Chapter 6 Questions
The nominal rate is found by adding the _________ and the real rate of return.
inflation
Junk bonds have what features?
they are rated below investment grade bonds
If a $1,000 par value bond is trading at a premium, the bond is:
trading for more than $1,000 in the market
T/F: A put bond allows the holder to force the issuer to buy the bond back at a stated price.
true
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 sensitivity of a bond's price to interest rate changes is dependent on which two variables?
- time to maturity - coupon rate
What terms apply to a bond?
- time to maturity - par value - coupon rate
Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?
- treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer - treasury bonds are issued by the US government while corporate bonds are issued by corporations - treasury bonds are considered free of default risk while corporate bonds are exposed to default risk
The US government borrows money by issuing:
- treasury notes - treasury bonds
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
If you are in the 20% federal income tax bracket, what is your after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes.
5%
Crossover bonds can also be called __ bonds.
5B
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
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
A bond's coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
What is a bond's current yield?
annual coupon payment/price
What is a premium bond?
bond that sells for more than face value
What is a discount bond?
bonds are bonds that sell for less than the face value
When interest rates in the market rise, we can expect the price of bonds to ________.
decrease
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
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
The relationship between nominal rates, real rates and inflation is called ___ ______ ______.
the Fisher Effect
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 bonds - one with a 5% coupon rate and the other with an 8% coupon rate - which one is more sensitive to interest rate risk, all other things being equal?
the bond with a 5% coupon rate
What does the AAA rating assigned by S&P mean?
the firm is in a strong position to meet its debt obligations
T/F: Longer-term bonds have greater interest rate sensitivity because a large portion of a bond's value comes from the face amount.
true
T/F: Low-grade bonds may not be rated by major rating agencies.
true
A bond's ______ payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
coupon
What is a corporate bond's yield to maturity (YTM)?
- YTM is the expected return for an investor who buys the bond today and holds it to maturity - YTM is the prevailing market interest rate for bonds with similar features
Which of the following are bonds that have actually been issued?
- convertible bond - put bond - CoCo bond
What are the two unique features of a U.S. federal government bond?
- exempt from state income taxes - are considered to be default-free
A corporate bond's yield to maturity:
- is usually not the same as a bond's coupon rate - changes over time
What is true about a bond's face value?
- it is the principal amount repaid at maturity - it is also known as the par value
What is true of bonds?
- they are normally interest-only loans - they are issued by both corporations and governments
What four variables are required to calculate the value of a bond?
- time remaining to maturity - yield to maturity - par value - coupon rate
T/F: Current yield = Annual coupon payment/Price
true
If you are holding a municipal bond that is trading at par to yield 6%, by how much will your after-tax yield change if your federal income tax bracket increases from 15% to 20%. Assume there are no state or local taxes
0%
To find the total bond value, add the present value of the amount paid at maturity to the _______ _______ _____ of the annual coupon payments.
annuity present value
What are municipal bonds?
bonds that have been issued by state or local governments
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
T/F: Bond ratings are concerned only with the possibility of price changes
false
T/F: Bonds that have dropped into junk territory are called "trash" bonds.
false
T/F: The higher the coupon rate, the greater the interest rate risk, all other things being equal.
false
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 an BBB rating.
higher risk of default
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows _________.
increases
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 will happen to a bond's time to maturity as the years go by?
it will decline
The bonds of a firm in financial distress may have a market value that is ____ then the face value at maturity.
less
A zero-coupon bond is a bond that ______ __ ________ ________.
makes no interest payments
Which one of the following is the most important source of risk from owning bonds?
market interest rate fluctuations
Bonds issued by state and local governments are called _________ _____.
municipal bonds
What is true of zero coupon bonds?
no coupon payments are made on the bonds
What are the cash flows involved in the purchase of a 5-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 5 years
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
The degree of interest rate risk depends on ___ ___________ __ ___ ____'_ _____ __ ________ ____ _______.
the sensitivity of the bond's price to interest rate changes
T/F: All else being equal, a one-year bond's price is less sensitive to interest rate changes as compared to that of a ten-year bond's price.
true
Most of the time, a floating-rate bond's coupon adjusts _____ _ ___ __ ____ ____ _____.
with a lag to some base rate
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 variables is NOT required to calculate the value of a bond?
original issue price of bond
The coupon payments on floating-rate bonds are __________.
adjustable
T/F: The government sells Treasury notes and bonds to the public every month.
true
T/F: Zero coupon bond calculations use semiannual periods to be consistent with coupon bond calculations.
true