Business Finance Exam 2 Ch 7

As a bond's time to maturity increases, the bond's sensitivity to interest rate risk: A. increases at an increasing rate. B. increases at a decreasing rate. C. increases at a constant rate. D. decreases at an increasing rate. E. decreases at a decreasing rate.

Answer: B. increases at a decreasing rate

Which of the following statements is correct concerning the term structure of interest rates? I. Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates. II. The term structure of interest rates includes both an inflation premium and an interest rate risk premium. III. The real rate of return has minimal, if any, affect on the slope of the term structure of interest rates. IV. The term structure of interest rates and the time to maturity are always directly related. A. I and II only B. II and IV only C. I, II, and III only D. II, III, and IV only E. I, II, and IV only

Answer: C. I, II, and III only

Which of these markets is the most active? a. The market for a small stock. b. The market for a corporate bond. c. The market for Treasury bonds. d. The market for pork bellies. e. The market for rare coins.

Answer: C. The market for Treasury bonds.

All else constant, a coupon bond that is selling at a premium, must have: a. a coupon rate that is equal to the yield to maturity. b. a market price that is less than par value. c. semi-annual interest payments. d. a yield to maturity that is less than the coupon rate. e. a coupon rate that is less than the yield to maturity.

Answer: D. a yield to maturity that is less than the coupon rate

The price a buyer actually pays to purchase a bond is called the _____ price. a. coupon b. spread c. clean d. dirty e. retail

Answer: D. dirty

Currently, the bond market requires a return of 11.6 percent on the 10-year bonds issued by Winston Industries. The 11.6 percent is referred to as which one of the following? A. coupon rate B. face rate C. call rate D. yield to maturity E. interest rate

Answer: D. yield to maturity

You are trying to compare the present values of two separate streams of cash flows which have equivalent risks. One stream is expressed in nominal values and the other stream is expressed in real values. You decide to discount the nominal cash flows using a nominal annual rate of 8 percent. What rate should you use to discount the real cash flows? A. 8 percent B. EAR of 8 percent compounded monthly C. comparable risk-free rate D. comparable real rate E. You cannot compare the present values of these two streams of cash flows.

Answer: D.comparable real rate

All else constant, a bond will sell at _____ when the yield to maturity is _____ the coupon rate. a. a premium; higher than b. a premium; equal to c. at par; higher than d. at par; less than e. a discount; higher than

Answer: E. a discount; higher than

Protective covenants: a. are primarily designed to protect the issuing corporation from unreasonable demands of bondholders. b. are consistent for all bonds issued by a corporation within the United States. c. are limited to stating actions which a firm must take. d. only apply to bonds that have a deferred call provision. e. are primarily designed to protect bondholders from future actions of the bond issuer.

Answer: E. are primarily designed to protect bondholders from future actions of the bond issuer

Parts of the indenture limiting certain actions that might be taken during the term of the loan to protect the interests of the lender are called: a. trustee relationships. b. sinking funds provisions. c. bond ratings. d. deferred call provisions. e. protective covenants.

Answer: E. protective covenants

The items included in a bond indenture that limit certain actions of the issuer in order to protect bondholder's interests are referred to as the: A. trustee relationships. B. bylaws. C. legal bounds. D. "plain vanilla" conditions. E. protective covenants.

Answer: E. protective covenants

The _____ premium is that portion of a nominal interest rate or bond yield that represents compensation for the possibility of nonpayment by the bond issuer. a. default risk b. taxability c. liquidity d. inflation e. interest rate risk

Answer: A. default risk

The written, legally binding agreement between the corporate borrower and the lender detailing the terms of a bond issue is called the: a. indenture. b. covenant. c. terms of trade. d. form 5140. e. call provision.

Answer: A. indenture

A bond that can be paid off early at the issuer's discretion is referred to as being which one of the following? A. zero coupon B. callable C. senior D. collateralized E. unsecured

Answer: B. callable

The annual coupon payment divided by the market price of a bond is called the: a. coupon rate. b. current yield. c. yield to maturity. d. bid-ask spread. e. capital gains yield.

Answer: B. current yield

A bond that is payable to whomever has physical possession of the bond is said to be: A. a new-issue. B. registered. C. a bearer bond. D. a debenture. E. collateralized.

Answer: C. a bearer bond

Bonds issued by the U.S. government: A. are considered to be free of interest rate risk. B. generally have higher coupons than those issued by an individual state. C. are considered to be free of default risk. D. pay interest that is exempt from federal income taxes. E. are called "munis".

Answer: C. are considered to be free of default risk

A bond is quoted at a price of $989. This price is referred to as which one of the following? A. call price B. face value C. clean price D. dirty price E. wholesale price

Answer: C. clean price

You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur? A. short-term; low coupon B. short-term; high coupon C. long-term; zero coupon D. long-term; low coupon E. long-term; high coupon

Answer: C. long-term; zero coupon

The relationship between nominal interest rates on default-free, pure discount securities and the time to maturity is called the: a. liquidity effect. b. Fisher effect. c. term structure of interest rates. d. inflation premium. e. interest rate risk premium.

Answer: C. term structure of interest rates

Credit ratings: A. measure relative default risk; i.e., AAA-rated corresponds to 'least likely to default,' not to 'has an X% chance of default.' B. are provided by ratings agencies (e.g., S&P) and paid for by investors. C. are broadly divided up into 'investment grade' and 'speculative grade' or 'junk bonds.' D. A and C. E. all of the above.

Answer: D. A and C

Which one of the following relationships is stated correctly? A. The coupon rate exceeds the current yield when a bond sells at a discount. B. The call price must equal the par value. C. An increase in market rates increases the market price of a bond. D. Decreasing the time to maturity increases the price of a discount bond, all else constant. E. Increasing the coupon rate decreases the current yield, all else constant.

Answer: D. Decreasing the time to maturity increases the price of a discount bond, all else constant.

A U.S. Treasury bond that is quoted at 100:11 is selling: A. for 11 percent more than par value. B. at an 11 percent discount. C. for 100.11 percent of face value. D. at par and pays an 11 percent coupon. E. for 100 and 11/32nds percent of face value.

Answer: E. for 100 and 11/32nds percent of face value.

A 'fallen angel' is a bond that has moved from: A. being publicly traded to being privately traded. B. being a long-term obligation to being a short-term obligation. C. having a yield-to-maturity in excess of the coupon rate to having a yield-to- maturity that is less than the coupon rate. D. senior status to junior status for liquidation purposes. E. investment grade to speculative grade.

Answer: E. investment grade to speculative grade

In the event of default, _____ debt holders must give preference to more _____ debt holders in the priority of repayment distributions. a. short-term; long-term b. long-term; short-term c. senior; junior d. senior; subordinated e. subordinated; senior

Answer: E. subordinated; senior