Chapter 6a Smartbook

When interest rates in the market rise, we can expect the price of bonds to ______.

decrease

Debt cannot be subordinated to ____

equity

True or false: The higher the coupon rate, the greater the interest rate risk, all other things being equal.

F

ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?

$60 in interest at the end of each year for 10 years and a $1,000 repayment of principal at the end of 10 years

What is a premium bond?

A bond that sells for more than face value

A bond's ________ payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders.

Coupon

If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ______ $1,000.

less than

What is a discount bond?

Discount bonds are bonds that sell for less than the face value.

Junk bonds have the following features:

They are rated below investment grade bonds.

What is the definition of a bond's time to maturity?

What is the definition of a bond's time to maturity?

What is a corporate bond's yield to maturity (YTM)? Multiple select question. YTM is the prevailing market interest rate for bonds with similar features. YTM is the expected return for an investor who buys the bond today and holds it to maturity. YTM is the yield that will be earned if the bond is sold immediately in the market. YTM is another term for the bond's coupon rate.

YTM is the prevailing market interest rate for bonds with similar features. YTM is the expected return for an investor who buys the bond today and holds it to maturity.

If a bond is selling at a discount from its par value, the YTM must be ______ the coupon rate.

greater than

A bond with a BB rating has a ______ than a bond with a BBB rating.

higher risk of default

When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ______.

increases

The degree of interest rate risk depends on ______.

the sensitivity of the bond's price to interest rate changes

What does a bond's rating reflect?

the ability of the firm to repay its debt and interest on time

The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables? Multiple select question. par value time to maturity bond rating coupon rate

time to maturity coupon rate

If a $1,000 par value bond is trading at a premium, the bond is:

trading for more than $1,000 in the market.

A debenture is a(n) ______ bond, for which no specific pledge of property is made.

unsecured

True or false: All else being equal, a 1-year bond's price is less sensitive to interest rate changes as compared to that of a 10-year bond's price.

T

True or false: Longer-term bonds have greater interest rate sensitivity because a large portion of a bond's value comes from the face amount.

T

If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?

The 10-year bond.

If you are holding two bonds—one with a 5 percent coupon rate and the other with an 8 percent coupon rate—which one is more sensitive to interest rate risk, all other things being equal?

The bond with a 5 percent coupon rate.

True or false: Low-grade bonds may not be rated by major rating agencies.

T

Bond ratings are based on the probability of default risk, which is the risk that ______.

the bond's issuer may not be able to make all the required payments

Which of the following is not a difference between debt and equity? Multiple choice question. Equity represents ownership interest, while debt does not. Equity is publicly traded, while debt is not. Unlike dividend omissions to equity holders, unpaid debt obligations can lead to bankruptcy. A corporation's interest payments on debt are tax deductible, but the dividends it pays to equity holders are not.

Equity is publicly traded, while debt is not.

True or false: A debenture is a bond secured with collateral.

F

Which of the following are true about a bond's face value? Multiple select question. It is the principal amount repaid at maturity. It is also known as the par value. A bond's face value is the same for all corporations. It is the market value of the bond at the time of maturity.

It is the principal amount repaid at maturity. It is also known as the par value.

What will happen to a bond's time to maturity as the years go by?

It will decline.

The bonds of a firm in financial distress may have a market value that is ________than the face value at maturity. (Enter only one word per blank.)

Less

What does the AAA rating assigned by S&P mean?

The firm is in a strong position to meet its debt obligations.

As a general rule, which of the following are true of debt and equity? Multiple select question. The maximum reward for owning debt is fixed. Creditors generally have voting power. Debt and equity represent the same financial claims. Equity represents an ownership interest.

The maximum reward for owning debt is fixed. Equity represents an ownership interest.

Which of the following are true of bonds? Multiple select question. They are normally interest-only loans. They are issued by both corporations and governments. Bond principal does not have to be repaid.

They are normally interest-only loans. They are issued by both corporations and governments.

A bond's coupon payment is:

a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders.

To find the total bond value, add the present value of the amount paid at maturity to the ______ of the annual coupon payments.

annuity present value

A corporate bond's yield to maturity: Multiple select question. changes over time. is usually not the same as a bond's coupon rate. is always equal to a bond's coupon rate. remains fixed over the life of the bond.

changes over time. is usually not the same as a bond's coupon rate.

A key difference between interest payments and dividend payments is: Multiple select question. interest is not tax deductible. dividends are not tax deductible. interest is tax deductible. dividends are tax deductible.

dividends are not tax deductible. interest is tax deductible.

When using trial and error to compute the yield to maturity (YTM) for a 6 percent coupon bond that trades at a premium, the process can be shortened if the initial guess is ______ 6 percent.

lower than

Which one of the following is the most important source of risk from owning bonds?

market interest rate fluctuations

Which of the following variables is not required to calculate the value of a bond?

original issue price of bond

Equity represents a(n) _____ interest of a firm

ownership

Which of the following terms apply to a bond? Multiple select question. dividend yield par value time to maturity coupon rate

par value time to maturity coupon rate

What four variables are required to calculate the value of a bond? Multiple select question. par value yield to maturity coupon rate time remaining to maturity Price at the time of bond issue

par value yield to maturity coupon rate time remaining to maturity

Which type of debt is given preference in the event of default?

senior