Chapter 6
default
A bond issuer is said to be in _______ if it does not pay the interest or the principal in accordance with the terms of the indenture agreement or if it violates one or more of the issue's restrictive covenants.
Coupon
The interest payment paid on a bond, calculated by multiplying the bond's interest rate by its face (par) value.
a discount
When the bond's coupon rate is less than the bondholder's required return, the bond's intrinsic value will be less than its par value, and the bond will trade at (a discount/par/a premium).
Term loan
A loan, generally obtained from a bank or insurance company, on which the borrower agrees to make a series of payments consisting of interest and principal.
3.05%
Assume you make the following investments: A $10,000 investment in a 10-year T-bond that has a yield of 11.50% A $20,000 investment in a 10-year corporate bond with an A rating and a yield of 14.95% Based on this information, and the knowledge that the difference in liquidity risk premiums between the two bonds is 0.40%, what is your estimate of the corporate bond's default risk premium?
unreasonable
Based on the Liam data, it is (unreasonable/reasonable) to expect that Liam's potential bond investment will exhibit an intrinsic value greater than $1,000.
Income bond
Bond Type? A corporate bond that pays interest to its bondholders only if the issuer earns sufficient income to allow the payment of the bond's interest payments.
A mortgage bond
Bond Type? Your brother, Sam, who restricts his investments to blue-chip corporations of equal credit risk called yesterday to ask your advice about investing in bonds to fund your nephew's future college education. Sam said that he was interested in investing in only very safe and secure investments.
$1,238.85
Booker Petroleum Refiners (BPR) has an issue of 8-year, 11% annual coupon bonds outstanding. The bonds, which were originally issued 12 years ago, have a face value (FV) of $1,000, a yield-to-maturity (YTM) of 7%, and are noncallable. What is the current market price of BPR's bonds?
a. $37.50 b.$1000 c. 4.375%
For example, assume Liam wants to earn a return of 8.75% and is offered the opportunity to purchase a $1,000 par value bond that pays a 7.50% coupon rate (distributed semiannually) with three years remaining to maturity. Compute: a. Bond's semiannual coupon payment b. Bond's par value c. Semiannual required rate
floating-rate
If the coupon interest rate is 4.375% for the first six months and changes to a rate equal to the 10-year Treasury bond rate plus 1.3% thereafter, the bond is called a __________ bond.
a. will b. would like
Remember, a bond's coupon rate partially determines the interest-based return that a bond (will/might) pay, and a bondholder's required return reflects the return that a bondholder (is obligated/would like) to receive from a given investment.
discount
Sometimes borrowers avoid periodic interest payments by agreeing to borrow a given amount and repay a maturity, or face, value that is greater than the amount borrowed. Such a debt instrument is said to be issued at a ________
False
T/F: Just like term loans, bond issues do not have to be registered with the Securities and Exchange Commission (SEC).
False
T/F: The interest rate on a term loan must be fixed over the life of the loan, whereas the interest rate on a bond issue can vary over the life of the issue.
indentrue
The contract that describes the terms of a borrowing arrangement between a firm that sells a bond issue and the investors who purchase the bonds is called a/an _________
Issuer
The entity that promises to make the interest and maturity payments for a bond issue is called the ________
Yield to call
The name given to the return earned by an investor who purchases a bond for its market price, holds it until it is called on its first call date, and receives all interest payments and the call price between the date of purchase and the call date.
Current yield
The portion of a bondholder's return that results from a bond's interest payment, calculated by dividing the bond's interest payment by its market value.
yield to maturity
The return earned by a bondholder who purchases a bond today at its market price, assuming that the bond will be held until maturity and that all coupons and the maturity payment will be received in accordance with the indenture.
Repurchase agreement
Tiger Telecommunications Company needs to borrow $1 million overnight and is willing to secure the loan with a portfolio of securities that the borrower will repurchase tomorrow at a higher price. This is an example of a:
8.88% Current yield = Annual Interest Payment / Bond Price
What is the current yield on Booker Petroleum Refiners's outstanding bonds?
-1.88% Expected Capital Gains Yield = Bond's YTM - Current Yield
What is the expected one-year capital gain yield on the bonds of Booker Petroleum Refiners?
b. Municipal bonds
What type of bonds are those issued by the New York City government? a. Treasury bonds b. Municipal bonds c. Corporate bonds
a. The interest payments from municipal bonds are exempt from state and federal taxes.
Which of the following statements is true about bonds? b. The interest payments from corporate bonds are not exempt from state and federal taxes. a. The interest payments from municipal bonds are exempt from state and federal taxes.
a. When the coupon rate is greater than the required return, the bond should trade at a premium.
Which of the following statements is true? a. When the coupon rate is greater than the required return, the bond should trade at a premium. b. When the coupon rate is greater than the required return, the bond should trade at a discount. c. When the coupon rate is greater than the required return, the bond's intrinsic value will be less than its par value. d. A bond should trade at a par when the coupon rate is greater than the required return.
b. Treasury bonds
Which of the following types of bonds has the least default risk? a. Corporate bonds b. Treasury bonds c. Municipal bonds
Callable bonds Callable bonds usually offer higher yields, because they can be called before maturity, thus increasing the interest rate reinvestment risk for investors. If interest rates fall sufficiently low, the issuer may call the bond, which forces investors to reinvest capital earlier than planned at low interest rates. Investors expect to gain higher yields for the greater risk that they take when investing in callable bonds.
Which type of bonds offer a higher yield? a. Callable bonds b. Noncallable bonds
Premium
Are the bonds of Booker Petroleum Refiners selling at a discount, at par, or at a premium?
$3,554,701.01
Assume that a $4,000,000 par value, semiannual coupon U.S. Treasury note with five years to maturity has a coupon rate of 6%. The yield to maturity of the bond is 8.80%. Using this information and ignoring the other costs involved, the value of the Treasury note is __________
Debenture
The term used to describe an unsecured, or non-collateralized, bond.
investment grade bond
A bond that has been judged by credit rating agencies as having a relatively low probability of default on the payment of its interest and maturity payment.
call provision
A bond's _____ gives the issuer the right to call, or redeem, a bond at specific times and under specific conditions.
coupon payment
A bond's _____ refers to the interest payment or payments paid by a bond.
b. The bond will not be called.
A bond's yield to maturity (YTM) is the percentage return that it is expected to generate if the bond is assumed to be held until it matures. Calculating a bond's YTM requires you to make several assumptions. Which of the following is one of these assumptions? a. The bond has an early redemption feature. b. The bond will not be called.
commercial paper
A discounted unsecured security issued by large and exceptionally financially sound firms and sold to other sophisticated businesses
money market mutual fund
A security in which an investment company pools and manages capital from many investors in order to invest primarily in short-term financial assets that would otherwise be unavailable to the individual investors
callable bonds
A type of bond that allows the bond issuer to retain the privilege of redeeming it at a pre-specified price at some time prior to its normal maturity date.
Foreign debt
An example of this form of debt is issued by a German borrower, sold in the United States, and denominated in U.S. dollars.
Revenue bond
An example of this type of bond is an airport construction bond in which the revenues generated via the airport's landing fees are used to service the interest payments and pay the maturity payments.
YTM = 7.095% YTC = 6.473%
Blue Moose Home Builders Inc. has 9% annual coupon bonds that are callable and have 18 years left until maturity. The bonds have a par value of $1,000, and their current market price is $1190.35. However, Blue Moose Home Builders Inc. may call the bonds in eight years at a call price of $1,060. What are the YTM and yield to call (YTC) on bonds?
US Treasury Bond
Bond Type? A bond issued by the United States Treasury.
Zero coupon bond
Bond Type? Your broker, Teresa, called earlier with an offer to invest in a corporate bond that sells at a significant discount from its face value and does not pay an annual or semiannual interest payment.
b. A bond with 30% return on capital, total debt to total capital of 15%, and 6% yield
Bonds are classified into investment-grade bonds and junk bonds. Which of the following bonds is likely to be classified as an investment-grade bond? a. A bond with 10% return on capital, total debt to total capital of 85%, and 13% yield b. A bond with 30% return on capital, total debt to total capital of 15%, and 6% yield
c. 8 years
If interest rates are expected to remain constant, what is the best estimate of the remaining life left for Blue Moose Home Builders Inc.'s bonds? a. 18 years b. 5 years c. 8 years d. 13 years
a. When interest rates are higher than they were when the bonds were issued A shareholder wealth-maximizing issuer will employ a sinking fund bond-retirement procedure that reduces the required number of bonds each year at the lowest cost. An increase in market interest rates from the time when the bonds were issued decreases the market price of the bonds. This allows the issuer to repurchase each bond for less than its $1,000 par value. This is less expensive than either paying the call price if the bonds are callable or depositing a fixed amount or fixed percentage of the bond issue in a sinking fund escrow account each year. Remember that a call price is equal to the par value of the bonds plus the required call premium, which is usually equal to one year's worth of interest.
Issuers can gradually reduce the outstanding balance of a bond issue by using a sinking fund account into which they deposit a specified amount of money each year. To operationalize the sinking fund provision of an indenture, issuers can (1) purchase a portion of the debt in the open market or (2) call the bonds if they contain a call provision. Under what circumstances would a firm be more likely to buy the required number of bonds in the open market as opposed to using one of the other procedures? a. When interest rates are higher than they were when the bonds were issued b. When interest rates are lower than they were when the bonds were issued
c. The New York City government
New York City issued a general obligation bond for a canal in 1812. It was the first formal debt instrument with a fixed repayment schedule issued by a city. Who is the issuer of the bonds? a. Federal Reserve Bank of New York b. Bank of New York c. The New York City government
a. $1,053 b. greater c. premium
Now, consider the situation in which Liam wants to earn a return of 7%, but the bond being considered for purchase offers a coupon rate of 9%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bond's intrinsic value to the nearest whole dollar, then its intrinsic value of _______ is (greater/less) than its par value, so that the bond is trading at a (discount/premium)
exceed
When the bond's coupon rate is greater to the bondholder's required return, the bond's intrinsic value will ________ its par value, and the bond will trade at a premium.
Call provision
Which feature of a bond contract allows the issuer to redeem bonds under specified terms prior to maturity?
a. increase b. decrease
You heard that rating agencies have downgraded a bond's rating. The yield on the bond is likely to _____, and the bond's price will _____ .
