FN340 ch. 7

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

Which six factors determine the yield on a bond?

- Default risk - Interest rate risk - Expected future inflation - Taxability - Liquidity - Real rate of return

What are three important features of Treasury notes and bonds?

- Default-free - Highly liquid - Taxable

Convertible Bond

Can be exchanged for shares of stock

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? Multiple choice question.

100/1000 = 10%

Structured Note

Based on financial securities, commodities, or currencies

What is a bond's current yield?

Current yield = Annual coupon payment/Current price

Put Bond

Owner can force issuer to repay prior to maturity at a stated price

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

CAT Bond

Protects insurance companies from natural disasters

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

Spread

T/F Interest earned on Treasury notes and bonds is taxable True false question.

True

T/F The major difference between Western financial practices and Islamic law is that Islamic law does not permit charging or paying interest.

True

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

are different

In financial markets the difference between the ________ price and the ask price is known as the spread.

bid

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

bought and held to maturity

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

cat

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

current

With ________ -rate bonds, the coupon payments are adjustable.

floating

A limitation of bond ratings is that they ____.

focus exclusively on default risk

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

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

indenture

A zero coupon bond is a bond that ____.

makes no interest payments

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

nominal; nominal

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

payback

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

suggests accepting

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

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

with a lag to some base rate

Which of the following are usually included in a bond's indenture? A) The total amount of bonds issued B) The repayment arrangements C) The names of the bondholders D) The bond's rating

A and B

As a general rule, which of the following are true of debt and equity? A) The maximum reward for owning debt is fixed B) Creditors generally have voting power C) Equity represents an ownership interest D) Debt and equity represent the same financial claims

A and C

Which of the following institutions issue bonds that are traded in the bond market? A) State governments B) Sole proprietorships C) Public corporations D) The federal government

A, C, and D

What does the clean price for a bond represent?

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

How is investing in U.S. Treasury bonds different from investing in corporate bonds? A) Treasury issues have no default risk. B) Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not. C) U.S. Treasury bonds have longer maturities than corporate bonds. D) Interest from U.S. Treasuries is exempt from all taxation while corporate bond interest is taxable at all levels.

A and B

The discounted payback period has which of these weaknesses? A) Arbitrary cutoff date B) Loss of simplicity as compared to the payback method C) Exclusion of some cash flows D) Lack of a decision rule

A, B, and C

What are some reasons why the bond market is so big? A) Many corporations have multiple bond issues outstanding. B) Federal government borrowing activity in the bond market is enormous. C) Corporations are required to raise more money from bonds than from stocks. D) Various state and local governments also participate in the bond market.

A, B, and D

Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds? A) Treasury bonds do not offer any tax benefits to investors but corporate bonds do. B) Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. C) Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer. D) Treasury bonds are issued by the US government while corporate bonds are issued by corporations.

B, C, and D

Which of the following is not a difference between debt and equity? A) A corporation's interest payments on debt are tax deductible, but the dividends it pays to equity holders are not B) Unlike dividend omissions to equity holders, unpaid debt obligations can lead to bankruptcy C) Equity is publicly traded while debt is not D) Equity represents ownership interest while debt does not

C

T/F A bond's value is not affected by changes in the market rate of interest.

False

T/F The inflation premium will be higher if the rate of inflation is low.

False

What is a real rate of return?

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

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

The U.S. Treasuries market

Why does a bond's value fluctuate over time?

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

T/F The price you actually pay to purchase a bond will generally exceed the clean price.

True

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

inflation; inflation

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

issuing bonds

The Fisher effect decomposes the nominal rate into:

the inflation rate and the real rate

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

the market price of the bonds

Which one of the following is the most important source of risk from owning bonds? A) Market interest rate fluctuations B) Coupon interest rate fluctuations C) Mergers D) Loss of a bond certificate

A