Chapter 7 Question Bank

all junk bonds typically have which of these features?

high probability of default; less than investment-grade rating

a corporation issues 50,000 bonds at $1,000 each. The bonds mature in 5 years and have a coupon rate of 7%. What will be the total annual interest expense for the corporation?

$3.5 million

what is the present value of the annual interest payments on a 20 year, $1,000 par value bond with a 5% coupon paid annually, if the yield on similar bonds is 10%?

$425.68

assume a bond has a $1,000 par value, a coupon rate of 6%, annual interest payments, and seven years to maturity. If the yield on similar bonds is 8%, what is the current market value of this bond?

$895.87

if the rate of inflation is 3% and the real rate of return is 9%, the nominal rate is approximately ___.

12%

in terms of time to maturity, U.S. Treasury notes and bonds have initial maturities ranging from ___ years.

2 to 30 years

use your calculator to find the YTM on a 20-year, $1,000 par value bond that pays coupons of 4.5% semi-annually and currently sells for $1, 104.89.

3.75%

if you are in the 15% federal tax bracket, what will be your after-tax yield on a US treasury bond that is currently priced at par and yielding 5%?

4.25%

what will your after-tax yield be on a corporate bond that is currently priced to yield 7% if you are in the 25% tax bracket?

5.25%

what is a bond's current yield?

Annual Coupon Payment / Current Price

which of the following is not a difference between debt and equity?

Equity is publicly traded while debt is not.

the major difference between Western financial practice and Islamic law is that Islamic law does not permit charging or paying interest. TRUE or FALSE.

TRUE

which of the following are common protective covenants?

The firm must maintain working capital at or above a specified level; The firm must limit dividends to equity holders; The firm cannot merge with any other firm

a bond has a quoted price of $984.63, a face value of $1,000, a semi annual coupon of $20, in the maturity of 10 years. match its current yield and its YTM below.

YTM = 4.11% <---> Current yield = 4.06%

what is a corporate bond's yield to maturity (YTM)?

YTM is the expected return for an investor who buys the bond today and hold it to maturity; YTM is the prevailing market interest rate for bonds with similar features

what is a premium bond?

a bond that sells for more than face value

a bond's YTM will exceed its current yield when the bond is selling at ___.

a discount

which quote, asked or bid, would an investor expect to pay if he or she was buying a bond?

bid

which two prices can be found in the Wall Street journal daily treasury bond listing?

bid price; asked price

the amount by which the call Price exceeds the par value of the bond is called ___?

call Premium

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.

as a maturity of a bond increases, interest rate risk ___.

decreases at a decreasing rate

the liquidity premium compensates investors based on the bond's ___.

degree of marketability

what are three important features of treasury notes and bonds?

highly liquid; taxable; default-free

assume you own a bond currently valued at $989. If the market rate of interest drops, the bonds current market value will ___.

increase

a bond's yield to maturity considers the interest earnings and the change in the bond's price while the current yield considers ___.

interest earnings only

the federal government can raise money from financial markets to finance its deficits by ___.

issuing bonds

which of the following is true about a multi-year typical bond's coupon?

it is a fixed annuity payment.

what is the definition of a bond's time to maturity?

it is the number of years until the face value is due to be repaid.

what will happen to the default risk premium during periods of economic uncertainty?

it will increase

what is an interest-only loan?

it's a loan in which the borrower pays interest periodically and repay the principal when the bond matures.

why is the bond market less transparent than the stock market?

many bond transactions are negotiated privately.

which one of the following is the most important source of risk from owning bonds?

market interest rate fluctuations

which of the following variables are required to calculate the value of a bond?

market yield; remaining life of bond; coupon rate

the default risk premium refers to the extra compensation demanded by investors for the possibility that the issuer might ___.

not make all the promised payments

which of these is included in the calculation of a bond's yield to maturity?

par value; current price; coupon rate

how is APR computed?

rate per period x number of periods per year

if a given set of cash flows expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ___ rate.

real

when the term structure of interest rates is downward-sloping, ___.

short-term rates are higher than long-term rates

if you are holding two identical bonds, except that one matures in 10 years and the other matures in five years, which bonds price will be more sensitive to interest rate risk?

the 10-year bond

what is the bid price?

the bid is the price at which a dealer is willing to buy securities.

why does the bonds value fluctuate over time?

the coupon rate and par value are fixed, while market interest rates change

which of the following institutions issue bonds that are traded in the bond market?

the federal government; state governments; public corporations

if you own corporate bonds, you will be concerned about interest rate risk as it affects ___.

the market price of the bonds

which of the following are usually included in a bond's indenture?

the repayment arrangements; the total amount of bonds issued

when the US government wants to borrow money for the long-term (more than one year) it issues ___.

treasury bonds; treasury notes

if you invest in a corporate bond, how many times can you expect, in general, to receive interest?

twice a year

if you purchase the bond costing $1,143 with par value of $1,000 that pays a semi-annual coupon of 5%, how much will each coupon payment be?

$25

if you invest in a $1,000 corporate bond that has a 9% coupon and make semiannual payments, you can expect to receive ___.

$45 every six months

a bond pays annual interest payments of $50, has a par value of $1,000, and a market price of $1,200. How is the coupon rate computed?

$50 / $1,000

what is the effective annual yield for a bond that pays interest semi-annually and has a quoted yield to maturity of 10%?

10.25%

at what tax rate will you be indifferent between a muni that yields 7% in the comparable corporate bonds yielding 9%? Assume no state taxes.

22.20%

if you are in the 20% tax bracket, what is your after-tax yield on a par value municipal bond using 5%? Ignore state and local taxes.

5%

if an investment appreciates by 7% while the rate of inflation is 2%, what is the nominal rate of return?

7%

how is a conventional bond different from a zero coupon bond?

a conventional bond pays periodic interest whilst zeroes make no interest payments; conventional bonds can sell at par, at a discount from par, or at a premium over par while zeroes cannot

what is a real rate of return?

it is a rate of return that has been adjusted for inflation.

which of the following are true about a bond's face value?

it is also known as the par value; it is the principal amount repaid at maturity

a market is considered transparent if ___.

it's prices and trading volume are easily observed

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

suppose you own a 30-year bond interest by GE in a 2-year Bond issued by PG with identical coupon rates and par values. Which Bond would you decrease in value more as interest rates rise?

the GE bond will lose more because it has a longer maturity.

assume you own a bond that was issued by a blue-chip company. If the market rate of interest rises, what will happen to the value of your bond?

the bond value will fall.

you own two bonds--1 with a 5% coupon and one with a 6% coupon. Which one is more sensitive to interest rate risk, all other things being equal?

the bond with the 5% coupon rate is more sensitive.

which of the following is true about interest rate risk (if all else equal)?

the longer the time to maturity, the greater the interest rate risk; the lower the coupon rate, the greater the interest rate risk

which of the following are features of municipal bonds?

they are issued by state and local governments; the interest on municipal bonds is exempt from federal taxes

what are municipal bonds?

bonds that have been issued by state or local governments

how is a zero coupon Bond different from a conventional Bond?

zero-coupon bonds make no interest payments; zero-coupon bonds are always issued at a discount

secondary markets in sukuk are extremely illiquid because most sukuk are ___.

bought and held to maturity

the reason that interest rate risk is greater for ___ term bonds than for ___ term bonds is that the change in rates has a greater effect on the present value of the ___ than on the present value of the ___.

long; short; face value; coupon payment

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%.

pay $800 today and receive $1,000 at the end of five years.

what is the value of a bond if the present value of interest of cash flows is $200 and the present value of the par value to be received when the bond matures is $750?

$950

which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?

treasury bonds are issued by the US government while corporate bonds are issued by corporations; treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer; treasury bonds are considered free of default risk while corporate bonds are exposed to default risk.

the inflation premium will be higher if the rate of inflation is low. TRUE or FALSE?

FALSE

a corporate bond's yield to maturity ___.

can be greater than, equal to, or less than the bond's coupon rate; changes over time

what interest rates in the market Fall, Bond values are likely to increase because the present value of the bonds remaining cash ___.

increases

in general, a corporate bond's coupon rate ___.

is fixed until the bond matures