FNAN 300 LearnSmart Chapter 6

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What are "fallen angel" bonds?

Bonds that have dropped from investment grade to junk bond status

What are the three components that influence the Treasury yield curve?

Expected future inflation The interest rate risk premium The real rate of return

True or false: A debenture is a bond secured with collateral

False

A limitation of bond ratings is that they _____.

Focus exclusively on default risk.

A bond with a BB rating has a ____ than a bond with a 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 will happen to a bond's time to maturity as the years go by?

It will decline

A part of the indenture limiting certain actions during the term of the loan are termed ______.

Protective covenants

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

If you are holding two bonds - one with a 5% coupon rate and other with a 8% coupon rate - which one is more sensitive to interest rate risk, all other things being equal?

The bond with the 5% coupon rate

The term structure of interest rates examines the ____.

Relationship between short-term and long-term interest rates

The US government borrows money by issuing:

Treasury Notes Treasury Bonds

A corporate bond's yield to maturity:

Is usually not the same as a bond's coupon rate Changes over time

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

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

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 _____.

$1220

What is the real rate of return?

It is a rate of return that has been adjusted for inflation It is a percentage change in buying power

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.

True or false: Long-term debt has maturities greater than one year

True

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

5.25%

Which three of the following are common shapes for the term structure of interest rates?

Humped Downward Sloping Upward Sloping

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

What is a bond's accrued interest?

It is interest that has been earned but not yet received by the current bondholder

What is the bid price?

It is the price an investor will receive if he sells a bond to a dealer It is the price at which a dealer is willing to buy securities

What is the asked price?

It is the price at which an investor can buy a particular security from a dealer It is the price at which a dealer is willing to sell a particular security

Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact Treasury bond yields?

Liquidity Premium Default Risk Premium

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 are some features of the OTC market for bonds?

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

What are the two major forms of long-term debt?

Private issue Public issue

Which type of debt is given preference in the event of default?

Senior

What does a bond's rating reflect?

The ability of the firm to repay its debt and interest on time

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

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

What does the clean price for a bond represent?

The quoted price excluding accrued interest

The term structure of interest rates describes ________.

The relationship between nominal rates and time to maturity The pure time value of money

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

The total amount of bonds issued The repayment arrangements

Which of the following are features of municipal bonds?

They are issued by state and local governments The interest on municipal bonds is, in some cases exempt from state taxes in the state of issue. The interest on municipal bonds is exempt from federal taxes

Which of the following are true of bonds?

They are normally interest-only loans They are issued by both corporations and governments

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

Trading for more than $1,000 in the market

What are the two unique features of a U.S. federal government bond?

U.S. Treasury issues are considered to be default-free U.S. Treasury issues are exempt from state income taxes

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

With a lag to some base rate

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

A bond's coupon payment is:

a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders

The bid-ask spread represents the ______.

dealer's profit

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

greater than

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

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

A zero-coupon bond is a bond that _____.

makes no interest payments

Equity represents a(n) ______ interest of a firm

ownership

The degree of interest rate risk depends on ____.

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

Junk bonds have the following features:

they are rated below investment grade bonds

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

Interest rate risk premium Inflation Premium Real Interest Rate

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)x(1+h)

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%

A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a ____________.

Call provision

The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?

Coupon Rate Time to Maturity

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

Which of the following are bonds that have actually been issued?

a put bond a Convertible bond a CoCo bond

What is the current yield on a $1,000 par value bond that sells for $900 if the coupon rate is 10 percent?

11.11%

If the rate of inflation is 3% and the real rate of return is 9 percent, the nominal rate is approximately _____ percent.

12

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

What are crossover bonds?

Bonds that have both an investment grade and a junk bond rating

What four variables are required to calculate the value of a bond?

Coupon rate Yield to maturity Par value Time remaining to maturity


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