CH 7 Blueprint and adaptive

View each of the below-listed provisions that are often contained in bond indentures alone. Which of these provisions would tend to REDUCE the yield to maturity that investors would otherwise require on a newly issued bond? 1. Fixed assets are used as security for a bond. 2. A given bond is subordinated to other classes of debt. 3. The bond can be converted into the firm's common stock. 4. The bond has a sinking fund. 5. The bond has a call provision. 6. The indenture contains covenants that restrict the use of additional debt.

1, 3, 4, 6

which of the following bonds would have the largest duration

10-year zero coupon bonds

If all interest rates in the economy fall by 1%, which of the following bonds would have the greatest percentage increase in value?

20-year, zero coupon bond

Interest rates on 20-year Treasury and corporate bonds with different ratings, all noncallable, are as follows: T-bond = 6.32% A = 8.46% AAA = 7.78% BBB = 9.28% The differences in rates among these issues were most probably caused by:

Default and liquidity risk differences

(T/F) A zero coupon bond pays no interest. It is offered at par value, which is where it sells initially. These bonds provide compensation to investors in the form of capital appreciation.

False

(T/F) If the appropriate rate of interest on a bond is greater than its coupon rate, the market value of that bond will be above par value.

False

(T/F) The "penalty" for having a low bond rating is less severe when the Security Market Line is relatively steep than when it is not so steep.

False

(T/F) There is a direct relationship between bond ratings and the required rate of return on bonds; that is, the higher the rating, the higher is the required rate of return.

False

Which of the following statements is FALSE? In all of the statements, assume that "other things are held constant."

For a given bond of any maturity, a given percentage point increase in the going interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from an identical decrease in the interest rate.

A noncallable 10-year T-bond has a 12% annual coupon, the yield curve is flat, and it has a10% yield to maturity. A 15-year noncallable T-bond has an 8% annual coupon, the yield curve is flat, and is has a 10% yield to maturity. Which of the following statements is CORRECT?

If interest rates decline, the prices of both bonds would increase, but the 15-year bond would have a larger percentage increase in price.

__________ bonds pay interest only if the firm has earnings, while an indexed (purchasing power) bond bases interest payments on an inflation index to protect the holder from inflation.

Income

__________ bonds are rated triple B or higher, and many banks and other institutional investors are legally limited to only holding these bonds.

Investment grade

Which of the following statements about bond price risk is CORRECT, assuming that all else is equal?

Long-term bonds have less reinvestment risk than short-term bonds.

Which of the following statements about sinking funds is CORRECT?

Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued.

Eagle Enterprises Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not convertible, not callable, and has no sinking fund. On the other hand, Eagle Enterprises could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Eagle Enterprises would have to pay on the second bond, the convertible, callable bond with the sinking fund, to have it sell initially at par?

The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%

There are four main types reflecting who the issuers are: ______ , corporate, state and local government, and foreign.

Treasury

(T/F) A common provision in a bond indenture is a sinking fund. Sinking funds require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond's face value.

True

A bond is more likely to be called if its price is _____ par—because this means that the going market interest rate is less than its coupon rate.

above

An original issue discount (OID) bond is any bond originally offered at a price ______ par value.

below its

A(n) ________ is a long-term contract under which a borrower agrees to make payments of interest and principal on specific dates.

bond

A _________ provision gives the issuer the right to redeem the bonds under specified terms prior to their normal maturity date, although not all bonds have this provision.

call

_______ bonds are exchangeable at the option of the holder for the issuing firm's common stock.

convertible

In a premium bond, over time its value will ______ approaching its maturity value at maturity

decrease

A _____ bond is one that sells below its par value.

discount

To account for the effects related to both a bond's maturity and coupon, many analysts focus on a measure called ______, which is the weighted average of the time it takes to receive each of the bond's cash flows.

duration

A bond's current yield must always be either

equal to its yield to maturity or between its yield to maturity and its coupon rate.

If interest rates rise, then the value of the bond __________ ; however, if interest rates fall, then the value of the bond ______

falls, rises

Mortgage bonds are backed by ______

fixed assets

Bonds can be _____ -rate bonds with a constant coupon rate over the life of the bond, or they can be _______ -rate bonds with a coupon rate that varies over time depending on the level of interest rates.

fixed, floating

in a discount bond, over time its value will __________ approaching its maturity value at maturity

increase

For fixed-rate bonds it's important to realize that the value of the bond has a(n) __________ relationship to the level of interest rates.

inverse

Which type of risk is more relevant to an investor depends on the investor's ______ , which is the period of time an investor plans to hold a particular investment.

investment horizon

Under Chapter 7 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be

liquidated, and the sale proceeds must be used to pay off claims against it according to the priority of the claims as spelled out in the Bankruptcy Act.

Family Traditions Home Fashions would call its outstanding callable bonds if _____.

market interest rates decline sharply

The ______ value of a bond is its stated face value or maturity value, and its coupon interest rate is the stated annual interest rate on the bond.

par

The value of any financial asset is the _______ value of the cash flows the asset is expected to produce.

present

______ risk is the risk of a decline in a bond's value due to an increase in interest rates

price

Longer maturity bonds have high _____ risk, but low ____ risk

price, reinvestment

______ risk is the risk that a decline in interest rates will lead to a decline in income from a bond portfolio

reinvestment

higher coupon bonds have a higher level of _______ risk, and a lower level of _____ risk

reinvestment, price

Each type differs with respect to _____ and expected return.

risk

Because sinking fund provisions facilitate their orderly retirement, bonds with these provisions are regarded as being _____ so they will have ___ coupon rates than similar bonds without these provisions.

safer, lower

Some bonds have ________ provisions which require the issuer to systematically retire a portion of the bond issue each year.

sinking fund

(T/F) A 20-year, annual coupon bond with one year left to maturity has the same price risk as a 10-year, annual coupon bond with one year left to maturity. Both bonds are of equal risk, have the same coupon rate, and the prices of the two bonds are equal.

true

________ bonds pay no annual interest but are sold at a _______ par, thus compensating investors in the form of capital appreciation.

zero coupon, discount below

All else being equal, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?

Adding a call provision

A ____ bond is one that sells above its par value

Premium

____ bonds contain a provision that allows holders to sell them back to the company prior to maturity at a prearranged price.

Putable