BCOR 340 Chapter 6

A corporate bond's yield to maturity:

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

Equity represents a(n) ______ interest of a firm

Ownership

A part of the indenture limiting certain actions during the term of loan are termed

Protective covenants

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

Senior

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

If you re 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

The relationship between nominal rates, real rates and inflation is called

The Fisher Effect

A limitation of bond ratings is that they ______

focus exclusively on default risk

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?

$5,000 per bond

ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1000 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 will your aftertax yield on a corporate bond that is currently priced to yield 7% if you are in the 25 percent tax bracket?

(yield) x (1 - tax rate) .07 x (1 - .25) = 5.25%

Which of the following are bonds that have actually been issued?

-A CoCo Bond -A convertible Bond -A put bond

As a general rule, which of the following are true of debt and equity?

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

What is a bid price?

-It is the price an investor will receive if he sells a bond to a dealer -It is the price at which a dealer is willing to buy securities

What is the asked price?

-It is the price at which an investor can buy a particular security from a dealer -It is the price at which a dealer is willing to sell a particular security

What are the two major forms of long-term debt?

-Public issue -Private issue

Which of the following may increase the yield on corporate bonds as compensations to investors but will not impact treasury bond yields?

-The Default risk premium (treasury bonds have no default risk) -Liquidity Premium (Corporate bonds are not liquid; Treasury bonds are highly liquid)

What are some features of the OTC market for bonds?

-The OTC has no designated physical location -OTC dealers are connected electronically

Which of the following are features of municipal bonds?

-The interest on municipal bonds is exempt from federal taxes -The interest on municipal bonds is, in some cases, exempt from state taxes in the state of issue -They are issued by state and local government

What are the three components that influence the Treasury yield curve?

-The interest rate risk premium -Expected future inflation -The real rate of return

Which of the following are true of bonds?

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

Junk bonds have the following features:

-They are rated below investment grade bonds -They have a high probability of default -They pay a high rate of interest

What four variables are required to calculate the value of a bond?

-Time remaining to maturity -Yield to maturity -Par Value -Coupon Rate

Which of the following terms apply to a bond?

-Time to maturity -Par Value -Coupon Rate

The US government borrows money by issuing

-Treasury Notes -Treasury Bonds

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 is a corporate bond's yield to maturity (YTM)?

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

The term structure of interest rates describes _____

-the pure time value of money -the relationship between nominal rates and time to maturity

Which three of the following are common shapes for the term structure of interest rates?

-upward sloping -humped -downward sloping

You invest in a bond paying 6% interest paid semiannually with a face value of $1,000. The bond matures in 8 years and similar bonds yield 5%. What is the current value of the bond?

1065.28

What is the current yield on a $1000 par value bond that sells for $900 if the coupon rate is 10 percent?

11.11%. Current yield= annual amount/ PV (or Price of bond). .10 X $1000= 100 PMT $100/$900= .11111 =11.11%

If the rate of inflation is 3 percent and the real rate of return is 9 percent, the nominal rate is approximately _____ percent

12%

What are crossover bonds?

Bonds that have both an investment grade and a junk bond rating

The bid-ask spread represents the _____.

Dealer's profit

True or False: a debenture is a bond secured with collateral

False, a debenture is an unsecured bond

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

Increases

What is the nominal rate of return on an investment?

It is the actual percentage change in the dollar value of an investment un-adjusted for inflation

What is the inflation premium?

It is the additional return demanded by investors to compensate for expected inflation

What is a bond's accrued interest?

It is the interest that has been earned but not yet received by the current bondholder

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

It will decline

A zero-coupon bond is a bond that

Makes no interest payments

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

Market interest rate fluctuations

What does a bond's rating reflect?

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

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

The bond with a 5% coupon rate

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

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

What does the clean price for a bond represent?

The quoted price excluding accrued interest

True or false: In general, the price that is paid for a bond will exceed its quoted price

True

A bond's coupon payment is:

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

If a $1000 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

If a $1000 par value bond is trading at a premium, the bond is:

trading for more than $1,000 in the market