CH 8 Corporate Finance

focus on default risk

A limitation of bond ratings is that they ____.

issuing bonds

The federal government can raise money from financial markets to finance its deficits by ___.

inflation

The inflation premium is the additional return demanded by investors to compensate for _____.

2 to 30

U.S. Treasury notes and bonds have initial maturities ranging from ___ years.

Treasury Inflation-Protected Securities

What does TIPS stand for?

Market interest rate fluctuations

Which one of the following is the most important source of risk from owning bonds?

Promised payments are specified in real terms

How are TIPS different from traditional bonds?

Zeroes make no interest payments. Zeroes are always issued at a discount.

How is a zero coupon bond different from a conventional bond?

- Treasury issues have virtually no default risk. - Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not.

How is investing in U.S. Treasury bonds different from investing in corporate bonds?

the market price of the bonds

If you own corporate bonds, you will be concerned about interest rate risk as it affects ____.

False

A bond's value is not affected by changes in the market rate of interest.

Par value Applicable market rate Coupon Time remaining to maturity

What is required to calculate the current value of a bond?

Current price Par value Coupon rate

Which of these affect a bond's yield to maturity?

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.

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

- can be greater than, equal to, or less than the bond's coupon rate - changes over time

A corporate bond's yield to maturity ____.

- Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeroes can not. - A conventional bond pays periodic coupon interest whiles zeroes make no interest payments.

How is a conventional bond different from a zero coupon bond?

greater than

In an inflationary environment, the nominal rate will be _________ the real rate.

is fixed until the bond matures

In general, a corporate bond's coupon rate ____,

Upward sloping

In general, which shape does the term structure of interest rates usually have?

True

True or false: In general, the stock market is more transparent than the bond market.

True

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

The quoted price, which excludes accrued interest

What does the clean price for a bond represent?

Time to maturity The bond's current price Coupon rate

What information is needed to compute a bond's yield to maturity?

YTM is the expected return on a bond that is held until it matures.

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

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

What is a discount bond?

bond that sells for more than face value. This will happen if market rates are lower than the coupon rate.

What is a premium bond?

The return based on the current price and future cash flows adjusted for default risk.

What is the expected return on a bond?

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

What is the nominal rate of return on an investment?

The promised yield assumes no default risk.

What key assumption makes the promised yield different from the expected return?

Treasury notes Treasury bonds

When the US government wants to borrow money for the long-term (more than one year) it issues:

It is the yield based on the current price and expected cash flows, assuming no default.

Which is the promised yield on a bond?

State governments Public corporations The federal government

Which of the following institutions issue bonds that are traded in the bond market?

- Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. - 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.

Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?

The asked price The bid price

Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?