FINA 4310 Exam 2

The duration of a 5-year zero-coupon bond is ________ years.

5 years

Which of the following is not a true statement regarding municipal bonds? The interest income from a municipal bond is exempt from federal income taxation. A municipal bond is a debt obligation issued by the federal government. The interest income from a municipal bond is exempt from state and local taxation in the issuing state. A municipal bond is a debt obligation issued by state or local governments.

A municipal bond is a debt obligation issued by the federal government.

Bonds rated ________ or better by Standard & Poor's are considered investment grade.

BBB

Bonds issued in the currency of the issuer's country but sold in other national markets are called ________.

Eurobonds

A collateralized bond is commonly referred to as a debenture.

False

For bonds selling at a premium, the Current Yield is always greater than the Coupon Rate.

False

If bond A ranks pari-passu with bond B that means that in bankruptcy bond A will be paid before bond B.

False

Walmart issuing a bond denominated in Yen to investors outside Japan would be called a Eurobond and would not be considered a foreign bond and would not be nicknamed a Samurai.

False

Convexity implies that duration predictions: I. Underestimate the percentage increase in bond price when the yield falls. II. Underestimate the percentage decrease in bond price when the yield rises. III. Overestimate the percentage increase in bond price when the yield falls. IV. Overestimate the percentage decrease in bond price when the yield rises.

I and IV only

You have an investment horizon of 6 years. You choose to hold a bond with a duration of 6 years and continue to match your investment horizon and duration throughout your holding period. Your realized rate of return will be the same as the promised yield on the bond if: I. Interest rates increase. II. Interest rates stay the same. III. Interest rates fall.

I, II, and III

To earn a high rating from the bond rating agencies, a company would want to have: I. A low EBITDA/Interest ratio II. A low debt-to-equity ratio III. A high quick ratio

II and III only

Market economists all predict a rise in interest rates. An astute bond manager wishing to maximize her capital gain might employ which strategy?

Switch from high-duration to low-duration bonds

Inflation-indexed Treasury securities are commonly called ________.

TIPS

A BMW USD-denominated corporate bond sold in the U.S., i.e. to investors based in the U.S., would be referred to as a foreign bond and nicknamed a Yankee

True

All else the same, longer maturity bonds are more sensitive to changes in the market interest rate than shorter maturity bonds.

True

Bonds issued by subsidiaries that are Senior obligations could be considerded structurally subordinated if the issue is not fully guaranteed by the Holding Company.

True

Convexity describes the characteristic of a bond to have a larger %-age gain when interest rates move down 1 %-age point than the %-age loss which that same bond would experience for a 1 %-age point rise in interest rates.

True

Default Premium and Credit Spread are synonyms for the differential in yield between corporate and Treasury bonds.

True

If the Liquidity Preference hypothesis of the term structure of interest rates is correct then a totally flat yield curve (horzontal) will signal falling short term interest rates in future.

True

Non-investment grade bonds typically have a Total Debt / EBITDA multiple of 3.5x or higher.

True

The Negative Pledge debt covenant is always in reference to any future borrowings of the issuer

True

The pure Expectation Hypothesis of the yield curve says that forward rates implied by the shape of the yield curve are the truly expected future interest rates at which we expect to be able to invest money.

True

The way TIPS are priced with the rate of inflation reflected in the principal of the bond, the cash coupon represents the Real Rate of return.

True

The yield differential between a BBB corporate bond and a Treasury bond of the same maturity would be referred to as the BBB credit spread

True

When you buy a bond with a Negative Pledge indenture you can be sure that the issuer is not going to use any of the current assets of the company as collateral for future debt issues.

True

All other things equal (YTM = 10%), which of the following has the longest duration? a 20-year bond with a 9% coupon a 30-year bond with a 10% coupon a 20-year bond with a 7% coupon a 10-year zero-coupon bond

a 30-year bond with a 10% coupon

A debenture is ________.

an unsecured bond

An investor in a T-bill earns interest by _________

buying the bill at a discount from the face value to be received at maturity

A ________ bond gives the issuer an option to retire the bond before maturity at a specific price after a specific date.

callable

If you are holding a premium bond, you must expect a ________ each year until maturity. If you are holding a discount bond, you must expect a ________ each year until maturity. (In each case assume that the yield to maturity remains stable over time.)

capital loss; capital gain

Consider the expectations theory of the term structure of interest rates. If the yield curve is downward-sloping, this indicates that investors expect short-term interest rates to ________ in the future.

decrease

In the context of a bond portfolio, price risk and reinvestment rate risk exactly cancel out at a time horizon equal to the ________.

duration of the portfolio

As a result of bond convexity, an increase in a bond's price when yield to maturity falls is ________ the price decrease resulting from an increase in yield of equal magnitude.

greater than

You can be sure that a bond will sell at a premium to par when ________.

its coupon rate is greater than its yield to maturity

The bonds of Elbow Grease Dishwashing Company have received a rating of C by Moody's. The C rating indicates that the bonds are ________.

junk bonds

Everything else equal, the ________ the maturity of a bond and the ________ the coupon, the greater the sensitivity of the bond's price to interest rate changes.

longer; lower

The primary difference between Treasury notes and bonds is ________.

maturity at issue

You hold a subordinated debenture in a firm. In the event of bankruptcy which of the following will be paid off after you have been paid?

preferred stock

The invoice price of a bond is the ________.

stated or flat price in a quote sheet plus accrued interest

Yields on municipal bonds are generally lower than yields on similar corporate bonds because of differences in ________.

taxation

A 1% decline in yield will have the least effect on the price of a bond with a ________. 20-year maturity, selling at 100 10-year maturity, selling at 80 20-year maturity, selling at 80 10-year maturity, selling at 100

10 year maturity, selling at 100

Rank the interest sensitivity of the following from the most sensitive to an interest rate change to the least sensitive: I. 8% coupon, noncallable 20-year maturity par bond II. 9% coupon, currently callable 20-year maturity premium bond III. Zero-coupon 30-year maturity bond

III, I, II

An 8% coupon semi-annual bond is selling at Par and is quoted in the WSJ as a bond yielding 8%. That is a BEY of 8% when investors in reality experience a true yield (EAR) of 8.16%

True

You pay $1,092 for a 10yr bond today with a semi-annual coupon of 6%. You re-invest all coupon payments at an annual rate of 5%. After a period of 5 years you have a sudden need for cash and are forced to sell the bond. The 5-yr market rate at that point is equal to 4%. What was the effective annual yield that you have earned over the holding period of 5 years? (note semi annual coupon pmts) . Why was your holding period yield so much higher than the yield to maturity (YTM) at the time of purchase?

because you have re-invested coupons at a rate higher than the initial YTM and you gained from a move lower in the market interest rate