Chapter 7 Quiz

What are the three components of the nominal rate of return?

Compensation for the inflation effect on the investment earnings Real rate of return Compensation for the inflation effect on the original investment

If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes.

5%

Assume you own a bond currently valued at $989. If the market rate of interest drops, the bond's current market value will _____.

increase

The three components of the Treasury yield curve include the real rate, expected future

inflation

The U.S. Treasuries market is the _____ in the world in terms of trading volume.

largest

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

The interest rate risk premium is the additional compensation demanded by investors for holding ____ bonds.

longer-term

All other things being equal, the

lower

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

What is the asked price?

The asked price is the price at which a dealer is willing to sell.

Which has a higher value, the bid price quote or the asked price quote?

The asked price quote is higher.

True or false: In general, the stock market is more transparent than the real estate market.

True

A Treasury yield curve depicts the _____.

Yields for different maturities of Treasury securities.

The interest from a municipal bond is exempt from ____ income taxes.

federal

The longer the term, the

greater

In case of default:

subordinated debt holders must give preference to other specified creditors

What does a Moody's bond rating of C typically indicate?

The issuer is in default

What is the formula to determine the price of a U.S. Treasury bond listed at 122 if the par value is $5,000?

$5,000 × 122%

What is the price of a U.S. Treasury bond that is listed at 90 if the par value is $1,000?

$900

What is a premium bond?

A bond that sells for more than face value

How has TRACE improved transparency in the corporate bond market?

Corporate bond dealers are now required to report trade information through TRACE.

What are the three components of the Treasury yield curve?

Expected inflation Real rate of return Interest rate risk premium

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

Many bond transactions are negotiated privately.

What are some features of the OTC market for bonds?

The OTC has no designated physical location. OTC dealers are connected electronically.

What is the difference between a bond's "clean price" and its "dirty price"?

The clean price excludes interest accrued since the last coupon payment, while the dirty price includes accrued interest.

Why does a bond's value fluctuate over time?

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

True or false: In general, the price that is paid for a bond will exceed its quoted price.

True

U. S. Treasury bonds:

are quoted as a percentage of par.

If a $1,000 face value U.S. Treasury bond is quoted at 85, then the bond can be purchased _____.

at 85 percent of face value plus any accrued interest

In financial markets the difference between the

bid

If the market rate of interest

declines

In an inflationary environment, the nominal rate will be _________ the real rate.

greater than

When interest rates in the market fall, bond values are likely to increase because the present value of the bond's remaining cash flows ____.

increases

In general, a corporate bond's coupon rate ____,

is fixed until the bond matures

The OTC has _____ designated physical location.

no

The rates on financial securities are generally quoted as

nominal

The Fisher effect decomposes the nominal rate into:

the inflation rate and the real rate

If a given set of cash flows is expressed in

Blank 1: nominal Blank 2: nominal

premium is the portion of a nominal interest rate or bond yield that represents compensation for unfavorable

Blank 1: taxability Blank 2: tax

What are original issue discount bonds?

Bonds that are issued with a very low coupon rate.

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

Equity is publicly traded while debt is not

True or false: Equity represents an ownership interest.

True

The amount by which the call price exceeds the par value of the bond is called the _____.

call premium

How is an APR computed?

Rate per period × Number of periods per year

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

Within the context of financial markets, complete the following equation: Bid − Ask =

Spread

Corporate bond dealers are now required to report trade information through _____.

TRACE

Suppose a bond's clean price is $1,050, and the bond currently has accrued interest of $30. What is the dirty price?

$1,080

Whatever, Incorporated, has a bond outstanding with a coupon rate of 5.96 percent and semiannual payments. The yield to maturity is 5.3 percent and the bond matures in 19 years. What is the market price if the bond has a par value of $1,000?

$1,081.52

Whipple Corporation just issued 315,000 bonds with a coupon rate of 6.23 percent paid semiannually that mature in 20 years. The bonds have a YTM of 6.67 percent and have a par value of $2,000. How much money was raised from the sale of the bonds? (Round your intermediate calculations to two decimal places and final answer to the nearest whole dollar amount.)

$644,334,000

Which one of these correctly specifies the relationship between the nominal rate and the real rate?

(1 + R) = (1 + r) × (1 + h)

Which six factors determine the yield on a bond?

-real rate of return -interest rate risk -expected future inflation -liquidity -default risk -taxability

Most corporate bonds pay coupon interest payments

2

A bond with a current yield of 7.55 percent is quoted at 104.696. What is the coupon rate of the bond:?

7.90%

If the rate of inflation is 3 percent and the real rate of return is 5 percent, the nominal rate is approximately ____ percent.

8

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

950

How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project's lifetime.

An increase in the size of the first cash inflow will decrease the payback period, all else held constant.

True or false: A bond's value is not affected by changes in the market rate of interest.

False

True or false: If you invest in junk bonds, there is a high likelihood that you will earn a very high return.

False

True or false: The inflation premium will be higher if the rate of inflation is low.

False

True or false: The real rate of return will generally be higher than the nominal rate of return.

False

Which three components determine the shape of the term structure of interest rates?

Inflation premium Real interest rate Interest rate risk premium

How is investing in U.S. Treasury bonds different from investing in corporate bonds?

Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not. Treasury issues have no default risk.

What does the dirty price represent?

It includes the quoted price and interest accrued since the last coupon payment.

Which of the following is true about a typical multiple-year bond's coupon?

It is a fixed annuity payment.

What is a real rate of return?

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

How significant is the real rate of return in determining the shape of the term structure of interest rates?

Not very significant Less significant than inflation

What are the federal income tax implications of receiving $50 in interest income from a municipal bond versus a corporate bond?

Only the interest on the corporate bond will be taxed.

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

Par value Coupon rate Current price

Which of the following terms apply to a bond?

Par value Time to maturity Coupon rate

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

What is the equation for approximating the nominal rate of return?

R = r + h

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 exempt from federal taxes. They are issued by state and local governments.

A bond's YTM will exceed its current yield when the bond is selling at ____.

a discount

The main reason it is important to distinguish between debt and equity is that the benefits and risks _____.

are different

A bond with exotic features is often called a _____ bond.

cat

A corporate bond's yield to maturity ____.

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

rate is the stated interest payment made on a bond.

coupon

A 10-year AAA corporate bond is most apt to have a yield that ____ the yield on a 10-year AAA state government bond.

exceeds

A discount bond's coupon rate is equal to the annual interest divided by the:

face value.

-rate bonds, the coupon payments are adjustable.

floating

A limitation of bond ratings is that they ____.

focus exclusively on default risk

If a given set of cash flows is 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

The written agreement between the corporation and the lender detailing the terms of the debt issue is the

indenture

When comparing a 1-year bond's price to a 30-year bond's price, the 1-year bond's price is relatively

insensitive

The current yield is defined as the annual interest on a bond divided by the:

market price

A sinking fund is one type of:

repayment provision

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

the market price of the bonds

The degree of interest rate risk depends on ____.

the sensitivity of the bond's price to interest rate changes

If a $1,000 par value bond is trading at a premium, the bond is _____.

trading for more than $1,000 in the market

If the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ____.

$1,220

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

7%

What are three important features of Treasury notes and bonds?

Default-free Highly liquid Taxable

What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?

10%

provision allows the company to repurchase or "

Blank 1: call Blank 2: call

price excludes interest accrued since the last coupon payment, while the

Blank 1: clean Blank 2: dirty

premium is the portion of a nominal interest rate that represents compensation for expected future

Blank 1: inflation Blank 2: inflation

What does the clean price for a bond represent?

The quoted price, which excludes interest accrued since the last coupon date.

How is the real rate of return different from the nominal rate of return?

The real rate of return is adjusted for the effect of inflation whereas nominal rate is not adjusted for the effect of inflation.

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 are considered free of default risk while corporate bonds are exposed to default risk. Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer.

True or false: Interest earned on Treasury notes and bonds is taxable

True

True or false: The major difference between Western financial practices and Islamic law is that Islamic law does not permit charging or paying interest.

True

True or false: The price you actually pay to purchase a bond will generally exceed the clean price.

True

What are some reasons why the bond market is so big?

Various state and local governments also participate in the bond market. Federal government borrowing activity in the bond market is enormous. Many corporations have multiple bond issues outstanding.

Which of the following is not one of the six factors used to determine the yield on a bond?

Voting rights

A corporate bond's yield to maturity:

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

yield does not include the capital gain from the price discount, whereas the YTM does include it.

current

The correlation between the real rate of interest and every interest rate is:

high

A bond with a BBB rating has a ______ than a bond with an A rating.

higher risk of default

One of the main disadvantages of the discounted payback period rule is that the cutoff is arbitrarily set and cash flows beyond that point are _____.

ignored

If you were classified as a high income/high tax bracket investor, you might find municipal bonds an attractive investment because ____.

income from municipal bonds is exempt from federal taxes

According to the approximation formula for the nominal rate of return (R), the nominal rate will ________ if inflation (h) increases.

increase

As the maturity of a bond increases, interest rate risk ____.

increases at a decreasing rate

One of the components of the nominal rate of return is the compensation for the

inflation

The term structure of interest rates is determined by the real rate of interest, the interest rate risk premium, and the

inflation

What is an interest-only loan?

it's a loan which the borrower pays interest periodically and repays the principle when the bond matures

A market is considered transparent if ____.

its prices and trading volume are easily observed

The _____ premium is the portion of a nominal interest rate or bond yield that represents compensation for lack of _____.

liquidity; liquidity

A bond's principal is repaid on the ________ date.

maturity

The Treasury yield curve plots the yields on Treasury notes and bonds relative to

maturity

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

maturity

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.

The price that represents what a dealer is willing to pay for a security is the _____.

bid price

When an investor sells a bond, the price received by a dealer is always the ____.

bid price

Ana just received the semiannual payment of $35 on a bond she owns. This is called the ______ payment..

coupon

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

A zero coupon bond is a bond that ____.

makes no interest payments

The term structure of interest rates examines the ____.

relationship between short-term and long-term interest rates

Which of the following are common protective covenants?

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

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.

Which of these are required to calculate the current value of a bond?

Coupon rate Time remaining to maturity Applicable market rate Par value

What information is needed to compute a bond's yield-to-maturity?

Coupon rate Time to maturity The bond's current price

What is a discount bond?

Discount bonds are bonds that sell for less than the face value

The discounted payback period has which of these weaknesses?

Loss of simplicity as compared to the payback method Arbitrary cutoff date Exclusion of some cash flows

is the term that indicates preference in position over other lenders.

Seniority

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

Which is the largest security market in the world in terms of trading volume?

The U.S. Treasuries market

Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?

The asked price The bid price

What is the bid price?

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

You own two bonds—one with a 5 percent coupon and one with a 6 percent coupon. Which one is more sensitive to interest rate risk, all other things being equal?

The bond with the 5 percent coupon rate is more sensitive.

Why is the YTM of a discount bond greater than the bond's current yield?

The current yield does not include the capital gain from the price discount.

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

The federal government State governments Public corporations

All junk bonds typically have which of these features?

Less than investment-grade rating High probability of default

The rates on financial securities are generally quoted as _____ rates.

nominal

Bond ratings are based on the probability of default risk, which is the risk that ___.

the bond's issuer may not be able make all the required payments

The bond market requires a return of 6.2 percent on the 15-year bonds issued by Mingwei Manufacturing. The 6.2 percent is referred to as the:

yield to maturity.

If you are holding a municipal bond that is trading at par to yield 6 percent, by how much will your aftertax yield change if your income tax bracket increases from 15 percent to 20 percent. Assume there are no state or local taxes

0%

There is a bond that has a quoted price of 110.547 and a par value of $2,000. The coupon rate is 7.05 percent and the bond matures in 19 years. If the bond makes semiannual coupon payments, what is the effective annual interest rate?

7.12%

A bond has a par value of $1,000, a current yield of 7.67 percent, and semiannual coupon payments. The bond is quoted at 100.39. What is the coupon rate of the bond?

7.70%

premium is the portion of a nominal interest rate or bond yield that represents compensation for lack of

Blank 1: liquidity Blank 2: liquidity

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

Match each one of these bonds with their characteristic.

CAT bond matches Choice, Protects insurance companies from natural disasters Protects insurance companies from natural disasters Convertible bond matches Choice, Can be exchanged for shares of stock Can be exchanged for shares of stock Put bond matches Choice, Owner can force issuer to repay prior to maturity at a stated price Owner can force issuer to repay prior to maturity at a stated price Structured note matches Choice, Based on financial securities, commodities, or currencies Based on financial securities, commodities, or currencies

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

Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeros must be offered at a discount from par A conventional bond pays periodic interest whiles zeros make no interest payments.

What is a bond's current yield?

Current yield = Annual coupon payment/Current price

What is the nominal rate of return on an investment?

It is the rate that has not been adjusted for inflation.

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

It will increase.

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 Coupon rate Remaining life of bond

How significant is the inflation premium on the shape of the term structure of interest rates? (Select all that apply.)

More significant than the real rate of return Very significant

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.

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

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

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

The repayment arrangements The total amount of bonds issued

Which is more transparent, the stock market or the bond market?

The stock market is more transparent.

True or false: If you invest in a bond that is rated AAA by S&P, you can be reasonably assured that your investment has very little default risk.

True

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

Secondary markets in sukuk are extremely illiquid because most sukuk are:

bought and held to maturity

If a bond is rated Baa by Moody's and BB by Standard & Poor's, the bond will be regarded as a(n) _____ bond.

crossover

yield is the bond's annual coupon divided by its price.

current

is an unsecured bond, for which no specific pledge of property is made.

debenture

When interest rates in the market rise, we can expect the price of bonds to ____.

decrease

As the time to maturity increases, the interest rate risk premium ____.

increases at a decreasing rate

The amount of time needed for the cash flows from an investment to pay for its initial cost is the _____ period.

payback

The interest rate risk

premium

is the compensation investors demand for bearing interest rate risk.

premium

The information needed to compute a bond's yield to maturity includes the bond's , coupon rate, and maturity date. Listen to the complete question

price

fund is an account managed by the bond trustee for the purpose of repaying the bonds.

sinking

The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.

suggests accepting

The taxability premium is the additional compensation demanded on ____.

taxable bonds

The coupon rate on an original issue discount bond will be ___.

very low

Most of the time, a floating-rate bond's coupon adjusts ____.

with a lag to some base rate

What is the likely impact on all interest rates when the real rates are high?

It will increase

What is accrued interest?

It is interest that has been earned but not yet received.

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.

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

It is the principal amount repaid at maturity. It is also known as the par value.

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.

Why did Disney issue 100-year bonds, dubbed "Sleeping Beauty" bonds, in the 1990s?

To lock-in historically low interest rates for a long time

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

Twice a year

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.

What will the impact be on your risk exposure if your bond has recently been categorized as a "fallen angel"?

Your risk will increase.

A bond with 16 years to maturity and a semiannual coupon rate of 5.08 percent has a current yield of 5.39 percent. The bond's par value is $2,000. What is the bond's price?

$1,884.97

A firm decides to raise money by issuing 5 million bonds with a par value of $5,000 each for 10 years at a coupon rate of 7 percent. At the time of issue, the bonds were sold for $5,500 each. What will the par value of the bonds be in year 5?

$5,000 per bond

Wine and Roses, Incorporated, offers a bond with a coupon of 5.0 percent with semiannual payments and a yield to maturity of 5.90 percent. The bonds mature in 10 years. What is the market price of a $1,000 face value bond?

$932.74

Which of the following is true about interest rate risk?

All else equal, the longer the time to maturity, the greater the interest rate risk. All else equal, the lower the coupon rate, the greater the interest rate risk.

Protective covenants are classified into two types:

Blank 1: negative Blank 2: positive or affirmative

As a general rule, which of the following are true of debt and equity?

Equity represents an ownership interest The maximum reward for owning debt is fixed

Dilan owns a bond that will pay him $45 each year in interest plus $1,000 as a principal payment at maturity. The $1,000 is referred to as the:

Face Value

If a bond is selling at a discount from its par value, the YTM must be _____ the coupon rate.

greater than

A newly issued bond has a coupon rate of 5 percent and semiannual interest payments. The bonds are currently priced at par. The effective annual rate provided by these bonds must be:

greater than 5 percent.