Ch. 6: Part 2
Secured debt is tied to specific assets, called ____________.
collateral
Which type of bond generally offers the highest yield?
corporate
What is the term used in finance to represent simple, standard, and common?
Plain vanilla
Which of the following are steps bondholders can take to minimize default risk?
Security Seniority Protective covenants
Which debt is paid first in the event of bankruptcy?
Senior Debt
Which of the following are not plain vanilla bonds?
Zero-coupon Bonds Convertible Bonds Floating-rate Bonds
A graph of the yield curve shows the bond yield to maturity on the _____ axis and the time to maturity on the _____ axis.
vertical, horizontal
A plot drawn to show the relationship between bond yields and maturity is known as the
yield curve
A measure of return that takes account of both coupon payments and change in a bond's value over its life is a standard measure known as
yield to maturity
The discount rate that makes the present value of the bond's payments equal to its price is known as the
yield to maturity
Marley Corporation's bonds have four years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 5%. If the price of the bond is $841.51, the yield to maturity is _____. (Use trial and error to calculate yield).
10% Rationale: First, calculate the coupon payment: $1,000 x .05 = $50. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $841.51. You will see that by doing trial and error on the 4 given yields in the multiple choice question (5%, 8%, 10%, and 12%), the correct yield is 10%: $841.51 = $50/(1+.1) + $50/(1+.1)^2+ $50/(1+.1)^3+ $1,050/(1.1)^4
An individual invested $1,000 in a bond with a coupon payment of $12. The price of the bond increased to $1,400. What is the rate of return on this bond?
41.2% Rationale: Rate of return=(coupon income + price change)/investment= ($12+$400)/$1,000=.412 or 41.2%
Mortor's Corporation sold 6 year bonds for $1,072.62, with a face value of $1,000 and a coupon rate of 8%. The annual yield to maturity is
6.5% Rationale: First, calculate the coupon payment: $1,000 x .08 = $80. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $1,072.62. You will see that by doing trial and error on the 4 given yields in the multiple choice question (6%, 6.5%, 7%, and 7.5%), the correct yield is 6.5%: $1,072.62 = $80/(1+.065) + $80/(1+.065)^2+ $80/(1+.065)^3+ $80/(1.+.065)^4+ $80/(1 + .065)^5+ $1,080/(1+.065)^6
If the nominal rate of interest is 10% and the rate of inflation is 3%, the real interest rate is ____.
6.8% Rationale: 1 + real interest rate = (1 +.1)/(1 +.03) = 1.068 - 1 = .068 or 6.8%
Even when the yield curve of a long-term bond is upward-sloping some investors prefer short-term bonds. Which of the following reasons would explain why this statement is true?
Short-term investors can profit if interest rates rise Prices of long-term bonds fluctuate more than prices of short-term bonds
The U.S. Treasury issues ___________, which adjust nominal cash flows based on the consumer price index.
TIPS Rationale: Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds that adjust nominal cash flows based on changes in the consumer price index.
A bond that is priced below its face value is said to sell for
a discount
A bond that is priced above its face value is said to sell for
a premium
The current yield on a bond is equal to
annual coupon payment divided by bond price
Corporate debt depends on the value and the risk of the firm's
assets
Limitation or subordination of new debt is a form of a protective ____________ on existing debt.
covenant
The additional yield on a bond that investors require for bearing default risk is known as
default premium
The risk that a bond issuer may not pay on its bonds in known as
default risk
If interest rates fall, the rate of return on a bond will be _____ the yield to maturity.
greater than
The banking crisis of 2007-2009 shows that investors prefer ________ in bonds; therefore, heavily traded bonds offer ________ yields.
higher liquidity, lower
Long-term bond prices are more sensitive than short-term bond prices to
increases in interest rates
Which type of bond links coupon payments to inflation?
indexed bonds
Because the _____ rate is uncertain, so is the _______ rate of interest offered on bonds.
inflation, real
Bonds rated Baa or above by Moody's or BBB or above by Standard & Poors are known as
investment grade bonds
Bonds rated Ba or below by Moody's or BB and below by Standard & Poors are known as
junk bonds
The return on a bond that sells at a premium is ____________ (greater or less) than the current yield.
less
If interest rates rise, the rate of return on a bond will be _____ the yield to maturity.
less than
Conditions imposed on borrowers to protect lenders from unreasonable risk are known as
protective covenants
The total income per period per dollar invested is known as the
rate of return
When a firm puts up collateral assets to back up a loan, the debt is said to be:
secured
Investors looking to minimize risk will hold which type of debt?
senior
For bonds priced at face value, the rate of return is
the coupon rate