Corporate Finance MGMT 332 Chapter 6
The model that precisely specifies the relationship between the nominal rate and the real rate is:
(1+R) = (1+r)x(1+h)
A corporation issues 50,000 bonds at a face value of $1,000 each. The bonds mature in 5 years and have a coupon rate of 7 percent. What will the total annual interest expense be for the corporation?
50,000 x 1,000 x .07 = $3,500,000
What is a premium bond?
A bond that sells for more than face value
What is a bond's accrued interest?
It is interest that has been earned but not yet received by the current bondholder
What does historical data suggest about the nature of short-term and long-term interest rates?
Sometimes short-term rates are higher and sometimes long-term rates are higher
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
What are the three components that influence the treasury yield curve?
The interest rate risk premium Expected future inflation The real rate of return
Junk bonds have the following features:
They are rated below investment grade bonds
True or false: Long-term debt has maturities greater than one year.
True
True or false: The price you actually pay to purchase a bond will generally exceed the clean price.
True Invoice price = Clean price + Accrued interest
Which three of the following are common shapes for the term structure of interest rates?
Upward sloping; humped; downward sloping
What is a corporate bond's yield to maturity (YTM)?
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.
What are fallen angel bonds?
bonds that have dropped into junk territory
A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a ----.
call provision
A limitation of bond ratings is that they ---.
focus exclusively on default risk. Do not incorporate interest rate risk.
When interest rates in the marker fall, bond values will increase because the present value of the bond's remaining cash flows ---.
increases
If you are in the 20% federal income tax bracket, what is your after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes.
interest income from munis is exempt from federal income tax.
Which of the following are true about bonds?
issued by both corporations and governments; are normally interest-only loans
What does the dirty price represent?
it includes the quoted price and accrued interest
What is the inflation premium?
it is the additional return demanded by investors to compensate for expected inflation
Bonds issued by state and local governments are called
municipal bonds
Which type of debt is given preference in the event of default?
senior
Bond ratings are based on the probability of default risk, which is the risk that ---.
the bond's issuer may not be able make all the required payments
If the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ----.
$1220
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.
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
Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact Treasury bond yields?
Default risk premium - Treasury bonds have no default risk Liquidity premium - Corporate bonds are not liquid; Treasury bonds are highly liquid
Which of the following is NOT a difference between debt and equity?
Equity is publicly traded while debt is not
What ae the two unique features of a US federal government bond?
Exempt from state income taxes Considered to be default-free
True or false: A debenture is a bond secured with collateral.
False
Which three components determine the shape of he term structure of interest rates?
Inflation premium Interest rate risk premium Real interest rate
A zero-coupon bond is a bond that ----.
Makes no interest payments
What are some features of the OTC market for bonds?
OTC dealers are connected electronically The OTC has no designated physical location
Which of the following variables is NOT required to calculate the value of a bond?
Original issue price of bond
The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?
Time to maturity Coupon Rate
When using trial and error to compute the yield to mature (YTM) for a 6% coupon bond that trade at premium, the process can be shortened if the initial guess is --- 6%.
lower than
Equity represents a ---- interest of a firm.
ownership
A part of the indenture limiting certain actions during the term of the loan are termed ---.
protective covenants
What four variables are required to calculate the value of a bond?
Coupon rate; Yield to maturity; Time remaining to maturity; Par value
What is a discount bond?
Discount bonds are bonds that sell for less than the face value.
What is a real rate of return?
It is rate of return that has been adjusted for inflation. It is a percentage change in buying power. Measures changes in buying power.
What is the definition of bond's time to maturity?
It is the number of years until the face value is paid off.
What is the asked price?
It is the price at which a dealer is willing to sell a particular security It is the price at which an investor can buy a particular security from a dealer.
Which of the following are true about a bond's face value?
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 decrease
What is the price of a US Treasury bond that is listed at 90 if the par value is $1,000?
$1,000 x 0% = $900
Suppose a bond's clean price is $1,050, and the bond currently has accrued interest of $30. What is the dirty place?
$1,050 + 30 = $1,080
As an investor in the bond market, why should you be concerned about changes in interest rates?
Changes in interest rates cause changes in bond prices.
Which of these correctly identify differences between US Treasury bonds and corporate bonds?
-Treasury bonds are issued by the US government while corporate bonds are issued by corporations. -Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. - Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer.
If you are holding a municipal bond that is trading at par to yield 6%, by how much will your after-tax yield change if your federal income tax bracket increases from 15% to 20%. Assume there are no state or local taxes.
0%
If you are holding two identical bonds, except the one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?
10-year bond
A bond's coupon payment is
A fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders.
A bond's coupon payment is:
A fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders.
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating.
A firm decides to raise money by issuing 5 million bonds with a par value of $5,000 each for 10 years at a coupon rate of 7 percent. At the time of issue, the bonds were sold for $5,500 each. What will the par value of the bonds be in year 5?
Par value is not affected by interest rates, market price, or time. $5,000 per bond.
What are the cash flows involved in the purchase of a 5-year zero-coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent.
Pay $800 today and receive $1,000 at the end of 5 years Zero coupon bonds do not pay periodic interest.
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
If you are holding 2 bonds - 1 with a 5% coupon rate and the other with a 8% coupon rate - which on is more sensitive to interest rate risk, all other things being equal?
The bond with a 5% coupon rate.
As a general rule, which of the following are true of debt and equity?
The max reward for owning debt is fixed Equity represents an ownership interest
What does the clean price for a bond represent?
The quoted price excluding accrued interest
The term structure of interest rates describes ----?
The relationship between nominal rates and time to maturity. The pure time value of money.
Which of the following are usually included in a bond's indenture?
The repayment arrangements The total amount of bonds issued
What does a Treasury yield curve show?
The yield for different maturities of Treasury notes and bonds
The US government borrows money by issuing:
Treasury notes and bonds
True or False: In general, the price that is paid for a bond will exceed its quoted price.
True
What are the two major forms of long-term debt?
public and private issue
Which of the following are bonds that have actually been issued.
convertible bond; put bond; CoCo bond
What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100 and a coupon interest payment of $100 per year?
coupon rate = 100/1,000 = 10%
A key difference between interest payments and dividend payments is ?
dividends are not tax deductible; interest is tax deductible
Most of the time, a floating-rate bond's coupon adjusts ----.
with a lag to some base rate
