business finance ch 6

Which of the following variables is NOT required to calculate the value of a bond?

Original issue price of bond

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

What is the equation for approximating the nominal rate of return? R = the nominal rate of interest r = the real rate of interest h = the inflation rate

R = r + h

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 identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?

The 10-year bond

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 an 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

The nominal rate is found by adding the _____ and the real rate of return.

inflation

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.

Which of the following terms apply to a bond?

- Coupon rate - Par value - Time to maturity

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

What is a real rate of return?

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

Which of the following are features of municipal bonds?

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

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 are the three components that influence the Treasury yield curve?

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

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 true of bonds?

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

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

- Time remaining to maturity - Coupon rate - Par value - Yield to maturity

The US government borrows money by issuing:

- Treasury notes - Treasury bonds

What is a corporate bond's yield to maturity (YTM)?

- YTM is the expected return for an investor who buys the bond today and holds it to maturity. - YTM is the prevailing market interest rate for bonds with similar features.

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

- a put bond - a convertible bond - a CoCo bond

A key difference between interest payments and dividend payments is?

- interest is tax deductible - dividends are not tax deductible

A corporate bond's yield to maturity:

- is usually not the same as a bond's coupon rate - changes over time

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

- private issue - public issue

The term structure of interest rates describes ________.

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

What are municipal bonds?

Bonds that have been issued by state or local governments

As an investor in the bond market, why should you be concerned about changes in interest rates?

Changes in interest rates cause changes in bond prices.

What is a bond's current yield?

Current yield = Annual coupon payment/Price

Which of the following is not a difference between debt and equity?

Equity is publicly traded while debt is not

True or false: Bond ratings are concerned only with the possibility of price changes.

False

What is the nominal rate of return on an investment?

It is the actual percentage change in the dollar value of an investment unadjusted for inflation.

What does a Treasury yield curve show?

It shows the yield for different maturities of Treasury notes and bonds

What does a bond's rating reflect?

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

What does the AAA rating assigned by S&P mean?

The firm is in a strong position to meet its debt obligations

True or false: A put bond allows the holder to force the issuer to buy the bond back at a stated price.

True

True or false: Current yield = Annual coupon payment/Price

True

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

True

True or false: The government sells Treasury notes and bonds to the public every month.

True

A bond's coupon payment is:

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

The coupon payments on floating-rate bonds are _____.

adjustable

To find the total bond value, add the present value of the amount paid at maturity to the _____ of the annual coupon payments.

annuity present value

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

call provision

A bond's ______ payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders

coupon

When interest rates in the market rise, we can expect the price of bonds to ____.

decrease

A zero-coupon bond is a bond that ____.

makes no interest payments

Bonds issued by state and local governments are called _______ ______.

municipal bonds

Equity represents a(n) ________ interest of a firm.

owner's

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

protective covenants

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

The degree of interest rate risk depends on ____.

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

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

with a lag to some base rate