Ch 6 Smartbook

A zero coupon bond is a bond that

makes no interest payments

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

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

What does the clean price for a bond represent?

The quoted price excluding accrued interest

The US government borrows money by issuing:

Treasury notes and treasury bonds

The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables? bond rating time to maturity coupon rate par value

time to maturity coupon rate

The coupon payments on floating-rate bonds are _____.

adjustable

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

decrease

Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact Treasury bond yields? default risk premium interest rate risk premium liquidity premium inflation premium

default risk premium liquidity premium

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

False Bond ratings are concerned only with the possibility of default.

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 does the dirty price represent?

it includes the quoted price and accrued interest

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

Which of the following are true of bonds? Bond principal does not have to be repaid. They are issued by both corporations and governments. They are normally interest-only loans.

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

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 a real rate of return?

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

If you are in the 20 percent federal income tax bracket, what is your after tax yield on a municipal bond that is currently trading at par to yield 5 percent. Assume there are no state or local taxes.

5 percent

As a general rule, which of the following are true of debt and equity? The maximum reward for owning debt is fixed. Creditors generally have voting power. Debt and equity represent the same financial claims. Equity represents an ownership interest.

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

A bond's coupon payment is:

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

If bonds for AT&T are quoted at 115, they can be purchased:

at 115 percent of par value plus accrued interest.

A sukuk is in compliance with the Islamic law as the financing instrument is not charging any _________ or making money from money.

interest

Indentures and loan agreements often contain protective covenants designed to protect the interests of

lenders

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.

True or false: Longer-term bonds have greater interest rate sensitivity because a large portion of a bond's value comes from the face amount.

True

True or false: Low-grade bonds are rated below investment grade by the major rating agencies.

True

Which of the following terms apply to a bond? coupon rate time to maturity dividend yield par value

coupon rate time to maturity par value

A limitation of bond ratings is that they ____.

focus exclusively on default risk

What does a Treasury yield curve show?

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

A key difference between interest payments and dividend payments is:

dividends are not tax deductible. interest is tax deductible.

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

True

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

coupon

What are the three components that influence the Treasury yield curve? expected future inflation the default risk premium the interest rate risk premium the real rate of return

expected future inflation the interest rate risk premium the real rate of return

What are municipal bonds?

bonds issued by state or local governments

If a bond is issued with a ____________ provision it allows the issuer to repurchase part or all of the bond at defined prices and times.

call

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

call provision

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

public issue private issue

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

A protective covenant is part of an indenture or loan agreement that limits certain actions a company may take during the term of the loan to _____________ the lender's interests.

protect

If a bond is issued with a call provision, it allows the issuer to ______ part or all of the bond at defined prices and times.

repurchase

The degree of interest rate risk depends on ______.

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

Which of the following are usually included in a bond's indenture? the details of previous bond issues the total amount of bonds issued the names of the bondholders the repayment arrangements

the total amount of bonds issued the repayment arrangements

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

yield to maturity coupon rate par value time remaining to maturity

What is a discount bond?

Discount bonds are bonds that sell for less than the face value

Which of the following is not a difference between debt and equity? Equity is publicly traded, while debt is not. Equity represents ownership interest, while debt does not. A corporation's interest payments on debt are tax deductible, but the dividends it pays to equity holders are not. Unlike dividend omissions to equity holders, unpaid debt obligations can lead to bankruptcy.

Equity is publicly traded, while debt is not.

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

False A debenture is an unsecured bond.

Why is the bond market less transparent than the stock market?

Many bond transactions are negotiated privately.

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 cash flows involved in the purchase of a five-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 five 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 a bond's rating reflect?

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

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

True

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.

Which of the following are bonds that have actually been issued? a silent bond a convertible bond a put bond a bunt-n-run bond a CoCo bond

a convertible bond a put bond a CoCo bond

When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ______.

increases

Junk bonds have the following features:

they are rated below investment grade bonds

What is the purpose of a sinking fund?

to create a fund to repay bonds when they fall due

The bid-ask spread represents the

dealer's profit

What is a bond's current yield?

Current yield = annual coupon payment / current price

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 nominal rate of return on an investment?

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

True or false: All else being equal, a 1-year bond's price is less sensitive to interest rate changes as compared to that of a 10-year bond's price.

True

Which three of the following are common shapes for the term structure of interest rates? humped upward sloping V-shaped downward sloping

humped upward sloping downward sloping

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

inflation

Which one of the following is the most important source of risk from owning bonds? market interest rate fluctuations mergers loss of a bond certificate coupon interest rate fluctuations

market interest rate fluctuations

Bonds issued by state and local governments are called

municipal bonds

Which of the following variables is not required to calculate the value of a bond? original issue price of bond remaining life of bond coupon rate market yield to maturity

original issue price of bond

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

ownership

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: Investors require a premium for the risk that issuers other than the Treasury may not make all promised payments on the issued bonds.

true

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

true

True or false: The price you actually pay to purchase a bond will generally exceed the clean price.

true

It is the duty of the bond __________ to manage the sinking fund so that bonds can be repaid.

trustee

A debenture is a(n) ______ bond, for which no specific pledge of property is made.

unsecured

When long-term rates are higher than short-term rates, which of the following shapes will the term structure of interest rates usually have? humped flat upward sloping downward sloping

upward sloping

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

with a lag to some base rate

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

A sukuk is a contract that is related to:

Islamic law. riba.

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.

If you are holding a municipal bond that is trading at par to yield 6 percent, by how much will your aftertax yield change if your federal income tax bracket increases from 15 percent to 20 percent. Assume there are no state or local taxes.

0 percent Reason: Interest income from munis is exempt from federal income tax.

The term structure of interest rates examines the

relationship between short-term and long-term interest rates

A bond with a BB rating has a ______ than a bond with a BBB rating.

higher risk of default

A corporate bond's yield to maturity: remains fixed over the life of the bond. is usually not the same as a bond's coupon rate. is always equal to a bond's coupon rate. changes over time.

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