Ch 7 Fin Man
If the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ____.
$1,220
A firm decides to raise money by issuing 5 million bonds with a par value of $5,000 each for 10 years at a coupon rate of 7 percent. At the time of issue, the bonds were sold for $5,500 each. What will the par value of the bonds be in year 5?
$5,000 per bond
A bond pays annual interest payments of $50, has a par value of $1,000, and a market price of $1,200. How is the coupon rate computed?
$50/$1,000
What is the value of a bond if the present value of interest cash flows is $200 and the present value of the par value to be received when the bond matures is $750?
$950
Which of the following is true about interest rate risk?
- All else equal, the lower the coupon rate, the greater the interest rate risk. - All else equal, the longer the time to maturity, the greater the interest rate risk.
Which of these are required to calculate the current value of a bond?
- Coupon rate - Par value - Applicable market rate - Time remaining to maturity
Which of the following are true about a bond's face value?
- It is the principal amount repaid at maturity. - It is also known as the par value.
Which of the following variables are required to calculate the value of a bond?
- Remaining life of bond - Market yield - Coupon rate - Par value
What is a corporate bond's yield to maturity (YTM)?
- YTM is the expected return for an investor who buys the bond today and holds it to maturity. - YTM is the prevailing market interest rate for bonds with similar features.
A corporate bond's yield to maturity ____.
- can be greater than, equal to, or less than the bond's coupon rate - changes over time
As a general rule, which of the following are true of debt and equity?
-The maximum reward for owning debt is fixed -Equity represents an ownership interest
Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?
-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.
How is investing in U.S. Treasury bonds different from investing in corporate bonds?
-Treasury issues have no default risk. -Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not.
Which of these is included in the calculation of a bond's yield to maturity?
-current price -coupon rate -par value
All junk bonds typically have which of these features?
-high probability of default -less than investment-grade rating
Which of the following are common protective covenants?
-the firm must limit dividends to equity holders -the firm must maintain working capital at or above a specified level -the firm cannot merge with any other firm
Which of the following are features of municipal bonds?
-the interest on municipal bonds is exempt from federal taxes -they are issued by state and local governments
Which of the following are usually included in a bond's indenture?
-the repayment arrangements -the total amount of bonds issued
What information is needed to compute a bond's yield-to-maturity?
-time to maturity -coupon rate -the bond's current price
Which of the following terms apply to a bond?
-time to maturity -par value -coupon rate
The U.S. government borrows money by issuing:
-treasury bonds -treasury notes -treasury bills
What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?
10% (Coupon rate = $100/$1,000 = .10, or 10%)
In terms of time to maturity, U.S. Treasury notes and bonds have initial maturities ranging from ___ years.
2 to 30
If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes. Multiple choice question.
5%
What is a premium bond?
A bond that sells for more than face value.
True or false: A bond's value is not affected by changes in the market rate of interest.
False
Which of the following is true about a typical multiple-year bond's coupon?
It is a fixed annuity payment.
What is the definition of a bond's time to maturity?
It is the number of years until the face value is due to be repaid.
What is an interest-only loan?
It's a loan in which the borrower pays interest periodically and repays the principal when the bond matures.
Which one of the following is the most important source of risk from owning bonds?
Market interest rate fluctuations
What are the federal income tax implications of receiving $50 in interest income from a municipal bond versus a corporate bond?
Only the interest on the corporate bond will be taxed.
What are the two major forms of long-term debt?
Public issue and privately placed
How is an APR computed?
Rate per period x Number of periods per year
If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?
The 10-year bond
Suppose you own a 30-year bond issued by GE and a 2-year bond issued by PG with identical coupon rates and par values. Which bond will you decrease in value more as interest rates rise?
The GE bond will lose more because it has a longer maturity.
Assume you own a bond that was issued by a blue-chip company. If the market rate of interest rises, what will happen to the value of your bond?
The bond value will fall.
You own two bonds—one with a 5 percent coupon and one with a 6 percent coupon. Which one is more sensitive to interest rate risk, all other things being equal?
The bond with the 5 percent coupon rate is more sensitive.
Why does a bond's value fluctuate over time?
The coupon rate and par value are fixed, while market interest rates change.
Why is the YTM of a discount bond greater than the bond's current yield?
The current yield does not include the capital gain from the price discount.
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
What does a Moody's bond rating of C typically indicate?
The issuer is in default
Why did Disney issue 100-year bonds, dubbed "Sleeping Beauty" bonds, in the 1990s?
To lock-in historically low interest rates for a long time
What will the impact be on your risk exposure if your bond has recently been categorized as a "fallen angel"? Multiple choice question.
Your risk will increase
A bond's YTM will exceed its current yield when the bond is selling at ____.
a discount
Protective covenants are classified into two types: ________ and ________ covenants.
affirmative; negative
Bond yields (are/aren't) quoted like APRs.
are
The main reason it is important to distinguish between debt and equity is that the benefits and risks _____.
are different
When a corporation or government wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities that are generically called
bonds
The amount by which the call price exceeds the par value of the bond is called the _____.
call premium
A _______ provision allows the company to repurchase or "________" part or all of the bond issue at stated prices over a specified period.
call; call
In general, which will have a higher pretax yield? (Assume the bonds are comparable.)
corporate bond
A bond's _____ rate is the stated interest payment made on a bond.
coupon
If a bond is rated Baa by Moody's and BB by Standard & Poor's, the bond will be regarded as a(n) _____ bond.
crossover
The _______ yield does not include the capital gain from the price discount, whereas the YTM does include it.
current
The _______ yield is the bond's annual coupon divided by its price.
current
A ________ is an unsecured bond, for which no specific pledge of property is made.
debenture
If the market rate of interest (increases/declines), bond values increase.
declines
As the maturity of a bond increases, interest rate risk increases at a(n) ___________ (decreasing/increasing) rate.
decreasing
Which of these risks is addressed by bond ratings?
default risk
If the market rate of interest rises, the value of the bond will _____ (fall/rise).
fall
True or false: If you invest in junk bonds, there is a high likelihood that you will earn a very high return.
false
The interest from a municipal bond is exempt from ____ income taxes.
federal
The longer the term, the (smaller/greater) the interest rate sensitivity.
greater
If a bond is selling at a discount from its par value, the YTM must be _____ the coupon rate.
greater than
Longer-term bonds have (smaller/greater) interest rate sensitivity because a (smaller/larger) portion of a bond's value comes from the face amount.
greater; larger
A bond with a BBB rating has a ______ than a bond with an A rating.
higher risk default
If you were classified as a high income/high tax bracket investor, you might find municipal bonds an attractive investment because ____.
income from municipal bonds is exempt from federal taxes
Assume you own a bond currently valued at $989. If the market rate of interest drops, the bond's current market value will _____.
increase
When interest rates in the market fall, bond values are likely to increase because the present value of the bond's remaining cash flows ____.
increases
As the maturity of a bond increases, interest rate risk ____.
increases at a decreasing rate
The written agreement between the corporation and the lender detailing the terms of the debt issue is the __________.
indenture
When comparing a 1-year bond's price to a 30-year bond's price, the 1-year bond's price is relatively _______ (sensitive/insensitive) to interest rate changes.
insensitive
A bond's yield to maturity considers the interest earnings and the change in the bond's price while the current yield considers ____.
interest earnings only
The relationship between bond prices and the market rate of interest is ____.
inverse; if the market rate of interest rises, bond prices will fall
Interest on municipal bonds ________ (is/isn't) federally taxed.
isn't
The federal government can raise money from financial markets to finance its deficits by ___.
issuing bonds
If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ______ $1,000.
less than
The reason that interest rate risk is greater for Blank______ term bonds than for Blank______ term bonds is that the change in rates has a greater effect on the present value of the Blank______ than on the present value of the Blank______.
long; short; face value; coupon payments
A company may decide to issue bonds with maturities of greater than 30 years in order to lock in (low/high) interest rates for a long time.
low
All other things being equal, the (lower/higher) the coupon rate, the greater the interest rate risk.
lower
When using trial and error to compute the yield to maturity (YTM) for a 6 percent coupon bond that trades at a premium, the process can be shortened if the initial guess is ____ 6 percent.
lower than
A bond's _____ time to is the number of years until the face value is due to be repaid.
maturity
A sinking fund is one type of:
repayment provision
_________ is the term that indicates preference in position over other lenders.
seniority
A ________ fund is an account managed by the bond trustee for the purpose of repaying the bonds.
sinking
In case of default:
subordinated debt holders must give preference to other specified creditors
Bond ratings are based on the probability of default risk, which is the risk that ___.
the bond's issuer may not be able make all the required payments
If you own corporate bonds, you will be concerned about interest rate risk as it affects ____.
the market price of the bonds
The degree of interest rate risk depends on ____.
the sensitivity of the bond's price to interest rate changes
If a $1,000 par value bond is trading at a premium, the bond is _____.
trading for more than $1,000 in the market
True or false: Equity represents an ownership interest.
true
True or false: If you invest in a bond that is rated AAA by S&P, you can be reasonably assured that your investment has very little default risk.
true
If you invest in a corporate bond, how many times can you expect, in general, to receive interest?
twice a year
Most corporate bonds pay coupon interest payments _____ times per year.
two
What are municipal bonds?
Bonds that have been issued by state or local governments
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
What are "fallen angel" bonds?
Bonds that have dropped from investment grade to junk bond status
What is a bond's current yield?
Current yield = Annual coupon payment/Current price
What is a discount bond?
Discount bonds are bonds that sell for less than the face value.
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not