Finance Final Chapter 7

Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return? a. The required rate of return would increase because the bond would then be more risky to a bondholder. b. It is impossible to say without more information. c. The required rate of return would decline because the bond would then be less risky to a bondholder. d. Because of the call premium, the required rate of return would decline. e. There is no reason to expect a change in the required rate of return.

A

Which of the following bonds has the greatest price risk? a. A 10-year $100 annuity. b. A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments. c. A 10-year, $1,000 face value, zero coupon bond. d. All 10-year bonds have the same price risk since they have the same maturity. e. A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.

C

A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT? a. The bond's current yield is less than 8%. b. If the yield to maturity increases, then the bond's price will increase. c. The bond's coupon rate is less than 8%. d. If the yield to maturity remains at 8%, then the bond's price will decline over the next year. e. If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year.

D

. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates, other things held constant.

False

A firm with a sinking fund that gives it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.

False

An indenture is a bond that is less risky than a mortgage bond

False

Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30- day bond than if you bought a 30-year bond

False

Bonds are exposed to both reinvestment risk and price risk. Longer-term low-coupon bonds, relative to shorter-term high-coupon bonds, are generally more exposed to reinvestment risk than price risk.

False

Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts price risk to companies, it offers no advantages to corporate issuers.

False

If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where r = YTM = 5%, the bond would sell at a premium over its $1,000 par value.

False

If a bond's coupon rate exceeds its yield to maturity, then its expected return to investors will also exceed its yield to maturity

False

Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds.

False

Once a firm declares bankruptcy, it must be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and legal fees

False

One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the use of debt until the bonds mature.

False

Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.

False

Other things held constant, a callable bond would have a lower required rate of return than a non-callable bond because it would have a shorter expected life.

False

Other things held constant, including the coupon rate, a corporation would rather issue noncallable bonds than callable bonds

False

Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices.

False

The expected capital gains yield on a bond will always be zero or positive because no investor would purchase a bond with an expected capital loss.

False

The expected return on a corporate bond will generally exceed the bond's yield to maturity

False

The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates

False

The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm has filed for bankruptcy.

False

The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates.

False

The yield to maturity for a coupon bond that sells at a premium consists entirely of a positive capital gains yield; it has a zero current interest yield.

False

Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated

False

You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline.

False

All else equal, senior debt generally has a lower yield to maturity than subordinated debt

True

If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where r = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.

True

If a firm raises capital by selling new bonds, it could be called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk

True

Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds

True

Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength

True

Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds

True

Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond's face value.

True

The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.

True

The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond's remaining maturity.

True

The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant.

True

The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.

True

You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.

True

You hold two bonds, a 10-year, zero coupon, issue and a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from its current level, the zero coupon bond will experience the larger percentage decline.

True