Chapter 6 Reading Questions

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

-private issue -public issue

What is a discount bond?

Discount bonds are bonds that sell for less than the face value

Debt cannot be subordinated to ___

Equity

Which of the following is not a difference between debt and equity?

Equity is publicly traded while debt is not

T/F: A debenture is a bond secured with collateral.

False

What is the definition of a bond's time to maturity?

It is the number of years until the face value is paid off

What does a bond's rating reflect?

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

When interest rates in the market rise, we can expect the price of the bond to ___.

decrease

When interest rates in the market rise, we can expect the price of the bond to _____.

decrease

A limitation of bond ratings is that they ___.

focus exclusively on default risk

If a bond is selling at a discount from its par value, the YTM must be ___ the coupon rate.

greater than

If a bond is selling at a discount from its par value, the YTM must be ____ the coupon rate.

greater than

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

increases

If a $1,000 par value bond is treading at a discount, it means that the market value of the bond is ____ $1,000

less than

When using trial and error to compute the yield to maturity (YTM) for 6 percent coupon bond that trades at a premium, the process can be shortened if the initial guess is ______ 6 percent.

lower than

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

market interest rate fluctuations

Which of the following car variables is not required to calculate the value of a bond?

original issue price of bond

Equity represents a(n) _____ interest of a firm.

ownership

a part of the indenture limiting certain actions during the term of the loan are termed ____.

protective covenants

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

senior

If you are 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

Bond ratings are based on the probability of default risk, which is the risk that ___.

the bond's issuer may not be able make all the required payments

Junk bonds have the following features:

they are rated below investment grade bonds

If a $1,000 par value bond is trading at a premium, the bond is:

trading for more than $1,000 in the market

A debenture is a(n) ___ bond, for which no specific pledge of property is made.

unsecure

A corporate bond's yield to maturity:

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

A corporate bond's yield to maturity:

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

A bond with a BB rating has a ____ than a bond with an BBB rating.

Higher risk of default

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

The degree of interest rate risk depends on _____.

The sensitivity of the bond's price to interest rate changes

Which of the following are true about a bond's face value?

- it is also known as the par value - it i the principal amount repaid at maturity

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

- par value - time remaining to maturity - yield to maturity - coupon rate

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

- the maximum reward for owning debt is fixed - equity represents an ownership interest

Which of the following are usually included in a bond's indenture?

- the total amount of bonds issued - the repayment arrangements

The bonds of a firm in financial distress may have a market value that is ____ than the face value at maturity.

less

The bonds of a firm in financial distress may have a market value that is _____ than the face value at maturity.

less

When interest rates in the market rise, we can expect the price of bonds to ____

decrease

T/F: Bond ratings are concerned only with the possibility of price changes.

false

A bond with a BB rating has a ___ than a bond with a BBB rating.

higher risk of default

When interest rates in the market fall, bond value will increase because the present value of the bond's remaining cash flow _____.

increases

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

increases

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

it will decline

The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables.

- time to maturity - coupon rate

The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?

- time to maturity - coupon rate

Which of the following are true of bonds?

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

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

ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 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.

Which of the following terms apply to a bond?

- coupon rate - time to maturity - par value

A key difference between interest payments and dividend payments is?

- dividends are not tax deductible - interest is tax deductible

Crossover bonds can also be called ____ bonds.

5B

What is premium bond?

A bond that sells for more than face value

As an investor in the bond market, why should you be concerned about changes in interest rates?

Changes in interest rates cause changes in bond prices.

T/F: All else being equal, a one-year bond's price is less sensitive to interest rate changes as compared to that of a ten-year bond's price.

True

T/F: Current yield = Annual coupon payment/price

True

T/F: Current yield = annual coupon payment/price

True

T/F: Long-term debt has maturities greater than one year.

True

T/F: Longer-term bonds have greater interest rate sensitivity because a large portion of a bond's value comes from the face amount.

True

T/F: Low-grad bonds may not be rated by major rating agencies.

True

A bond's coupon payment is:

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

To find the total bond value, add the present value of the amount paid at maturity to the ____ of the annual coupon payments.

annuity present value

What are crossover bonds?

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

What are "fallen angel" bonds?

Bonds that have dropped from investment grade to junk bond status

T/F: Bonds that have dropped into junk territory are called "trash" bonds.

False

T/F: The higher the coupon rate, the greater the interest rate risk, all other things being equal

False

A bond's ____ payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders

coupon

What is a bond's current yield?

Current yield = annual coupon payment / current price