FNAN 300 LearnSmart Chapter 6
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