lives.
B)risks are higher.
C)maturity values are higher than their market values.
D)returns are attractive to risk-averse investors.
E)returns are tax free.

Question 73

A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If an investor's simple annual required rate of return is 12 percent, how much should the investor be willing to pay for this bond?

A)$941.36
B)$1,051.25
C)$1,115.57
D)$1,391.00
E)$1,113.00

Question 74

Changes in a firm's bond rating affect its ability to:

A)claim deductions in tax liability computation.
B)procure raw material in sufficient quantity for manufacturing processes.
C)increase the coupon rate on bonds issued to investors.
D)borrow long-term capital as well as the cost of such funds.
E)exercise a call provision on its bonds.

Question 75

The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond is paid every six months, and the simple annual yield is 14 percent. From the given information, calculate the annual coupon rate on the bond. 

A)10%
B)12%
C)14%
D)17%
E)21%

Question 76

If Standard & Poor's ratings of a firm's bonds is below BBB, the _____. 

A)firm will find it difficult to find potential investors when issuing new bonds
B)default risk premium associated with the bonds will be less than the risk premium associated with bonds rated AAA
C)firm will easily find investors when issuing new bonds because bonds with high yields have no risk associated with them
D)default risk associated with the bonds is less than that of bonds that are rated AAA
E)firm will immediately have to exercise the call provision and issue new bonds

Question 77

Cold Boxes Corporation has 100 bonds outstanding with a maturity value of $1,000. The required rate of return on these bonds is currently 10 percent, and interest is paid semiannually. The bonds mature in 5 years, and their current market value is $768 per bond. Which of the following is the annual coupon interest rate?

A)8%
B)6%
C)4%
D)2%
E)0%

Question 78

Tony's Pizzeria plans to issue bonds with a par value of $1,000 and 10 years to maturity. These bonds will pay $45 interest every 6 months. Current market conditions are such that the bonds will be sold at net $937.79. What is the yield to maturity (YTM) of the issue as a broker would quote it to an investor?

A)11%
B)10%
C)9%
D)8%
E)7%

Question 79

An investor just purchased a 10-year, $1,000 par value bond. The coupon rate on this bond is 8 percent annually, with interest being paid every six months. If the investor expects to earn a 10 percent simple rate of return on this bond, how much should the investor pay for it?

A)$1,122.87
B)$1,003.42
C)$875.38
D)$950.75
E)$877.11

Question 80

Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest being paid semiannually. The face value of the bond is $1,000. The required simple rate of return on this debt has now risen to 16 percent. What is the current value of this bond?

A)$1,273
B)$554
C)$7,783
D)$550
E)$450