Ch 7 Conceptual Questions

76) The taxability risk premium compensates bondholders for which one of the following? A) Yield decreases in response to market changes B) Lack of coupon payments C) Possibility of default D) A bond's unfavorable tax status E) Decrease in a municipality's credit rating

D) A bond's unfavorable tax status

67) You are trying to compare the present values of two separate streams of cash flows that 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) Nominal rate minus the risk-free rate

D) Comparable real rate

13) 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.

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

64) Which one of the following rates represents the change, if any, in your purchasing power as a result of owning a bond? A) Risk-free rate B) Realized rate C) Nominal rate D) Real rate E) Current rate

D) Real rate

70) The Fisher effect is defined as the relationship between which of the following variables? A) Default risk premium, inflation risk premium, and real rates B) Nominal rates, real rates, and interest rate risk premium C) Interest rate risk premium, real rates, and default risk premium D) Real rates, inflation rates, and nominal rates E) Real rates, interest rate risk premium, and nominal rates

D) Real rates, inflation rates, and nominal rates

44) The break-even tax rate between a taxable corporate bond yielding 7 percent and a comparable nontaxable municipal bond yielding 5 percent can be expressed as: A) .05/(1 − t*) = .07. B) .05 − (1 − t*) = .07. C) .07 + (1 − t*) = .05. D) .05 (1 − t*) = .07. E) .05 (1 + t*) = .07.

A) .05/(1 − t*) = .07.

1) Allison just received the semiannual payment of $35 on a bond she owns. Which term refers to this payment? A) Coupon B) Face value C) Discount D) Call premium E) Yield

A) Coupon

72) Which one of the following premiums is compensation for the possibility that a bond issuer may not pay a bond's interest or principal payments as expected? A) Default risk B) Taxability C) Liquidity D) Inflation E) Interest rate risk

A) Default risk

68) Real rates are defined as nominal rates that have been adjusted for which of the following? A) Inflation B) Default risk C) Accrued interest D) Interest rate risk E) Both inflation and interest rate risk

A) Inflation

17) Which one of the following bonds is the least sensitive to interest rate risk? A) 3-year; 4 percent coupon B) 3-year; 6 percent coupon C) 5-year; 6 percent coupon D) 7-year; 6 percent coupon E) 7-year; 4 percent coupon

B) 3-year; 6 percent coupon

52) Al is retired and his sole source of income is his bond portfolio. Although he has sufficient principal to live on, he only wants to spend the interest income and thus is concerned about the purchasing power of that income. Which one of the following bonds should best ease Al's concerns? A) 6-year coupon bonds B) 5-year TIPS C) 20-year coupon bonds D) 5-year municipal bonds E) 7-year income bonds

B) 5-year TIPS

56) Which one of the following is the price at which a dealer will sell a bond? A) Call price B) Asked price C) Bid price D) Bid-ask spread E) Par value

B) Asked price

22) Which one of these statements is correct? A) Most long-term bond issues are referred to as unfunded debt. B) Bonds often provide tax benefits to issuers. C) The risk of a company financially failing decreases when the company issues bonds. D) All bonds are treated equally in a bankruptcy proceeding. E) A debenture is a senior secured debt.

B) Bonds often provide tax benefits to issuers.

34) A bond that can be paid off early at the issuer's discretion is referred to as being which type of bond? A) Par value B) Callable C) Senior D) Subordinated E) Unsecured

B) Callable

63) Today, June 15, you want to buy a bond with a quoted price of 98.64. The bond pays interest on January 1 and July 1. Which one of the following prices represents your total cost of purchasing this bond today? A) Clean price B) Dirty price C) Asked price D) Quoted price E) Bid price

B) Dirty price

33) A sinking fund is managed by a trustee for which one of the following purposes? A) Paying bond interest payments B) Early bond redemption C) Converting bonds into equity securities D) Paying preferred dividends E) Reducing bond coupon rates

B) Early bond redemption

2) Bert owns a bond that will pay him $45 each year in interest plus $1,000 as a principal payment at maturity. What is the $1,000 called? A) Coupon B) Face value C) Discount D) Yield E) Dirty price

B) Face value

46) Which one of the following risks would a floating-rate bond tend to have less of as compared to a fixed-rate coupon bond? A) Real rate risk B) Interest rate risk C) Default risk D) Liquidity risk E) Taxability risk

B) Interest rate risk

7) A $1,000 par value corporate bond that pays $60 annually in interest was issued last year. Which one of these would apply to this bond today if the current price of the bond is $996.20? A) The bond is currently selling at a premium. B) The current yield exceeds the coupon rate. C) The bond is selling at par value. D) The current yield exceeds the yield to maturity. E) The coupon rate has increased to 7 percent.

B) The current yield exceeds the coupon rate.

61) U. S. Treasury bonds: A) are highly illiquid. B) are quoted as a percentage of par. C) are quoted at the dirty price. D) pay interest that is federally tax-exempt. E) must be held until maturity.

B) are quoted as a percentage of par.

26) An example of a negative covenant that might be found in a bond indenture is a statement that the company: A) shall maintain a current ratio of 1.1 or higher. B) cannot lease any major assets without bondholder approval. C) must maintain the loan collateral in good working order. D) shall provide audited financial statements in a timely manner. E) shall maintain a cash surplus of $100,000 at all times.

B) cannot lease any major assets without bondholder approval.

73) The interest rate risk premium is the: A) additional compensation paid to investors to offset rising prices. B) compensation investors demand for accepting interest rate risk. C) difference between the yield to maturity and the current yield. D) difference between the market interest rate and the coupon rate. E) difference between the coupon rate and the current yield.

B) compensation investors demand for accepting interest rate risk.

49) Recently, you discovered a convertible, callable bond with a semiannual coupon of 5 percent. If you purchase this bond you will have the right to: A) force the issuer to repurchase the bond prior to maturity. B) convert the bond into equity shares. C) defer all taxable income until the bond matures. D) convert the bond into a perpetuity paying 5 percent. E) have the principal amount adjusted for inflation.

B) convert the bond into equity shares.

29) Road Hazards has 12-year bonds outstanding. The interest payments on these bonds are sent directly to each of the individual bondholders. These direct payments are a clear indication that the bonds can accurately be defined as being issued: A) at par. B) in registered form. C) in street form. D) as debentures. E) as callable bonds.

B) in registered form.

18) 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.

B) increases at a decreasing rate.

79) The yields on a corporate bond differ from those on a comparable Treasury security primarily because of: A) interest rate risk and taxes. B) taxes and default risk. C) default and interest rate risks. D) liquidity and inflation rate risks. E) default, inflation, and interest rate risks.

B) taxes and default risk.

57) If you sell a bond with a coupon of 6 percent to a dealer when the market rate is 7 percent, which one of the following prices will you receive? A) Call price B) Par value C) Bid price D) Asked price E) Bid-ask spread

C) Bid price

12) Which one of the following relationships applies to a par value bond? A) Yield to maturity > Current yield > Coupon rate B) Coupon rate > Yield to maturity > Current yield C) Coupon rate = Current yield = Yield to maturity D) Coupon rate < Yield to maturity < Current yield E) Coupon rate > Current yield > Yield to maturity

C) Coupon rate = Current yield = Yield to maturity

75) Which one of the following risk premiums compensates for the inability to easily resell a bond prior to maturity? A) Default risk B) Taxability C) Liquidity D) Inflation E) Interest rate risk

C) Liquidity

28) Which one of these is most apt to be included in a bond's indenture one year after the bond has been issued? A) Current yield B) Written record of all the current bond holders C) List of collateral used as bond security D) Current market price E) Price at which a bondholder can resell a bond to another bondholder

C) List of collateral used as bond security

20) 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

C) Long-term; zero coupon

48) Last year, you purchased a TIPS at par. Since that time, both market interest rates and the inflation rate have increased by .25 percent. Your bond has most likely done which one of the following since last year? A) Decreased in value due to the change in inflation rates B) Experienced an increase in its bond rating C) Maintained a fixed real rate of return D) Increased in value in response to the change in market rates E) Increased in value due to a decrease in time to maturity

C) Maintained a fixed real rate of return

24) Last year, Lexington Homes issued $1 million in unsecured, noncallable debt. This debt pays an annual interest payment of $55 and matures six years from now. The face value is $1,000 and the market price is $1,020. Which one of these terms correctly describes a feature of this debt? A) Semiannual coupon B) Discount bond C) Note D) Trust deed E) Collateralized

C) Note

39) Which one of the following statements concerning bond ratings is correct? A) Investment grade bonds are rated BB or higher by Standard & Poor's. B) Bond ratings assess both interest rate risk and default risk. C) Split-rated bonds are called crossover bonds. D) The highest rating issued by Moody's is AAA. E) A "fallen angel" is a term applied to all "junk" bonds.

C) Split-rated bonds are called crossover bonds.

14) Round Dot Inns is preparing a bond offering with a coupon rate of 6 percent, paid semiannually, and a face value of $1,000. The bonds will mature in 10 years and will be sold at par. Given this, which one of the following statements is correct? A) The bonds will become discount bonds if the market rate of interest declines. B) The bonds will pay 10 interest payments of $60 each. C) The bonds will sell at a premium if the market rate is 5.5 percent. D) The bonds will initially sell for $1,030 each. E) The final payment will be in the amount of $1,060.

C) The bonds will sell at a premium if the market rate is 5.5 percent.

78) Which one of the following statements is false concerning the term structure of interest rates? A) Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates. B) The term structure of interest rates includes both an inflation premium and an interest rate risk premium. C) The term structure of interest rates and the time to maturity are always directly related. D) The real rate of return has minimal, if any, effect on the slope of the term structure of interest rates. E) The interest rate risk premium increases as the time to maturity increases.

C) The term structure of interest rates and the time to maturity are always directly related.

21) A premium bond that pays $60 in interest annually matures in seven years. The bond was originally issued three years ago at par. Which one of the following statements is accurate in respect to this bond today? A) The face value of the bond today is greater than it was when the bond was issued. B) The bond is worth less today than when it was issued. C) The yield to maturity is less than the coupon rate. D) The coupon rate is less than the current yield. E) The yield to maturity equals the current yield.

C) The yield to maturity is less than the coupon rate.

62) A six-year, $1,000 face value bond issued by Taylor Tools pays interest semiannually on February 1 and August 1. Assume today is October 1. What will be the difference, if any, between this bond's clean and dirty prices today? A) No difference B) One months' interest C) Two months' interest D) Four months' interest E) Five months' interest

C) Two months' interest

53) Kurt has researched T-Tek and believes the firm is poised to vastly increase in value. He has decided to purchase T-Tek bonds as he needs a steady stream of income. However, he still wishes that he could share in the firm's success along with the shareholders. Which one of the following bond features will help him fulfill his wish? A) Put provision B) Positive covenant C) Warrant D) Crossover rating E) Call provision

C) Warrant

9) All else constant, a bond will sell at ________ when the coupon rate is ________ the yield to maturity. A) a premium; less than B) a premium; equal to C) a discount; less than D) a discount; higher than E) par; less than

C) a discount; less than

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

C) are considered to be free of default risk.

30) A bond that is payable to whomever has physical possession of the bond is said to be in: A) new-issue condition. B) registered form. C) bearer form. D) debenture status. E) collateral status.

C) bearer form.

35) A $1,000 face value bond can be redeemed early at the issuer's discretion for $1,030, plus any accrued interest. The additional $30 is called the: A) dirty price. B) redemption value. C) call premium. D) original-issue discount. E) redemption discount.

C) call premium.

59) A bond is quoted at a price of $1,011. This price is referred to as the: A) call price. B) face value. C) clean price. D) dirty price. E) maturity price.

C) clean price.

16) The price sensitivity of a bond increases in response to a change in the market rate of interest as the: A) coupon rate increases. B) time to maturity decreases. C) coupon rate decreases and the time to maturity increases. D) time to maturity and coupon rate both decrease. E) coupon rate and time to maturity both increase.

C) coupon rate decreases and the time to maturity increases.

3) A discount bond's coupon rate is equal to the annual interest divided by the: A) call price. B) current price. C) face value. D) clean price. E) dirty price.

C) face value.

6) The current yield is defined as the annual interest on a bond divided by the: A) coupon rate. B) face value. C) market price. D) call price. E) par value.

C) market price.

4) A bond's principal is repaid on the ________ date. A) coupon B) yield C) maturity D) dirty E) clean

C) maturity

43) Municipal bonds: A) are totally risk free. B) generally have higher coupon rates than corporate bonds. C) pay interest that is federally tax free. D) are rarely callable. E) are free of default risk.

C) pay interest that is federally tax free.

71) The pure time value of money is known as the: A) liquidity effect. B) Fisher effect. C) term structure of interest rates. D) inflation factor. E) interest rate factor.

C) term structure of interest rates.

23) Hot Foods has an investment-grade bond issue outstanding that pays $30 semiannual interest payments. The bonds sell at par and are callable at a price equal to the present value of all future interest and principal payments discounted at a rate equal to the comparable Treasury rate plus .50 percent. Which one of the following correctly describes this bond? A) The bond rating is B. B) Market value is less than face value. C) The coupon rate is 3 percent. D) The bond has a "make whole" call price. E) The interest payments are variable.

D) The bond has a "make whole" call price.

32) A note is generally defined as: A) a secured bond with an initial maturity of 10 years or more. B) a secured bond that initially matures in less than 10 years. C) any bond secured by a blanket mortgage. D) an unsecured bond with an initial maturity of 10 years or less. E) any bond maturing in 10 years or more.

D) an unsecured bond with an initial maturity of 10 years or less.

47) The collar of a floating-rate bond refers to the minimum and maximum: A) call periods. B) maturity dates. C) market prices. D) coupon rates. E) yields to maturity.

D) coupon rates.

60) Rosita paid a total of $1,189, including accrued interest, to purchase a bond that has 7 of its initial 20 years left until maturity. This price is referred to as the: A) quoted price. B) spread price. C) clean price. D) dirty price. E) call price.

D) dirty price.

42) Treasury bonds are: A) issued by any governmental agency in the U.S. B) issued only on the first day of each fiscal year by the U.S. Department of Treasury. C) bonds that offer the best tax benefits of any bonds currently available. D) generally issued as semiannual coupon bonds. E) totally risk free.

D) generally issued as semiannual coupon bonds.

15) A newly issued bond has a coupon rate of 7 percent and semiannual interest payments. The bonds are currently priced at par. The effective annual rate provided by these bonds must be: A) 3.5 percent. B) greater than 3.5 percent but less than 7 percent. C) 7 percent. D) greater than 7 percent. E) less than 3.5 percent.

D) greater than 7 percent.

45) A zero coupon bond: A) is sold at a large premium. B) pays interest that is tax deductible to the issuer at the time of payment. C) can only be issued by the U.S. Treasury. D) has more interest rate risk than a comparable coupon bond. E) provides no taxable income to the bondholder until the bond matures.

D) has more interest rate risk than a comparable coupon bond.

66) The Fisher effect primarily emphasizes the effects of ________ on an investor's rate of return. A) default B) market movements C) interest rate changes D) inflation E) the time to maturity

D) inflation

10) DLQ Inc. bonds mature in 12 years and have a coupon rate of 6 percent. If the market rate of interest increases, then the: A) coupon rate will also increase. B) current yield will decrease. C) yield to maturity will be less than the coupon rate. D) market price of the bond will decrease. E) coupon payment will increase.

D) market price of the bond will decrease.

36) A deferred call provision: A) requires the bond issuer to pay the current market price, minus any accrued interest, should the bond be called. B) allows the bond issuer to delay repaying a bond until after the maturity date should the issuer so opt. C) prohibits the issuer from ever redeeming bonds prior to maturity. D) prohibits the bond issuer from redeeming callable bonds prior to a specified date. E) requires the bond issuer pay a call premium that is equal to or greater than one year's coupon should the bond be called.

D) prohibits the bond issuer from redeeming callable bonds prior to a specified date.

5) The bond market requires a return of 9.8 percent on the 5-year bonds issued by JW Industries. The 9.8 percent is referred to as the: A) coupon rate. B) face rate. C) call rate. D) yield to maturity. E) current yield.

D) yield to maturity.

51) Nadine is a retired widow who is financially dependent upon the interest income produced by her bond portfolio. Which one of the following bonds is the least suitable for her to own? A) 6-year, high-coupon, put bond B) 5-year TIPS C) 10-year AAA coupon bond D) 5-year floating rate bond E) 7-year income bond

E) 7-year income bond

11) Which one of the following applies to a premium bond? A) Yield to maturity > Current yield > Coupon rate B) Coupon rate = Current yield = Yield to maturity C) Coupon rate > Yield to maturity > Current yield D) Coupon rate < Yield to maturity < Current yield E) Coupon rate > Current yield > Yield to maturity

E) Coupon rate > Current yield > Yield to maturity

31) Jason's Paints just issued 20-year, 7.25 percent, unsecured bonds at par. These bonds fit the definition of which one of the following terms? A) Note B) Discounted C) Zero-coupon D) Callable E) Debenture

E) Debenture

77) Which bond would you generally expect to have the highest yield? A) Risk-free Treasury bond B) Nontaxable, highly liquid bond C) Long-term, high-quality, tax-free bond D) Short-term, inflation-adjusted bond E) Long-term, taxable junk bond

E) Long-term, taxable junk bond

65) Which one of the following statements is correct? A) The risk-free rate represents the change in purchasing power. B) Any return greater than the inflation rate represents the risk premium. C) Historical real rates of return must be positive. D) Nominal rates exceed real rates by the amount of the risk-free rate. E) The real rate must be less than the nominal rate given a positive rate of inflation.

E) The real rate must be less than the nominal rate given a positive rate of inflation.

8) Which one of these equations applies to a bond that currently has a market price that exceeds par value? A) Market value < Face value B) Yield to maturity = Current yield C) Market value = Face value D) Current yield > Coupon rate E) Yield to maturity < Coupon rate

E) Yield to maturity < Coupon rate

19) You own a bond that pays an annual coupon of 6 percent that matures five years from now. You purchased this 10-year bond at par value when it was originally issued. Which one of the following statements applies to this bond if the relevant market interest rate is now 5.8 percent? A) The current yield to maturity is greater than 6 percent. B) The current yield is 6 percent. C) The next interest payment will be $30. D) The bond is currently valued at one-half of its issue price. E) You will realize a capital gain on the bond if you sell it today.

E) You will realize a capital gain on the bond if you sell it today.

54) A bond that has only one payment, which occurs at maturity, defines which one of these types of bonds? A) Debenture B) Callable C) Floating-rate D) Junk E) Zero coupon

E) Zero coupon

27) Protective covenants: A) apply to short-term debt issues but not to long-term debt issues. B) only apply to privately issued bonds. C) are a feature found only in government-issued bond indentures. D) only apply to bonds that have a deferred call provision. E) are primarily designed to protect bondholders.

E) are primarily designed to protect bondholders.

37) A call-protected bond is a bond that: A) is guaranteed to be called. B) can never be called. C) is currently being called. D) is callable at any time. E) cannot be called at this point in time.

E) cannot be called at this point in time.

50) Samantha owns a reverse convertible bond. At maturity, the principal amount will be repaid in: A) shares of stock. B) cash while the interest is paid in shares of stock. C) the form of a newly issued bond. D) either shares of stock or a newly issued bond. E) either cash or shares of stock.

E) either cash or shares of stock.

25) Callable bonds generally: A) grant the bondholder the option to call the bond any time after the deferment period. B) are callable at par as soon as the call-protection period ends. C) are called when market interest rates increase. D) are called within the first three years after issuance. E) have a sinking fund provision.

E) have a sinking fund provision.

40) 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) being a premium bond to being a discount bond. D) senior status to junior status for liquidation purposes. E) investment grade to speculative grade.

E) investment grade to speculative grade.

69) Interest rates that include an inflation premium are referred to as: A) annual percentage rates. B) stripped rates. C) effective annual rates. D) real rates. E) nominal rates.

E) nominal rates.

38) The items included in an indenture that limit certain actions of the issuer in order to protect a bondholder's interests are referred to as the: A) trustee relationships. B) bylaws. C) legal bounds. D) trust deed. E) protective covenants.

E) protective covenants.

58) The difference between the price that a dealer is willing to pay and the price at which he or she will sell is called the: A) equilibrium. B) premium. C) discount. D) call price. E) spread.

E) spread.

55) A highly illiquid bond that pays no interest but might entitle its holder to rental income from an asset is most apt to be a: A) NoNo bond. B) put bond. C) contingent callable bond. D) structured note. E) sukuk.

E) sukuk.

74) A Treasury yield curve plots Treasury interest rates relative to: A) market rates. B) comparable corporate bond rates. C) the risk-free rate. D) inflation rates. E) time to maturity.

E) time to maturity.