Ch. 6: Part 2

Secured debt is tied to specific assets, called ____________.

collateral

Which type of bond generally offers the highest yield?

corporate

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?

Security Seniority Protective covenants

Which debt is paid first in the event of bankruptcy?

Senior Debt

Which of the following are not plain vanilla bonds?

Zero-coupon Bonds Convertible Bonds Floating-rate Bonds

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% Rationale: 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)^2+ $50/(1+.1)^3+ $1,050/(1.1)^4

An individual invested $1,000 in a bond with a coupon payment of $12. The price of the bond increased to $1,400. What is the rate of return on this bond?

41.2% Rationale: Rate of return=(coupon income + price change)/investment= ($12+$400)/$1,000=.412 or 41.2%

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% Rationale: 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)^2+ $80/(1+.065)^3+ $80/(1.+.065)^4+ $80/(1 + .065)^5+ $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% Rationale: 1 + real interest rate = (1 +.1)/(1 +.03) = 1.068 - 1 = .068 or 6.8%

Even when the yield curve of a long-term bond is upward-sloping some investors prefer short-term bonds. Which of the following reasons would explain why this statement is true?

Short-term investors can profit if interest rates rise Prices of long-term bonds fluctuate more than prices of short-term bonds

The U.S. Treasury issues ___________, which adjust nominal cash flows based on the consumer price index.

TIPS Rationale: Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds that adjust nominal cash flows based on changes in the consumer price index.

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

a discount

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

a premium

The current yield on a bond is equal to

annual coupon payment divided by bond price

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

assets

Limitation or subordination of new debt is a form of a protective ____________ on existing debt.

covenant

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

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

greater than

The banking crisis of 2007-2009 shows that investors prefer ________ in bonds; therefore, heavily traded bonds offer ________ yields.

higher liquidity, lower

Long-term bond prices are more sensitive than short-term bond prices to

increases in interest rates

Which type of bond links coupon payments to inflation?

indexed bonds

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

inflation, real

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

Conditions imposed on borrowers to protect lenders from unreasonable risk are known as

protective covenants

The total income per period per dollar invested is known as the

rate of return

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

secured

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

senior

For bonds priced at face value, the rate of return is

the coupon rate