Managerial Finance Chapter 6

Which of the following are not plain vanilla bonds?

Convertible Bonds Zero-coupon Bonds Floating-rate Bonds

Investors looking to minimize risk will hold which type of debt?

senior

A bond that is priced above its face value is said to sell for

a premium

Corporate debt depends on the value and the risk of the firm's

assets

Governments and corporations borrow money by selling _______ to investors.

bonds

Secured debt is tied to specific assets, called

collateral

The interest payments to the bondholder are called the

coupon

A bond can also be called a:

debenture note

Bonds are defined as

debt securities

The additional yield on a bond that investors require for bearing default risk is known as

default premium

The risk that a bond issuer may not pay on its bonds in known as

default risk

A change in interest rate has the greatest effect on the present value of:

distant cash flows

The payment made when a bond matures is called the bond's:

face value

When interest rates rise, bond prices

fall

If interest rates fall, the rate of return on a bond will be _____ the yield to maturity.

greater than

When a firm puts up collateral assets to back up a loan, the debt is said to be:

secured

A graph of the yield curve shows the bond yield to maturity on the _____ axis and the time to maturity on the _____ axis.

vertical, horizontal

A plot drawn to show the relationship between bond yields and maturity is known as the

yield curve

A measure of return that takes account of both coupon payments and change in a bond's value over its life is a standard measure known as

yield to maturity

The discount rate that makes the present value of the bond's payments equal to its price is known as the

yield to maturity

Marley Corporation's bonds have four years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 5%. If the price of the bond is $841.51, the yield to maturity is _____. (Use trial and error to calculate yield).

10% Reason: First, calculate the coupon payment: $1,000 x .05 = $50. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $841.51. You will see that by doing trial and error on the 4 given yields in the multiple choice question (5%, 8%, 10%, and 12%), the correct yield is 10%: $841.51 = $50/(1+.1) + $50/(1+.1)22+ $50/(1+.1)33+ $1,050/(1.1)4

Mortor's Corporation sold 6 year bonds for $1,072.62, with a face value of $1,000 and a coupon rate of 8%. The annual yield to maturity is

6.5% Reason: First, calculate the coupon payment: $1,000 x .08 = $80. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $1,072.62. You will see that by doing trial and error on the 4 given yields in the multiple choice question (6%, 6.5%, 7%, and 7.5%), the correct yield is 6.5%: $1,072.62 = $80/(1+.065) + $80/(1+.065)22+ $80/(1+.065)33+ $80/(1.+.065)44+ $80/(1 + .065)55+ $1,080/(1+.065)6

If the nominal rate of interest is 10% and the rate of inflation is 3%, the real interest rate is ____.

6.8% Reason: 1 + real interest rate = (1 +.1)/(1 +.03) = 1.068 - 1 = .068 or 6.8%

When the interest rate is lower than the coupon rate on a bond, the price of the bond will be:

Higher than face value Reason: Take, for example, a 5 year, $1,000 bond offering a 10% coupon. If the interest rate is less than the coupon rate - for example, if the interest rate is 5%, the PV of the bond would be: $100/(1.05)1 + $100/(1.05)2 + $100/(1.05)3 + $100/(1.05)4 + $1,100/(1.05)5 = $1,216.47 - a higher price than the $1,000 face value.

The price of a bond is equal to the

PV(coupon) plus PV(face value)

What is the term used in finance to represent simple, standard, and common?

Plain vanilla

Which of the following are steps bondholders can take to minimize default risk?

Protective covenants Security Seniority

Which debt is paid first in the event of bankruptcy?

Senior Debt

Because the _____ rate is uncertain, so is the _______ rate of interest offered on bonds.

inflation, real

The __________ on government bonds provide a benchmark for all interest rates.

interest rates

Bonds rated Baa or above by Moody's or BBB or above by Standard & Poors are known as

investment grade bonds

Bonds rated Ba or below by Moody's or BB and below by Standard & Poors are known as

junk bonds

The return on a bond that sells at a premium is ____ (greater or less) than the current yield.

less

If interest rates rise, the rate of return on a bond will be _____ the yield to maturity.

less than

When the interest rate is higher than a bond's coupon rate, the bond will be priced at:

less than face value Reason: Take, for example, a 5 year, $1,000 bond offering a 10% coupon. If the interest rate is higher than the coupon rate - for example, if the interest rate is 12%, the PV of the bond would be: $100/(1.12)1 + $100/(1.12)2 + $100/(1.12)3 + $100/(1.12)4 + $1,100/(1.12)5 = $927.90 - a lower price than the $1,000 face value.

The price of a bond can be quoted as a _____ of face value.

percentage