FIN 301 - CH 7
T or F All other things being equal, the longer the time to maturity, the greater the interest rate for bonds
True
The main reason it is important to distinguish between debt and equity is that the benefits and risks ____. a) are similar b) are different c) never change
b
What is a discount bond? a) discount bonds are bonds that a distressed corporation sells at fire sale prices to raise emergency funds b) discount bonds are bonds that sell for less than face value c) discount bonds are bonds with short maturities d) discount bonds are junk bonds that are rated below investment grade
b
What is a premium bond? a) a bond of superior quality b) a bond that sells for more than face value c) a bond that sells for less than face value d) a bond that is not risky and rates as investment grade
b
Which of the following is NOT a difference between debt and equity? a) a corporation's interest payments on debt are tax deductible, but dividends it pays to equity holders are not b) equity is publicly traded while debt is not c) equity represents ownership interest while debt does not d) unlike dividend omissions to equity holders, unpaid obligations can lead to bankruptcy
b
What is the coupon rate on a bond that has a par value of $1000, a market value of $1100 and a coupon rate of $100 per year? a) 1% b) 10% c) it will depend on the bond rating for that year d) 9.09%
b reason: coupon rate = $100/$1000 = 0.1 = 10%
A corporate bond's yield to maturity ____. Choose all that apply a) is always equal to the bond's coupon rate b) can be greater than, equal to, or less than the bond's coupon rate c) remains fixed over the life of the bond d) changes over time
b,d
Bond ratings are based on the probability of default risk, which is the risk that ___. a) inflation may increase in the short term b) the bond's interest rates may change unexpectedly c) the bond's issuer may not be able to make all the required payments d) the bond's maturity date may change
c
Included in Bond Indenture
1) the basic terms of the bonds 2) the total amount of bonds issued 3) a description of property used as security 4) the repayment arrangements 5) the call provisions 6) details of the protective covenants
A bond pays annual interest payments of $50, has a par value of $1000, and a market price of $1200. How is the coupon rate computed? (equation with numbers filled in)
50/1000 = 0.05 = 5%
What is a bond's current yield?
Current yield = Annual coupon payment/ Current Price
T or F All other things being equal, the lower the coupon rate, the lower the interest rate risk
False Reason: All other things being equal, the lower the coupon rate, the greater the interest rate risk
T or F Equity represents an ownership interest
True
If a $1000 par value bond is trading at a premium, it means that the market value of the bond is ______. a) trading for more than $1000 in the market b) trading for less than $1000 in the market c) not actively traded due to its high price d) trading for $1000 in the market
a
As an investor in the bond market, why should you be concerned about changes in interest rates? a) changes in interest rates lead to changes in the par value of a bond b) changes in interest rates lead to changes in interest payments on fixed coupon bonds c) you shouldn't be as interest rate changes do not affect bonds d) changes in interest rates cause changes in bond prices
d
Which of the following is the most important source of risk from owning bonds? a) mergers b) loss of a bond certificate c) coupon interest rate fluctuations d) market interest rate fluctuations
d
Why does a bond's value fluctuate over time? a) a bond's value does not fluctuate over time b) a bond's par value changes over time c) the coupon rate varies, while market interest rates are fixed d) the coupon rate and par value are fixed, while market interest rates change
d) The coupon rate and par value are fixed, while market interest rates change reason: market interest rates vary, which causes the bond's value to change
in general, a corporate bond's coupon rate ___. a) decreases as a bond nears maturity b) changes in sync with market interest rates c) changes every year d) is fixed until the bond matures
d) is fixed until the bond matures Reason: some bonds have floating rates but most are fixed
a firm's bond rating sheds light on its ____ risk
default risk
Longer term bonds have (smaller/greater) interest rate sensitivity because a (smaller/larger) portion of a bond's value comes from the face amount
greater, larger
If a $1000 par value bond is trading at a discount, it means that the market value of the bond is (equal to, less than, or more than) $1000.
less than
two major forms of long term debt
public issue and privately placed
The sensitivity for bond price depends on _____ and _____
the time to maturity and the coupon rate
Indenture
the written agreement between the corporation (borrower) and its creditors detailing the terms of the debt issue. Referred to sometimes as deed of trust Usually, a trustee (ex: bank) is appointed by the corporation to represent the bondholders. The trust company must 1)make sure the terns of the indenture are obeyed 2)manage the sinking fund 3) represent the bondholders in default in case the company defaults on its payments to them
T or F A bond's value is not affected by changes in the market rate of interest
False reason: bond prices are inversely related to interest rates
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 ___. a)long; short; face value; coupon payments b)long; short; coupon payments; face value c) short; long; face value; coupon payments
a
When the interest rates in the market rise, we can expect the price of bonds to ___. a) decrease b) increase) c) not change
a Reason: bond prices vary inversely with interest rates
There is a(n) ____ relationship between market interest rates and bond values a) negative b) positive c) unstable d) random
a) negative Reason: When interest rates fall, the bond is worth more. When interest rates rise, the present value of the bond's remaining cash flow declines, and the bond is worth more.
What is a corporate bond's yield to maturity (YTM)? Choose all that Apply a) YTM is the expected return for an investor who buys the bond today and holds it to maturity b) YTM is another term for the bond's coupon rate c) YTM is the prevailing market interest rate for bonds with similar features d) YTM is the yield that will be earned if the bond is sold immediately in the market
a, c
Which of the following variables are required to calculate the value of a bond? a) coupon rate b) remaining life of bond c) market yield d) issue price of the bond
a,b,c
What is required to calculate the current value of a bond? Choose all that Apply a) time remaining to maturity b) coupon rate c) applicable market rate d) par value e) price at the time of bond issue
a,b,c,d
Which of the following are usually included in a bond's indenture? a) the repayment arrangements b) the bond's rating c) the total amount of bonds issued d) the names of the bondholders
a,c
Which of the following institutions issue bonds that are traded in the bond market? Pick all that Apply a) public corporations b) sole proprietorships c) State governments d) federal government
a,c,d
As a general rule, which of the following are true of debt and equity? Choose all the apply a) equity represents an ownership interest b) creditors generally have voting power c) debt and equity represent the same financial claims d) the maximum reward for owning debt is fixed
a,d
The degree of interest rate risk depends on __. a) the sensitivity of the bond's coupon rate to interest rate changes b) the face value of a bond c) the sensitivity of the bond's price to interest rate changes d) how many times the interest rate changes in a year
c
The federal government can raise money from financial markets to finance its deficits by ___. a) issuing stocks b) requesting foreign aid c) issuing bonds d) raising taxes
c) issuing bonds Reason: taxes can be used to finance deficits bit they are not directly linked to the financial markets
the ____ yield is the bond's annual coupon divided by its price.
current yield