Chapter 7 Financial Markets

Savings bonds are bonds issued by the Federal Reserve. a. True b. False

F

Under the STRIP program created by the Treasury, stripped securities are created and sold by the Treasury. a. True b. False

F

When would a firm most likely call bonds? a. after interest rates have declined b. if interest rates do not change c. after interest rates increase d. just before the time at which interest rates are expected to decline

A

____ require the owner to clip coupons attached to the bonds and send them to the issuer to receive coupon payments. a. Bearer b. Registered c. Treasury d. Corporate

A

Investors in Treasury notes and bonds receive ____ interest payments from the Treasury. a. annual b. semiannual c. quarterly d. monthly

B

Jim purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Jim will hold the bonds until maturity. Thus, he will earn a return of ____ percent. a. 12.00 b. 9.00 c. 10.50 d. More information is needed to answer this question.

B

Interest earned from Treasury bonds is a. exempt from all income tax. b. exempt from federal income tax. c. exempt from state and local taxes. d. subject to all income taxes.

C

A call provision on bonds normally a. allows the firm to sell new bonds at par value. b. gives the firm to sell new bonds above market value. c. allows the firm to sell bonds to the Treasury. d. allows the firm to buy back bonds that it previously issued.

D

For bonds issued under a _______ arrangement, the underwriter guarantees the issuer that the bonds will be sold at a specified price. a. specific value b. fixed proceeds c. best efforts d. firm commitment

D

A sinking-fund provision is a requirement that the issuing firm retire a certain amount of the bond issue each year. a. True b. False

T

Inflation-indexed Treasury bonds are intended for investors who wish to ensure that the returns on their investments keep up with the increase in prices over time. a. True b. False

T

Rule 144A creates liquidity for securities that are privately placed. a. True b. False

T

Stripped bonds are bonds whose cash flows have been transformed into a security representing the principal payment only and a security representing interest payments only. a. True b. False

T

Structured notes are issued by firms to borrow funds, and the repayment of interest and principal is based on specified market conditions. a. True b. False

T

Bonds issued by ____ are backed by the federal government. a. the Treasury b. AAA-rated corporations c. state governments d. city governments

A

Many bonds are listed on the New York Stock Exchange (NYSE). a. True b. False

T

Bonds that are secured by personal property are called a. chattel mortgage bonds. b. first mortgage bonds. c. second mortgage bonds. d. debentures.

A

Corporate bonds that receive a ____ rating from credit rating agencies are normally placed at ____ yields. a. higher; lower b. lower; lower c. higher; higher d. none of the above

A

Everything else being equal, which of the following bond ratings is associated with the highest yield? a. Baa b. A c. Aa d. Aaa

A

If interest rates suddenly ____, those existing bonds that have a call feature are ____ likely to be called. a. decline; more b. decline; less c. increase; more d. none of the above

A

Note maturities are usually ____, while bond maturities are ____. a. less than 10 years; 10 years or more b. 10 years or more; less than 10 years c. less than 5 years; 5 years or more d. 5 years or more; less than 5 years

A

When purchasing bonds, individual investors can use a ________ to specify the maximum price they are willing to pay for a bond. a. limit order b. market order c. stop order d. price order

A

Which of the following eurozone countries has not recently experienced debt repayment problems? a. Finland b. Greece c. Portugal d. Spain

A

___ bonds have the most active secondary market. a. Treasury b. Zero-coupon corporate c. Junk d. Municipal

A

____ bids for Treasury bonds specify a price that the bidder is willing to pay and a dollar amount of securities to be purchased. a. Competitive b. Noncompetitive c. Negotiable d. Non-negotiable

A

Financial calculator required.) Lisa can purchase bonds with 15 years until maturity, a par value of $1,000, and a 9 percent annualized coupon rate for $1,100. Lisa's yield to maturity is ____ percent. a. 9.33 b. 7.84 c. 9.00 d. none of the above

B

If a firm believes that it will have sufficient cash flows to cover interest payments, it may consider using ____ debt and ____ equity, which implies a ____ degree of financial leverage. a. more; less; lower b. more; less; higher c. less; more; higher d. none of the above

B

Municipal general obligation bonds are ____. Municipal revenue bonds are ____. a. supported by the municipal government's ability to tax; supported by the municipal government's ability to tax b. supported by the municipal government's ability to tax; supported by revenue generated from the project c. always subject to federal taxes; always exempt from state and local taxes d. typically zero-coupon bonds; typically zero-coupon bonds

B

The Financial Reform Act of 2010 established the __________ to provide oversight for credit rating agencies. a. Federal Ratings Bureau b. Office of Credit Ratings c. Office of Agency Supervision d. Ratings Oversight Commission

B

When firms issue ____, the amount of interest and principal to be paid is based on specified market conditions. The amount of the repayment may be tied to a Treasury bond price index or even to a stock index. a. auction-rate securities b. structured notes c. leveraged notes d. stripped securities

B

Which of the following is not true regarding the call provision? a. It typically requires a firm to pay a price above par value when it calls its bonds. b. The difference between the market value of the bond and the par value is called the call premium. c. A principal use of the call provision is to lower future interest payments. d. A principal use of the call provision is to retire bonds as required by a sinking-fund provision. e. A call provision is normally viewed as a disadvantage to bondholders.

B

Which of the following statements is incorrect? a. The municipal bond must pay a risk premium to compensate for the possibility of default risk. b. The Treasury bond must pay a slight premium to compensate for being less liquid than municipal bonds. c. The income earned from municipal bonds is exempt from federal taxes. d. All of the above are true.

B

Which of the following statements is true regarding STRIPS? a. they are issued by the Treasury b. they are created and sold by various financial institutions c. they are not backed by the U.S. government d. they have to be held until maturity e. all of the above are true regarding STRIPS

B

____ are not primary purchasers of bonds. a. Insurance companies b. Finance companies c. Mutual funds d. Pension funds

B

In general, variable-rate municipal bonds are desirable to investors who expect that interest rates will ____. a. remain unchanged b. fall c. rise d. none of the above

C

Leveraged buyouts are commonly financed by the issuance of: a. money market securities. b. Treasury bonds. c. corporate bonds. d. municipal bonds.

C

Some bonds are "stripped," which means that a. they have defaulted. b. the call provision has been eliminated. c. they are transferred into principal-only and interest-only securities. d. their maturities have been reduced.

C

The Treasury has relied heavily on ____-year bonds to finance the U.S. budget deficit. a. 50 b. 70 c. 10 d. 5

C

The coupon rate of most variable-rate bonds is tied to a. the prime rate. b. the discount rate. c. LIBOR. d. the federal funds rate.

C

The issuance of municipal securities is regulated by: a. the Securities and Exchange Commission. b. the Consumer Financial Protection Bureau. c. their respective state governments. d. the Federal Reserve.

C

Treasury bond dealers a. quote an ask price for customers who want to sell existing Treasury bonds to the dealers. b. profit from a very wide spread between bid and ask prices in the Treasury securities market. c. may trade Treasury bonds among themselves. d. make a primary market for Treasury bonds.

C

Which of the following institutions is most likely to purchase a private bond placement? a. commercial bank b. mutual fund c. insurance company d. savings institution

C

Which of the following is not an example of a municipal bond? a. general obligation bond b. revenue bond c. Treasury bond d. All of the above are examples of municipal bonds.

C

Which of the following is not mentioned in your text as a protective covenant? a. a limit on the amount of dividends a firm can pay b. a limit on the corporate officers' salaries a firm can pay c. the amount of additional debt a firm can issue d. the appointment of a trustee in all bond indentures e. All of the above are mentioned in the text as protective covenants.

D

Which of the following statements is not true regarding STRIPS? a. They are not issued by the Treasury. b. They are created and sold by various financial institutions. c. They are backed by the U.S. government. d. They have to be held until maturity. e. All of the above are true regarding STRIPS.

D

Which of the following would not be a likely example of a protective covenant provision? a. a limit on the amount of dividends a firm can pay b. a limit on the corporate officers' salaries a firm can pay c. the amount of additional debt a firm can issue d. a call feature

D

Bonds are issued in the primary market through a telecommunications network. a. True b. False

T

Corporate bonds can be placed with investors through a public offering or a private placement. a. True b. False

T

The bond market is served by bond dealers, who can play a broker role by matching up buyers and sellers. a. True b. False

T

The primary investors in bond markets are institutional investors such as commercial banks, bond mutual funds, pension funds, and insurance companies. a. True b. False

T

The yield to investors on Treasury bonds reflects the risk-free rate because these bonds are virtually free from credit (default) risk. a. True b. False

T

The yield to maturity is the annualized discount rate that equates the future coupon and principal payments to the initial proceeds received from the bond offering. a. True b. False

T

When a corporation issues bonds, it normally hires a securities firm that targets large institutional investors such as pension funds, bond mutual funds, and insurance companies. a. True b. False

T

Zero-coupon bonds do not pay interest. Instead, they are issued at a discount from par value. a. True b. False

T

Treasury bond auctions are normally conducted only at the beginning of each year. a. True b. False

F

Treasury bonds are issued by state and local governments. a. True b. False

F

Devin is, a private investor, purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Devin will hold the bonds until maturity. Thus, he will earn a return of ____ percent. a. 12 b. 9 c. 10.5 d. more information is needed to answer this question

B

(Financial calculator required.) Paul can purchase bonds with 15 years remaining until maturity, a par value of $1,000, and a 9 percent annual coupon rate for $1,100. Paul's yield to maturity is ____ percent. a. 9.33 b. 7.84 c. 9.00 d. none of the above

B

A credit rating agency is paid by: a. the purchasers of the bonds that the agency rates. b. the issuers of the bonds that the agency rates. c. the taxpayers, because the rating agencies are government agencies. d. the New York Stock Exchange or the over-the-counter market where the bonds are listed.

B

A ten-year, inflation-indexed bond has a par value of $10,000 and a coupon rate of 5 percent. During the first six months since the bond was issued, the inflation rate was 2 percent. Based on this information, the coupon payment after six months will be $____. a. 250 b. 255 c. 500 d. 510

B

Assume that you purchased corporate bonds one year ago that have no protective covenants. Today, it is announced that the firm that issued the bonds plans a leveraged buyout. The market value of your bonds will likely ____ as a result. a. rise b. decline c. be zero d. be unaffected

B

A ____ has first claim on specified assets, while a ____ is a debenture that has claims against a firm's assets that are junior to the claims of mortgage bonds and regular debentures. a. first mortgage bond; second mortgage bond b. first mortgage bond; debenture c. first mortgage bond; subordinated debenture d. chattel mortgage bond; subordinated debenture e. none of the above

C

A protective covenant may a. specify all the rights and obligations of the issuing firm and the bondholders. b. require the firm to retire a certain amount of the bond issue each year. c. restrict the amount of additional debt the firm can issue. d. none of the above

C

A variable rate bond allows a. investors to benefit from declining rates over time. b. issuers to benefit from rising market interest rates over time. c. investors to benefit from rising market interest rates over time. d. none of the above.

C

Assume U.S. interest rates are significantly higher than German rates. A U.S. firm with a German subsidiary could achieve a lower financing rate, without exchange rate risk by denominating the bonds in a. dollars. b. euros and making payments from U.S. headquarters. c. euros and making payments from its German subsidiary. d. dollars and making payments from its German subsidiary.

C

Bonds that are not secured by specific property are called a. a chattel mortgage. b. open-end mortgage bonds. c. debentures. d. blanket mortgage bonds.

C

For bonds issued under a _______ arrangement, the underwriter attempts to sell the bonds at a specified price but makes no guarantee to the issuer. a. floating value b. variable proceeds c. best efforts d. firm commitment

C

(Financial calculator required.) Erin is, a private investor, who can purchase $1,000 par value bonds for $980. The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until maturity. Erin's yield to maturity is ____ percent. a. 9.96 b. 10.00 c. 10.33 d. 10.24 e. none of the above

D

(Financial calculator required.) Steven, a private investor, can purchase $1,000 par value bonds for $980. The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until maturity. Steven's yield to maturity is ____ percent. a. 9.96 b. 10.00 c. 10.33 d. 10.24 e. none of the above

D

Online bond brokerage services offer several advantages including: a. pricing is more transparent because investors can easily compare bid and ask spreads. b. some services charge commissions, which may be more easily understood than bid and ask spreads. c. some brokers have narrowed their spreads so that they do not lose business to competitors. d. all of the above

D

The bond debenture is a legal document specifying the rights and obligations of both the issuing firm and the bondholders. a. True b. False

F

The key difference between a note and a bond is that note maturities are usually less than one year, while bond maturities are one year or more. a. True b. False

F

Which of the following is not true regarding zero-coupon bonds? a. They are issued at a deep discount from par value. b. Investors are taxed annually on the amount of interest earned, even though the interest will not be received until maturity. c. The issuing firm is permitted to deduct the amortized discount as interest expense for federal income tax purposes, even though it does not pay interest. d. Zero-coupon bonds are purchased mainly for tax-exempt investment account, such as pension funds and individual retirement accounts. e. all of the above are true

E

A private bond placement has to be registered with the SEC. a. True b. False

F

All of the bonds issued by a particular company will have the same maturity, price, and credit rating. a. True b. False

F

Bond dealers do not have an inventory of bonds. a. True b. False

F

Bond dealers specialize in small transactions (less than $100,000) in order to enable small investors to trade bonds. a. True b. False

F

Bonds issued by large well-known corporations in large volume are illiquid because most buyers hold these bonds until maturity. a. True b. False

F

Corporate bonds are more standardized than stocks. a. True b. False

F

Corporate bonds usually pay interest on an annual basis. a. True b. False

F

During weak economic periods, newly issued junk bonds require lower risk premiums than in strong economic periods. a. True b. False

F

High-risk bonds are called trash bonds. a. True b. False

F

If interest rates suddenly decline, those existing bonds that have a call feature are less likely to be called. a. True b. False

F

Many bonds have different call prices: a higher price for calling the bonds to meet sinking-fund requirements and a lower price if the bonds are called for any other reason. a. True b. False

F

Rule 144A, which allows small individual investors to trade privately-placed bonds (and some other securities) with each other without requiring that the firms that issued the securities to register them with the SEC. a. True b. False

F

Subordinated indentures are debentures that have claims against the firm's assets that are junior to the claims of both mortgage bonds and regular debentures. a. True b. False

F