Finance 6
The model that precisely specifies the relationship between the nominal rate and the real rate is: R = the nominal rate r = the real rate h = the rate of inflation
(1 + R) = (1 + r)×(1 + h)
Crossover bonds can also be called _____ bonds.
5B
What is the inflation premium?
It is the additional return demanded by investors to compensate for expected inflation
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 usually included in a bond's indenture?
The total amount of bonds issued The repayment arrangements
Which of the following are features of municipal bonds?
They are issued by state and local governments. The interest on municipal bonds is, in some cases exempt from state taxes in the state of issue. The interest on municipal bonds is exempt from federal taxes.
The US government borrows money by issuing:
Treasury bonds Treasury notes
Which of these correctly identify differences between U.S. 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.
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
A part of the indenture limiting certain actions during the term of the loan are termed ________.
protective covenants
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 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.
5%
What are the two unique features of a U.S. federal government bond?
U.S. Treasury issues are considered to be default-free. U.S. Treasury issues are exempt from state income taxes.
true or false: In general, the price that is paid for a bond will exceed its quoted price.
true
What are "fallen angel" bonds?
Bonds that have dropped from investment grade to junk bond status
What is the bid price?
the price a dealer is willing to pay for a security It is the price an investor will receive if he sells a bond to a dealer.
True or false: The price you actually pay to purchase a bond will generally exceed the clean price.
true
True or false: Zero coupon bond calculations use semiannual periods to be consistent with coupon bond calculations.
true
the ____ price is also called the "full" or "invoice" price.
dirty
Which three of the following are common shapes for the term structure of interest rates?
downward humped upward sloping
Debt cannot be subordinated to
equity
True or false: Bonds that have dropped into junk territory are called "trash" bonds.
false
True or false: The dirty price does not include accrued interest.
false
A limitation of bond ratings is that they ____.
focus exclusively on default risk
A bond with a BB rating has a ______ than a bond with an BBB rating.
higher risk of default
A key difference between interest payments and dividend payments is?
interest is tax deductible, dividends are not tax deductible
What does the dirty price represent?
it includes the quoted price and accrued interest
A zero coupon bond is a bond that
makes no interest payments
Bonds issued by state and local governments are called _______ ______.
municipal bonds
The term structure of interest rates examines the ____.
relationship between short-term and long-term interest rates
Junk bonds have the following features:
they are rated below investment grade bonds
If bonds for AT&T are quoted at 115, they can be purchased:
at 115% of par value plus accrued interest
If a $1,000 face value U.S. Treasury bond is quoted at 99.5, then the bond can be purchased _____.
at 99.5 percent of face value plus any accrued interest
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 Liquidity premium
Which three components determine the shape of the term structure of interest rates?
Interest rate risk premium Inflation premium Real interest rate
What is a real rate of return?
It is a percentage change in buying power. It is a rate of return that has been adjusted for inflation.
What is the nominal rate of return on an investment?
It is the actual percentage change in the dollar value of an investment unadjusted for inflation.
What does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately.
Which of the following is true of zero coupon bonds?
No coupon payments are made on the bonds
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
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 are some features of the OTC market for bonds?
The OTC has no designated physical location. OTC dealers are connected electronically.
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
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 real rate of return Expected future inflation The interest rate risk premium
When long-term rates are higher than short-term rates, which of the following shapes will the term structure of interest rates usually have?
Upward sloping
The coupon payments on floating-rate bonds are _____.
adjustable
Most of the time, a floating-rate bond's coupon adjusts ____.
with a lag to some base rate
A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a _________________.
call provision
The relationship between nominal rates, real rates and inflation is called ________ .
the Fisher Effect
True or false: Investors require a premium for the risk that issuers other than the Treasury may not make all promised payments on the issued bonds.
true
True or false: The government sells Treasury notes and bonds to the public every month.
true
True or false: Low-grade bonds may not be rated by major rating agencies.
true, Junk bonds may not have ratings by major agencies.
The term structure of interest rates describes ________.
the pure time value of money the relationship between nominal rates and time to maturity
Which type of debt is given preference in the event of default?
senior
The bid-ask spread represents the ___.
dealer's profit