Business Finance Chapter 6
What does the dirty price represent?
it includes the quoted price and accrued interest
What is a bond's current yield?
=annual coupon payment/ current price
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
In general, the price that is paid for a bond will exceed its quoted price.
True
Investors require a premium for the risk that issuers other than the Treasury may not make all promised payments on the issued bonds.
True
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 are some features of the OTC market for bonds?
The OTC has no designated physical location. OTC dealers are connected electronically.
The bid-ask spread represents the
dealer's profit
A zero coupon bond is a bond that
makes no interest payments
A put bond allows the holder to force the issuer to buy the bond back at a stated price.
true
The government sells Treasury notes and bonds to the public every month.
true
Which of the following are bonds that have actually been issued?
a convertible bond a put bond a CoCo bond
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
What four variables are required to calculate the value of a bond?
yield to maturity par value time remaining to maturity coupon rate
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.
The nominal rate is found by adding the Blank______ and the real rate of return.
inflation
Which of the following are true of bonds?
They are normally interest-only loans and they are issued by both corporations and governments.
The U.S. government borrows money by issuing
Treasury bonds, and treasury notes.
Indentures and loan agreements often contain protective covenants designed to protect the interests of Blank______.
lenders
indentures and loan agreements often contain protective covenants designed to protect the interests of Blank______.
lenders
What is the bid price?
-It is the price an investor will receive if he sells a bond to a dealer -It is the price at which a dealer is willing to buy securities
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
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
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. The interest on municipal bonds is exempt from federal taxes. They are issued by state and local governments.
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.
A sukuk is in compliance with the Islamic law as the financing instrument is not charging any blank 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.
What is a bond's accrued interest?
It is interest that has been earned but not yet received by the current bondholder
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.
What are the three components that influence the Treasury yield curve?
expected future inflation the real rate of return the interest rate risk premium
Equity represents a(n) interest of a firm.
ownership
A sukuk is a contract that is related to:
Islamic law. riba.
What does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
Current yield = Annual coupon payment/Price
True
Long-term debt has maturities greater than one year.
True
Which of the following are usually included in a bond's indenture?
the repayment arrangements the total amount of bonds issued
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?
coupon rate time to maturity
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows
increases
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows Blank______.
increases
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
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 bond is issued with a blank provision it allows the issuer to repurchase part or all of the bond at defined prices and time
call
When interest rates in the market rise, we can expect the price of bonds to
decrease
A limitation of bond ratings is that they
focus exclusively on default risk
A limitation of bond ratings is that they Blank______.
focus exclusively on default risk
A bond with a BB rating has a Blank______ than a bond with a BBB rating.
higher risk of default
Which of the following variables is not required to calculate the value of a bond?
original issue price of bond
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 blank the lender's interests.
protect
A part of the indenture limiting certain actions during the term of the loan are termed Blank______.
protective covenants
What are the two major forms of long-term debt?
public issue and private issue
If a bond is issued with a call provision, it allows the issuer to Blank______ part or all of the bond at defined prices and times.
repurchase
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 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.
If a $1,000 face value U.S. Treasury bond is quoted at 99.5, then the bond can be purch
at 99.5 percent of face value plus any accrued interest
The coupon payments on floating-rate bonds are
adjustable
Most of the time, a floating-rate bond's coupon adjusts
with a lag to some base rate
A corporate bond's yield to maturity:
- is usually not the same as a bond's coupon rate - changes over time
The term structure of interest rates describes
- the relationship between nominal rates and time to maturity - the pure time value of money
Bond ratings are concerned only with the possibility of price changes.
False
Bonds issued by state and local governments are called
municipal bonds
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 are municipal bonds?
Bonds that have been issued by state or local governments
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately.
What is the purpose of a sinking fund?
to create a fund to repay bonds when they fall due
It is the duty of the bond blank to manage the sinking fund so that bonds can be repaid.
trustee
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
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.