Chapter 7 PP

39) Fred and Ethel are both considering buying a corporate bond with a coupon rate of 8%, a face value of $1,000, and a maturity date of January 1, 2025. Which of the following statements is MOST correct? A) Because both Fred and Ethel will receive the same cash flows if they each buy a bond, they both must assign the same value to the bond. B) If Fred decides to buy the bond, then Ethel will also decide to buy the bond C) Fred and Ethel will only buy the bonds if the bonds are rated BBB or above implying low default risk. D) Fred may determine a different value for a bond than Ethel because each investor may have a different level of risk tolerance, and hence a different required return.

D

16) If two bonds have the same yield to maturity, they also have the same current yield.

F

4) In general, interest on bonds may be deferred until a later date at the discretion of management, making debt financing more appealing to corporate managers.

F

7) Debentures are expected to have a lower yield than secured bonds because the debentures are more risky and therefore less desirable.

F -debentures are riskier-->>Higher yield

5) Other things held equal, a bond with a call provision is worth more to investors than a bond without a call provision.

F -worth more to issuing firm

42) For the same bond above (Break and Crack), say the market interest rate is 13%, do you think the firm would call away the bond? Why/Why not?

No, it is advantageous for a firm to to call a bond if interest rates fall well below the coupon rate

1) Subordinated debentures are more risky than unsubordinated debentures because the claims of subordinated debenture holders are less likely to be honored in the event of liquidation.

T

10) The par value of a corporate bond indicates the payment that the issuer promises to make to the bondholder at maturity

T

11) If a bond sells for its par value, the coupon interest rate and yield to maturity are equal.

T

12) To determine the periodic interest payments that a bond makes, multiply the bond's stated coupon rate by its par value and divide by the number of coupon payments per year.

T

13) Unlike market value, the intrinsic value of an asset is estimated independently of risk.

T

14) Junk bonds are also called high-yield bonds.

T

15) The expected yield on junk bonds is higher than the yield on AAA-rated bonds because of the higher default risk associated with junk bonds.

T

17) Market value of a bond is expected to be higher than its liquidation value.

T

18) A common protective provision in a bond indenture is the limitation of dividends on the issuing firm's common stock.

T

19) A firm's bond rating would be favorably affected if they have low financial leverage (debt).

T

2) Convertible bonds are debt securities that can be converted into a firm's stock at a prespecified price.

T

3) A mortgage bond is secured by a lien on real property.

T

6) Bonds generally have a maturity date while preferred stocks do not.

T

8) The value of a bond is inversely related to changes in the investor's present required rate of return.

T

9) If a bond has a market value that is higher than its par value, then the required return on the bond must be less than the bond's coupon rate.

T

34) You want to invest in bonds. Explain whether or not each provision listed will make the bonds more or less desirable as an investment: call provision, convertible bond provision, or subordinated debt

investment: call provision, -->less convertible bond provision, or -->more subordinated debt-->less

43) For the same bond above (Break and Crack), say the market interest rate is 7%, do you think the firm would call away the bond? Why/Why not?

yes, firm can "refinance" bond

20) Which of the following bond provisions will make a bond more desirable to investors, other things being equal? A) The bond is convertible. B) The bond is callable. C) The coupon rate is lower. D) The bond is subordinated.

A

21) Progressive Corporation issued callable bonds. The bonds are most likely to be called if A) interest rates decrease. B) interest rates increase. C) Shafer Corporation needs additional financing. D) Shafer Corporation's stock price increases dramatically.

A

31) The interest on corporate bonds is typically paid A) semiannually. B) annually. C) quarterly. D) monthly.

A

45) Which of the following is true of a zero coupon bond? A) The bond makes no coupon payments. B) The bond sells at a premium prior to maturity. C) The bond has a zero par value. D) The bond has no value until the year it matures because there are no positive cash flows until then.

A

47) While checking the Wall Street Journal bond listings you notice that the price of an AT&T bond is the same as the price of a K-Mart bond. Based on this information you know that A) the bond with the lower coupon rate will have the lower current yield. B) both bonds have the same yield to maturity. C) both bonds will have the same bond rating. D) the bond with the longest time to maturity will have the highest yield to maturity.

A

25) If a firm were to experience financial insolvency, the legal system provides an order of hierarchy for the payment of claims. Assume that a firm has the following outstanding securities: mortgage bonds, common stock, debentures, and preferred stock. Rank the order in which investors that own mortgage bonds would have their claim paid? A) first B) second C) third D) fourth

A 1- mortgage bonds 2- debentures 3- preferred stock 4- common stock

29) Assume that Bunch Inc. has an issue of 18-year $1,000 par value bonds that pay 7% interest, annually. Further assume that today's expected rate of return on these bonds is 5%. How much would these bonds sell for today? Note: Payments are made annually on this bond. A) $1,233.79 B) $1,201.32 C) $1,134.88 D) $1,032.56

A N=18 PMT= (.07 x 1000)=70 i/y=5 FV=1000 ======================= PV= -1,233.79

24) If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, everything else equal (such as coupon rate, maturity, etc.) which would sell for the greatest price? A) the debenture B) the mortgage bond C) the subordinated debenture D) All of the above types of bonds would sell for the same price

B -Mortgage bond is least risky--> lower required ROR--> higher price

26) The Johnson Corporation issues a bond which has a coupon rate of 10.20%, a yield to maturity of 10.55%, a face value of $1,000, and a market price of $850. Therefore, the annual interest payment is A) $101.75. B) $102. C) $105.50. D) $120.0.

B PMT= (.1020 x 1000)=102

22) Which of the following statements is true regarding convertible bonds? A) The holder has the right to sell these bonds back to the issuer if the bonds don't perform well. B) The holder can convert these bonds into an equal number of new bonds if they choose to do so. C) These bonds are convertible into common stock of the issuing firm at a prespecified price. D) Each bond will be converted into a stock at the par value of the bond.

C

27) Which of the following is FALSE concerning bonds? A) The claim of shareholders get paid last. B) Mortgage bonds are secured by assets such as real estate. C) Debentures are secured by specific assets other than real estate. D) Subordinated debentures are riskier than unsubordinated debentures.

C

28) The present value of the expected future cash flows of an asset represents the asset's A) liquidation value. B) book value. C) price/intrinsic value. D) par value

C

38) In the present value bond valuation model, risk is generally incorporated into the A) maturity amount. B) timing of cash flows (assuming more risky cash flows are received early). C) discount rate or required return. D) cash flows (making some smaller if they are more risky).

C

48) Speculative, or non-investment-grade, bonds have an S&P bond rating of A) C or less. B) CCC or less. C) BB or less. D) BBB or less

C

50) Charlie Corporation has two bonds outstanding. Both bonds mature in 10 years, have a face value of $1,000, and have a yield to maturity of 8%. One bond is a zero coupon bond and the other bond has a coupon rate of 8%. Which of the following statements is true? A) Both bonds must sell for the same price if markets are in equilibrium. B) The zero coupon bond must have a higher price because of its greater capital gain potential. C) The zero coupon bond must sell for a lower price than the bond with an 8% coupon rate. D) All rational investors will prefer the 8% bond because it pays more interest.

C -because of the timing of the "interest payments"

23) If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, which would have the highest yield to maturity, everything else equal? A) the debenture B) the mortgage bond C) the subordinated debenture D) all of the above

C -subordinated debenture is most risky