FINC Ch6 Smartbook

Which of the following are steps bondholders can take to minimize default risk?

Protective covenants Security Seniority

Which debt is paid first in the event of bankruptcy?

Senior Debt

Which of the following sell bonds?

State and local governments U.S. Treasury Corporations

A bond that is priced below its face value is said to sell for

a discount

A bond that is priced above its face value is said to sell for

a premium

The current yield on a bond is equal to

annual coupon payment divided by bond price

A $100,000 bond quoted at 120% will sell for

$120,000 Reason: $100,000 x 1.20 = $120,000

A company issues a $5,000 bond that matures in 5 years with a coupon rate of 6% and a current interest rate of 6%. The bond will sell for

$5,000 Reason: When the bond coupon rate and the interest rate are the same, the bond will sell for face value. No calculations are necessary.

A company issues a $1,000 bond with a coupon rate of 6% that matures in 5 years. The current interest rate is 7%. How much will the bond issue sell for?

$959 Reason: Present value of the interest payments = $1,000 x .06 = 60 x [1-(1/(1.07)^5]/.07 = $246.0118462 Present value of the face amount of the bond = $1,000/(1.07)^5 = $712.9861795 Add the present value of the interest to the present value of the face of the bond = $958.998

Marley Corporation's bonds have four years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 5%. If the price of the bond is $841.51, the yield to maturity is _____. (Use trial and error to calculate yield).

10% Reason: First, calculate the coupon payment: $1,000 x .05 = $50. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $841.51. You will see that by doing trial and error on the 4 given yields in the multiple choice question (5%, 8%, 10%, and 12%), the correct yield is 10%: $841.51 = $50/(1+.1) + $50/(1+.1)22+ $50/(1+.1)33+ $1,050/(1.1)4

An individual invested $1,000 in a bond with a coupon payment of $12. The price of the bond increased to $1,400. What is the rate of return on this bond?

41.2% Reason: Rate of return=(coupon income + price change)/investment= ($12+$400)/$1,000=.412 or 41.2%

Mortor's Corporation sold 6 year bonds for $1,072.62, with a face value of $1,000 and a coupon rate of 8%. The annual yield to maturity is

6.5% Reason: First, calculate the coupon payment: $1,000 x .08 = $80. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $1,072.62. You will see that by doing trial and error on the 4 given yields in the multiple choice question (6%, 6.5%, 7%, and 7.5%), the correct yield is 6.5%: $1,072.62 = $80/(1+.065) + $80/(1+.065)22+ $80/(1+.065)33+ $80/(1.+.065)44+ $80/(1 + .065)55+ $1,080/(1+.065)6

If the nominal rate of interest is 10% and the rate of inflation is 3%, the real interest rate is ____.

6.8% Reason: 1 + real interest rate = (1 +.1)/(1 +.03) = 1.068 - 1 = .068 or 6.8%

You pay $1,200 for a bond and receive an annual coupon payment of $100. The current yield on the bond is _____.

8.33% Reason: Current yield= annual coupon payment/bond price = $100/$1,200 = .0833 or 8.33%

Which of the following are not plain vanilla bonds?

Floating-rate Bonds Zero-coupon Bonds Convertible Bonds

The price of a bond is equal to the

PV(coupon) plus PV(face value)

What is the term used in finance to represent simple, standard, and common?

Plain vanilla

Even when the yield curve of a long-term bond is upward-sloping some investors prefer short-term bonds. Which of the following reasons would explain why this statement is true?

Prices of long-term bonds fluctuate more than prices of short-term bonds Short-term investors can profit if interest rates rise

The U.S. Treasury issues ___________, which adjust nominal cash flows based on the consumer price index.

TIPS Reason: Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds that adjust nominal cash flows based on changes in the consumer price index.

The _________ measures the return to investors if they buy a bond at the asked price and hold it to maturity.

asked yield to maturity

The purchaser of a bond pays the ______ price, whereas the investor who already owns the bond and sells it receives the ________ price.

asked, bid

Corporate debt depends on the value and the risk of the firm's

assets

Governments and corporations borrow money by selling _______ to investors.

bonds

Secured debt is tied to specific assets, called ______.

collateral

Which type of bond generally offers the highest yield?

corporate

The interest payments to the bondholder are called the

coupon

A bond's _______ is fixed, but the present value is affected by changes in the ________.

coupon payment, interest rate

The _______ is the annual interest payment on a bond, expressed as a percentage of face value.

coupon rate

Limitation or subordination of new debt is a form of a protective _____ on existing debt.

covenant

Bonds are defined as

debt securities

The additional yield on a bond that investors require for bearing default risk is known as

default premium

The risk that a bond issuer may not pay on its bonds in known as

default risk

The payment made when a bond matures is called the bond's:

face value

When the coupon rate of a bond is equal to the current interest rate, the bond will sell for

face value

When interest rates rise, bond prices

fall

If interest rates fall, the rate of return on a bond will be _____ the yield to maturity.

greater than

The banking crisis of 2007-2009 shows that investors prefer ________ in bonds; therefore, heavily traded bonds offer ________ yields.

higher liquidity, lower

When the interest rate is lower than the coupon rate on a bond, the price of the bond will be:

higher than face value Reason: Take, for example, a 5 year, $1,000 bond offering a 10% coupon. If the interest rate is less than the coupon rate - for example, if the interest rate is 5%, the PV of the bond would be: $100/(1.05)^1 + $100/(1.05)^2 + $100/(1.05)^3 + $100/(1.05)^4 + $1,100/(1.05)^5 = $1,216.47 - a higher price than the $1,000 face value.

Long-term bond prices are more sensitive than short-term bond prices to

increases in interest rates

Which type of bond links coupon payments to inflation?

indexed bonds

Because the _____ rate is uncertain, so is the _______ rate of interest offered on bonds.

inflation, real

The __________ on government bonds provide a benchmark for all interest rates.

interest rates

Bonds rated Baa or above by Moody's or BBB or above by Standard & Poors are known as

investment grade bonds

Bonds rated Ba or below by Moody's or BB and below by Standard & Poors are known as

junk bonds

If interest rates rise, the rate of return on a bond will be _____ the yield to maturity.

less than

When the interest rate is higher than a bond's coupon rate, the bond will be priced at:

less than face value Reason: Take, for example, a 5 year, $1,000 bond offering a 10% coupon. If the interest rate is higher than the coupon rate - for example, if the interest rate is 12%, the PV of the bond would be: $100/(1.12)^1 + $100/(1.12)^2 + $100/(1.12)^3 + $100/(1.12)^4 + $1,100/(1.12)^5 = $927.90 - a lower price than the $1,000 face value.

The yield to maturity assumes the bond is held to _____.

maturity

A bond can also be called a:

note debenture

The price of a bond can be quoted as a _____ of face value.

percentage

Conditions imposed on borrowers to protect lenders from unreasonable risk are known as

protective covenants

The total income per period per dollar invested is known as the

rate of return

When interest rates fall, bond prices

rise

When a firm puts up collateral assets to back up a loan, the debt is said to be:

secured

Investors looking to minimize risk will hold which type of debt?

senior

The difference between the bid price and the asked price of a bond is the _______.

spread

For bonds priced at face value, the rate of return is

the coupon rate

A graph of the yield curve shows the bond yield to maturity on the _____ axis and the time to maturity on the _____ axis.

vertical, horizontal

A plot drawn to show the relationship between bond yields and maturity is known as the

yield curve

A measure of return that takes account of both coupon payments and change in a bond's value over its life is a standard measure known as

yield to maturity

The discount rate that makes the present value of the bond's payments equal to its price is known as the

yield to maturity

The discount rate that makes the present value of the bond's payments equal to its price is known as the Multiple choice question. yield to maturity

yield to maturity