FINA 5320 ch 6 homework
True or false: Longer-term bonds have greater interest rate sensitivity because a large portion of a bond's value comes from the face amount.
True
If you are holding two bonds—one with a 5 percent coupon rate and the other with an 8 percent coupon rate—which one is more sensitive to interest rate risk, all other things being equal?
The bond with a 5 percent coupon rate.
Which of the following are bonds that have actually been issued?
a CoCo bond a convertible bond a put bond
What is a premium bond?
a bond that sells for more than face value
A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a ______.
call provision
A bond's _______ payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders.
coupon
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
A bond with a BB rating has a ______ than a bond with a BBB rating
higher risk of default
The bonds of a firm in financial distress may have a market value that is _______ than the face value at maturity.
less
If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ______ $1,000.
less than
Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact Treasury bond yields?
liquidity premium default risk premium
Which type of debt is given preference in the event of default?
senior
What does a bond's rating reflect?
the ability of the firm to repay its debt and interest on time
Which of the following are usually included in a bond's indenture?
the total amount of bonds issued the repayment arrangements
What four variables are required to calculate the value of a bond?
yield to maturity par value coupon rate time remaining to maturity
A bond's coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders.
A part of the indenture limiting certain actions during the term of the loan are termed ______.
protective covenants
What is a discount bond?
Discount bonds are bonds that sell for less than the face value.
What is the bid price?
It is the price an investor will receive if he or she sells a bond to a dealer. It is the price at which a dealer is willing to buy securities
What are the two unique features of a U.S. federal government bond?
U.S. Treasury issues are considered to be default-free. U.S. Treasury issues are exempt from state income taxes.
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
The model that precisely specifies the relationship between the nominal rate and the real rate is: R = the nominal rate r = the real rate h = the rate of inflation.
(1 + R) = (1 + r)×(1 + h)
The relationship between nominal rates, real rates, and inflation is called ______ .
the Fisher Effect
True or false: Investors require a premium for the risk that issuers other than the Treasury may not make all promised payments on the issued bonds.
true
True or false: Long-term debt has maturities greater than one year.
true
True or false: Low-grade bonds are rated below investment grade by the major rating agencies.
true
If you are holding a municipal bond that is trading at par to yield 6 percent, by how much will your aftertax yield change if your federal income tax bracket increases from 15 percent to 20 percent. Assume there are no state or local taxes.
0
If you are in the 20 percent federal income tax bracket, what is your aftertax yield on a municipal bond that is currently trading at par to yield 5 percent. Assume there are no state or local taxes.
5 percent
Crossover bonds can also be called ______ bonds.
5B
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.
What is a bond's current yield?
Current yield = Annual coupon payment/Price
Which of the following is not a difference between debt and equity?
Equity is publicly traded, while debt is not.
What is a real rate of return?
It is a rate of return that has been adjusted for inflation. It is a percentage change in buying power.
Which of the following are true about a bond's face value?
It is also known as the par value. It is the principal amount repaid at maturity.
What is a bond's accrued interest?
It is interest that has been earned but not yet received by the current bondholder.
What is the nominal rate of return on an investment?
It is the actual percentage change in the dollar value of an investment unadjusted for inflation.
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 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 does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds.
What will happen to a bond's time to maturity as the years go by?
It will decline.
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately.
What are the cash flows involved in the purchase of a five-year zero coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent.
Pay $800 today and receive $1,000 at the end of five years.
What is the equation for approximating the nominal rate of return? R = the nominal rate of interest r = the real rate of interest h = the inflation rate.
R = r + h
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 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.
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, in some cases, exempt from state taxes in the state of issue. They are issued by state and local governments. The interest on municipal bonds is exempt from federal taxes.
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 true of bonds?
They are normally interest-only loans. They are issued by both corporations and governments.
Junk bonds have the following features:
They are rated below investment grade bonds.
Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?
Treasury bonds are considered free of default risk, while corporate bonds are exposed to default risk. Treasury bonds are issued by the U.S. government, while corporate bonds are issued by corporations. Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer.
The U.S. government borrows money by issuing ______.
Treasury notes Treasury bonds
True or false: All else being equal, a 1-year bond's price is less sensitive to interest rate changes as compared to that of a 10-year bond's price.
True
What is a corporate bond's yield to maturity (YTM)?
YTM is the prevailing market interest rate for bonds with similar features. YTM is the expected return for an investor who buys the bond today and holds it to maturity.
The coupon payments on floating-rate bonds are ______.
adjustable
To find the total bond value, add the present value of the amount paid at maturity to the Blank______ of the annual coupon payments.
annuity present value
If bonds for AT&T are quoted at 115, they can be purchased:
at 115 percent of par value plus accrued interest.
If a $1,000 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
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
If a bond is issued with a ______ provision it allows the issuer to repurchase part or all of the bond at defined prices and times.
call
The bid-ask spread represents the ______.
dealer's profit
When interest rates in the market rise, we can expect the price of bonds to ______.
decrease
The _____ price is also called the "full" or "invoice" price.
dirty
Debt cannot be subordinated to _____
equity
True or false: A debenture is a bond secured with collateral.
false
True or false: The higher the coupon rate, the greater the interest rate risk, all other things being equal.
false
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ______.
increases
The nominal rate is found by adding the ______ and the real rate of return.
inflation
A Sukuk is in compliance with Islamic law as the financing instrument is not charging any _____ or making money from money.
interest
A key difference between interest payments and dividend payments is:
interest is tax deductible. dividends are not tax deductible.
A corporate bond's yield to maturity:
is usually not the same as a bond's coupon rate. changes over time.
Indentures and loan agreements often contain protective covenants designed to protect the interests of ______.
lenders
The interest rate risk premium is the additional compensation demanded by investors for holding ______ bonds.
longer-term
When using trial and error to compute the yield to maturity (YTM) for a 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 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
Which of the following terms apply to a bond?
par value coupon rate time to maturity
A protective covenant is part of an indenture or loan agreement that limits certain actions a company may take during the term of the loan to _____ the lender's interests.
protect
What are the two major forms of long-term debt?
public issue private issue
Which three components determine the shape of the term structure of interest rates?
real interest rate interest rate risk premium inflation premium
The term structure of interest rates examines the ______.
relationship between short-term and long-term interest rates
If a bond is issued with a call provision, it allows the issuer to ______ part or all of the bond at defined prices and times.
repurchase
What does the clean price for a bond represent?
the quoted price excluding accrued interest
What are the three components that influence the Treasury yield curve?
the real rate of return the interest rate risk premium expected future inflation
The term structure of interest rates describes ______.
the relationship between nominal rates and time to maturity the pure time value of money
The degree of interest rate risk depends on ______.
the sensitivity of the bond's price to interest rate changes
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
What is the purpose of a sinking fund?
to create a fund to repay bonds when they fall due
True or false: In general, the price that is paid for a bond will exceed its quoted price.
true
true or false: A put bond allows the holder to force the issuer to buy the bond back at a stated price.
true
It is the duty of the bond _______ to manage the sinking fund so that bonds can be repaid.
trustee
A debenture is a(n) ______ bond, for which no specific pledge of property is made.
unsecured
Which three of the following are common shapes for the term structure of interest rates?
upward sloping humped downward sloping
Most of the time, a floating-rate bond's coupon adjusts ______.
with a lag to some base rate
Bond ratings are based on the probability of default risk, which is the risk that ______.
the bond's issuer may not be able to make all the required payments
True or false: The government sells Treasury notes and bonds to the public every month.
true
