Chapter 12

23) The security with the longest maturity is a Treasury A) note. B) bond. C) acceptance. D) bill.

B) bond.

17) The ________ value of a bond is the amount that the issuer must pay at maturity. A) market B) present C) discounted D) face

D) face

56) The risk on an agency bond is A) high. B) zero. C) moderate. D) low.

D) low.

17) The secondary market is where new issues of stocks and bonds are introduced.

Answer: FALSE

32) The bond contract that states the lender's rights and privileges and the borrower's obligations is called the A) bond syndicate. B) restrictive covenant. C) bond covenant. D) bond indenture.

D) bond indenture.

11) (I) The primary issuers of capital market securities are financial institutions. (II) The largest purchasers of capital market securities are corporations. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

D) Both are false.

47) Which of the following are true for the current yield? A) The current yield is defined as the yearly coupon payment divided by the price of the security. B) The current yield and the yield to maturity always move together. C) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond. D) All of the above are true. E) Only A and B of the above are true.

E) Only A and B of the above are true.

18) General obligation bonds have specific assets pledged as security or specific sources of revenue allocated for their repayment.

Answer: FALSE

44) Corporate bonds are less risky if they are ________ bonds and municipal bonds are less risky if they are ________ bonds. A) secured; revenue B) secured; general obligation C) unsecured; revenue D) unsecured; general obligation

B) secured; general obligation (revenue bonds based on the revenue stream of a project, could default...G.O.s are based on the full faith and credit of the issuer)

55) STRIPS (Separate Trading of Registered Interest and Principal Securities) are also called A) interest-based securities. B) zero-coupon securities. C) leveraged securities. D) covenant securities.

B) zero-coupon securities. (each interest and principle payment becomes a zero coupon bond)

35) Restrictive covenants can A) limit the amount of dividends the firm can pay. B) limit the ability of the firm to issue additional debt. C) restrict the ability of the firm to enter into a merger agreement. D) do all of the above. E) do only A and B of the above.

D) do all of the above.

1) Compared to money market securities, capital market securities have A) more liquidity. B) longer maturities. C) lower yields. D) less risk.

B) longer maturities.

12) The distribution of a firm's capital between debt and equity is its A) current ratio. B) liability structure. C) acid ratio. D) capital structure.

D) capital structure.

43) In its simplest form, a credit default swap provides A) insurance against default in the principle and interest payments of a credit instrument. B) an alternative method for bond issuers to pay principle and interest payments via a swap. C) bond investors with a method to swap interest payments for principle payments during a "credit event." D) the government with a guarantee that certain bond issues will not run into credit problems.

A) insurance against default in the principle and interest payments of a credit instrument.

59) By the time the subprime financial crisis hit in force, Fannie and Freddie had ________ subprime and Alt-A assets on their books. A) over $1 trillion of B) very few C) been prohibited from holding D) none of the above

A) over $1 trillion of

5) The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will ________ before they pay off their debt. A) rise B) fall C) become more volatile D) become more stable

A) rise

25) To sell an old bond when interest rates have ________, the holder will have to ________ the price of the bond until the yield to the buyer is the same as the market rate. A) risen; lower B) risen; raise C) fallen; lower D) risen; inflate

A) risen; lower

9) Governments never issue stock because A) they cannot sell ownership claims. B) the Constitution expressly forbids it. C) both A and B of the above. D) neither A nor B of the above.

A) they cannot sell ownership claims.

16) The current yield on a bond is a good approximation of the bond's yield to maturity when the bond matures in five years or less and its price differs from its par value by a large amount.

Answer: FALSE

9) Most corporate bonds have a face value of $1,000, are sold at a discount, and can only be redeemed at the maturity date.

Answer: FALSE

14) A financial guarantee ensures that the lender (bond purchaser) will be paid both principal and interest in the event the issuer defaults.

Answer: TRUE

15) The Commodity Futures Modernization Act (2000) removed derivative securities, such as credit default swaps, from regulatory oversight.

Answer: TRUE

3) Capital market securities are less liquid and have longer maturities than money market securities.

Answer: TRUE

18) The ________ rate is the rate of interest that the issuer must pay. A) market B) coupon C) discount D) funds

B) coupon

2) The primary issuers of capital market securities are local governments and corporations.

Answer: FALSE (Federal and local governments and corporations)

10) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons.

Answer: FALSE (bearer bonds have largely been replaced by registered bonds with no coupons)

6) Most of the time, the interest rate on Treasury notes is below that on money market securities because of their low default risk.

Answer: FALSE (treasury notes are 1-10 maturity. They require higher interest rates because of their interest rate risk)

1) Firms and individuals use the money markets primarily to warehouse funds for short periods of time until a more important need or a more productive use for the funds arises.

Answer: TRUE

11) A sinking fund is a requirement in the bond indenture that the firm pay off a portion of the bond issue each year.

Answer: TRUE

12) Debentures are long-term unsecured bonds that are backed only by the general creditworthiness of the issuer.

Answer: TRUE

13) In a leveraged buy-out, a firm greatly increases its debt level by issuing junk bonds to finance the purchase of another firm's stock.

Answer: TRUE

50) The current yield on a $5,000, 8 percent coupon bond selling for $4,000 is A) 5%. B) 8%. C) 10%. D) 20%. E) none of the above.

C) 10%.

49) The current yield on a $6,000, 10 percent coupon bond selling for $5,000 is A) 5%. B) 10%. C) 12%. D) 15%.

C) 12%.

10) (I) The primary issuers of capital market securities are federal and local governments, and corporations. (II) Governments never issue stock because they cannot sell ownership claims. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

15) (I) There are two types of exchanges in the secondary market for capital securities: organized exchanges and over-the-counter exchanges. (II) When firms sell securities for the very first time, the issue is an initial public offering. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

19) (I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate is usually fixed for the duration of the bond and does not fluctuate with market interest rates. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

3) (I) Securities that have an original maturity greater than one year are traded in money markets. (II) The best known money market securities are stocks and bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

D) Both are false.

40) Long-term unsecured bonds that are backed only by the general creditworthiness of the issuer are called A) junk bonds. B) callable bonds. C) convertible bonds. D) debentures.

D) debentures.

42) Financial guarantees A) are insurance policies to back bond issues. B) are purchased by financially weaker security issuers. C) lower the risk of the bonds covered by the guarantee. D) do all of the above. E) do only A and B of the above.

D) do all of the above.

41) A secured bond is backed by A) the general creditworthiness of the borrower. B) an insurance company's financial guarantee. C) the expected future earnings of the borrower. D) specific collateral.

D) specific collateral.

20) (I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate on old bonds fluctuates with market interest rates so they will remain attractive to investors. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

A) (I) is true, (II) false.

31) (I) Most corporate bonds have a face value of $1,000, pay interest semiannually, and can be redeemed anytime the issuer wishes. (II) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

A) (I) is true, (II) false. (actually can't be redeemed "anytime" but after a specified time, go with it.)

45) Which of the following are true for the current yield? A) The current yield is defined as the yearly coupon payment divided by the price of the security. B) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond. C) The current yield is always a poor approximation for the yield to maturity. D) All of the above are true. E) Only A and B of the above are true.

A) The current yield is defined as the yearly coupon payment divided by the price of the security.

29) Which of the following statements about Treasury inflation-indexed bonds is not true? A) The principal amount used to compute the interest payment varies with the consumer price index. B) The interest payment rises when inflation occurs. C) The interest rate rises when inflation occurs. D) At maturity, the securities pay the greater of face value or inflation-adjusted principal.

A) The principal amount used to compute the interest payment varies with the consumer price index. (just know this is correct answer...does not make sense based on text p.278)

38) A requirement in the bond indenture that the firm pay off a portion of the bond issue each year is called A) a sinking fund. B) a call provision. C) a restrictive covenant. D) a shelf registration.

A) a sinking fund.

26) Most of the time, the interest rate on Treasury notes and bonds is ________ that on money market securities because of ________ risk. A) above; interest-rate B) above; default C) below; interest-rate D) below; default

A) above; interest-rate

54) Bonds A) are securities that represent a debt owed by the issuer to the investor. B) obligate the issuer to pay a specified amount at a given date, generally without periodic interest payments. C) both A and B of the above. D) none of the above.

A) are securities that represent a debt owed by the issuer to the investor.

46) The nearer a bond's price is to its par value and the longer the maturity of the bond, the more closely the ________ approximates the ________. A) current yield; yield to maturity B) current yield; coupon rate C) yield to maturity; current yield D) yield to maturity; coupon rate

A) current yield; yield to maturity

13) The largest purchasers of capital market securities are A) households. B) corporations. C) governments. D) central banks.

A) households.

7) A firm will borrow long-term A) if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates before it retires its debt. B) if the extra interest cost of borrowing short-term due to rising interest rates does not exceed the expected premium that is paid for borrowing long-term. C) if short-term interest rates are expected to decline during the term of the debt. D) if long-term interest rates are expected to decline during the term of the debt.

A) if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates before it retires its debt.

33) Policies that limit the discretion of managers as a way of protecting bondholders' interests are called A) restrictive covenants. B) debentures. C) sinking funds. D) bond indentures.

A) restrictive covenants.

52) Corporations may enter the capital markets because A) they do not have sufficient capital to fund their investment opportunities. B) they want to preserve their capital to protect against expected needs. C) it is required by the Securities and Exchange Commission (SEC). D) none of the above.

A) they do not have sufficient capital to fund their investment opportunities.

4) Governments never issue stock because they cannot sell ownership claims.

Answer: TRUE

5) To sell an old bond when rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate.

Answer: TRUE

7) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation.

Answer: TRUE

28) (I) Because interest rates on Treasury bills are more volatile than rates on long-term securities, the return on short-term Treasury securities is usually above that on longer-term Treasury securities. (II) A Treasury STRIP separates the periodic interest payments from the final principal repayment. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

B) (I) is false, (II) true.

16) (I) Capital market securities fall into two categories: bonds and stocks. (II) Long-term bonds include government bonds and long-term notes, municipal bonds, and corporate bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

B) (I) is false, (II) true. (capital markets include bonds, stock and mortgages p. 273 introduction)

37) Call provisions will be exercised when interest rates ________ and bond values ________. A) rise; rise B) fall; rise C) rise; fall D) fall; fall

B) fall; rise (if market rates fall, your bond, having a higher rate, would sell at a premium)

57) The first step in finding the value of a bond is to A) discount back the cash flows using an interest rate that represents the yield available on other bonds of like risk and maturity. B) identify the cash flows the holder of the bond will receive. C) contact the holder of the bond. D) none of the above.

B) identify the cash flows the holder of the bond will receive.

51) When an old bond's market value is above its par value, the bond is selling at a ________. This occurs because the old bond's coupon rate is ________ the coupon rates of new bonds with similar risk. A) premium; below B) premium; above C) discount; below D) discount; above

B) premium; above

6) The primary reason that individuals and firms choose to borrow long-term is to A) reduce the risk that interest rates will fall before they pay off their debt. B) reduce the risk that interest rates will rise before they pay off their debt. C) reduce monthly interest payments, as interest rates tend to be higher on short-term than long-term debt instruments. D) reduce total interest payments over the life of the debt.

B) reduce the risk that interest rates will rise before they pay off their debt.

48) The current yield is a less accurate approximation of the yield to maturity the ________ the time to maturity of the bond and the ________ the price is from/to the par value. A) shorter; closer B) shorter; farther C) longer; closer D) longer; farther

B) shorter; farther

8) The primary issuers of capital market securities include A) the federal and local governments. B) the federal and local governments, and corporations. C) the federal and local governments, corporations, and financial institutions. D) local governments and corporations.

B) the federal and local governments, and corporations.

24) (I) To sell an old bond when interest rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate. (II) The risk that the value of a bond will fall when market interest rates rise is called interest-rate risk. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

30) (I) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation. (II) General obligation bonds do not have specific assets pledged as security or a specific source of revenue allocated for their repayment. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

39) (I) Callable bonds usually have a higher yield than comparable noncallable bonds. (II) Convertible bonds are attractive to bondholders and sell for a higher price than comparable nonconvertible bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

4) (I) Firms and individuals use the capital markets for long-term investments. (II) Capital markets provide an alternative to investment in assets such as real estate and gold. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

27) (I) In most years, the rate of return on short-term Treasury bills is below that on the 20-year Treasury bond. (II) Interest rates on Treasury bills are more volatile than rates on long-term Treasury securities. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.(short term rates are more volatile than long term rates p.277)

58) A change in the current yield ________ signals a change in the same direction of the yield to maturity. A) never B) rarely C) always D) often

C) always

22) The prices of Treasury notes, bonds, and bills are quoted A) as a percentage of the coupon rate. B) as a percentage of the previous day's closing value. C) as a percentage of $100 face value. D) as a multiple of the annual interest paid.

C) as a percentage of $100 face value.

53) Capital market trading occurs in A) the primary market. B) the secondary market. C) both A and B of the above. D) none of the above.

C) both A and B of the above.

21) Treasury bonds are subject to ________ risk but are free of ________ risk. A) default; interest-rate B) default; underwriting C) interest-rate; default D) interest-rate; underwriting

C) interest-rate; default

34) Typically, the interest rate on corporate bonds will be ________ the more restrictions are placed on management through restrictive covenants, because ________. A) higher; corporate earnings will be limited by the restrictions B) higher; the bonds will be considered safer by bondholders C) lower; the bonds will be considered safer by buyers D) lower; corporate earnings will be higher with more restrictions in place

C) lower; the bonds will be considered safer by buyers

14) Individuals and households frequently purchase capital market securities through financial institutions such as A) mutual funds. B) pension funds. C) money market mutual funds. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

8) Most municipal bonds are revenue bonds rather than general obligation bonds.

Answer: TRUE

2) (I) Securities that have an original maturity greater than one year are traded in capital markets. (II) The best known capital market securities are stocks and bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

36) (I) Restrictive covenants often limit the amount of dividends that firms can pay the stockholders. (II) Most corporate indentures include a call provision, which states that the issuer has the right to force the holder to sell the bond back. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true. (the indenture is the contract associated with a corporate bond. Corporate bonds usually contain call provision)