Chapter 10 Finance 409
16. All other things being equal, a bond's value will be below its maturity value of $1,000 if it pays interest of $100 per year and investors require a rate of return that is,: a. less than 10% b. exactly 10% c. higher than 10% d. either less than or greater than 10%
$100 interest per year: If price = $1,000 → 10% return, if price > $1,000 → less than 10% return Answer: c p 257 if price < $1,000 → investors can get more than 10% which would give investors a return equal to alternative equal risk investments which is what they would require
22. A trustee represents the company to ensure that the covenants of the bond indenture are met.
Answer: F p 236 represents the bond holders
11. The claims of collateralized bondholders are junior to the claims of debenture holders
Answer: F p 238-239 collateral is the assets pledged to back a bond issue, debenture bonds are unsecured (i.e. no assets back them), the are backed only by the general credit strength of the corporation
12. A convertible bond can be converted, at the issuing firm's option, into a specific number of shares of the issuer's common stock.
Answer: F p 240 at the investor's option
23. The call price of a callable bond is typically equal to par value plus two years interest.
Answer: F p 240 one year of interest
35. Global bonds are generally denominated in euros and are marketed globally.
Answer: F p 242 denominated in dollars
36. Common stock possesses the highest claim on the assets and cash flow of the firm.
Answer: F p 245 bonds have a higher claim
17. Preferred stock is an equity security that has a senior claim to the firm's earnings and assets over bonds.
Answer: F p 246 bonds must be paid first, preferred stock is senior over common stock
42. Preferred stock pays a dividend that is equal to its par value.
Answer: F p 246 dividend may be a percentage of its par value
39. The par value of a common stock is meaningful in that it is often used to determine the fixed annual dividend.
Answer: F p 246 par value of common stock has little relationship to the current price or book value of the stock, a preferred stock's dividend may be a percentage of its par value
45. The values of stocks and bonds are not affected by time value of money concepts
Answer: F p 252-265 this chapter showed how to use TVM to place a value on stocks and bonds
21. A bond with a coupon rate of 4% and a discount rate of 6% will pay $60 in interest each year
Answer: F p 257 dollar interest on bonds is based on the coupon rate not a discount rate, par (face) value = $1,000 → $1,000(0.04) = $40 interest each year
27. A bond will sell at a premium if its required return or discount rate is greater than its coupon rate.
Answer: F p 257 it will sell at a premium if its required return is less than its coupon rate
44. The shorter the maturity of a fixed-rate debt instrument, the greater the reduction in its value to a given interest rate increase.
Answer: F p 260 Either a longer term to maturity or a lower coupon rate, all else equal → increase a bond's sensitivity to market interest rate changes
40. The par value of a preferred stock is meaningful in that it may be used to determine the fixed annual dividend.
Answer: T p 246 dividend may be a percentage of its par value
19. The higher the discount rate or yield to maturity, the lower the price of a bond.
Answer: T p 255, 257 and equations 10.2 and 10.2a a higher discount rate → a lower present value
24. Suppose a firm's $1,000 par value convertible bond is currently worth $1,000. Its conversion ratio is 30 and the stock currently sells for $25 per share. Would it make better financial sense to hold onto the bond or convert it? a. hold onto the bond b. convert the bond c. can't tell from this information d. none of the above
Answer: a p 240 and slide 11
30. Consolidated Edison has just paid an annual dividend of $3 per share. If the expected growth rate for Con Ed is 10%, and your required rate of return is 16%, what is the maximum you should be willing to pay for this stock? (Pick the closest answer.) a. $55 b. $50 c. $46.50 d. $51.50
Answer: a p 263 and Equation 10.6
2. The largest annual supply of external funds for business corporations comes from issuance of which one of the following sources? a. privately placed stocks b. bonds c. preferred stocks d. common stocks
Answer: b p 232 and Table 10.1 bonds accounted for 90% of total securities issued 1998-2011
47. If a bond with a par value of $500 and a call premium of 6% is called in before its maturity date, the firm would pay the following to the bondholders: (Pick the closest answer.) a. $500 b. $530 c. $0 d. $560
Answer: b p 240 $500(1.06) = $530
25. Ameritech has just issued a $1,000 par value bond that will mature in 10 years. This bond pays interest of $45 every six months. If the annual yield to maturity of this bond is 8%, what is the price of the Ameritech bond if the market is in equilibrium? (Pick the closest answer.) a. $991.50 b. $1,067.96 c. $1,112.82 d. $1,046.58
Answer: b p 255-259 and slide 27-29 END MODE FV 1,000 N 20 PMT 45 I/Y 4 → PV = $1,067.95
29. You are trying to determine the fair price to pay for a share of Ford. If you buy this stock, you plan to hold it for a year. At the end of the year, you expect to receive a dividend of $5.50 and to sell the stock for $154. The discount rate for Ford stock is 16%. What should be the price of this stock? (Pick the closest answer.) a. $99.80 b. $137.50 c. $144.22 d. $151.66
Answer: b p 272 and Equation LE 10-1
20. A firm's stock is expected to pay a $2 annual dividend next year, and the current $50 stock price is expected to rise to $53 over the next year. What is the expected return during this one year time period? (Pick the closest answer.) a. 8% b. 10% c. 12% d. 15%
Answer: b p 272 and LE 10-2 $53 - $50 = $3 → $𝟑+$𝟐 $𝟓𝟎 = 𝟏𝟎%
28. The last dividend on GTE stock was $4, and the expected growth rate is 10%. If you require a rate of return of 20%, what is the highest price you should be willing to pay for GTE stock? (Pick the closest answer.) a. $40 b. $42.50 c. $44 d. none of the above
Answer: c P 263 and Equation 10.6
32. Chrysler has a bond outstanding with eight years remaining to maturity, a coupon rate of 5%, and semiannual payments. If the market price of the Chrysler bond is $729.05, what is the annual yield to maturity? (Pick the closest answer.) a. 7% b. 9% c. 10% d. 11%
Answer: c p 255-259 and slide 27-29 END MODE FV 1,000 N 16 PMT 25 PV -$729.05 → I/Y = 5% semiannual → 10% YTM
21. The constant dividend growth model assumes: a. a constant annual dividend b. a constant dividend growth rate for no more than the first 10 years c. that the discount rate must be greater than the dividend growth rate d. two of above are true assumptions
Answer: c p 263 and Equation 10.6
1. Firms issue more equities than bonds for the following reason(s). a. it is cheaper to raise equity than to borrow (borrowing is cheaper) b. bonds have a maturity date making them pricier (maturity date makes them cheaper) c. both a and b are true d. none of the above are true
Answer: d p 232 bonds accounted for 90% of total securities issued 1998-2011
49. Eurodollar bonds are: a. denominated in Eurodollars b. extremely long-term obligations c. scrutinized by the SEC d. none of the above
Answer: d p 242 dollar-denominated bonds sold outside the United States
31. RJR Nabisco recently experienced a market reevaluation due to a number of tobacco lawsuits. The firm has a bond outstanding with 15 years to maturity, and a coupon rate of 8%, with interest being paid semiannually. The required yield to maturity has risen to 16%. What is the price of the RJR Nabisco bond? a. $1,000 b. $804 c. $767 d. $550
Answer: d p 255-259 and slide 27-29 END MODE FV 1,000 N 30 PMT 40 I/Y 8 → PV = $549.69
26. Mary wants to purchase a 20-year bond that has a par value of $1,000 and makes semiannual interest payments of $40. If her required yield to maturity is 10%, which of the following is closest to how much should Mary be willing to pay for the bond? (Pick the closest answer.) a. $902 b. $925 c. $1000 d. $828
Answer: d p 255-259 and slide 27-29 END MODE FV 1,000 N 40 PMT 40 I/Y 5 → PV = $828.41
45. Which of the following bonds has the greatest interest rate risk? a. a 5 year, 10% coupon bond (shorter maturity) b. a 10 year, 10% coupon bond (higher coupon rate) c. a 5 year, 5% coupon bond (shorter maturity and higher coupon rate) d. a 10 year, 5% coupon bond
Answer: d p 260 and Figure 10.6 Either a longer term to maturity or a lower coupon rate, all else equal → increase a bond's sensitivity (risk) to market interest rate changes
22. What is the value of HM stock which currently has a dividend of $2 and is growing at 7%? The investor's required rate of return is 11%. (Pick the closest answer.) a. $46 b. $50 c. $52 d. 53.50
Answer: d p 263 and Equation 10.6 D1 = $2(1.07) = $2.14 𝐏𝟎 = $𝟐.𝟏𝟒 𝟏𝟏%−𝟕% = $𝟐.𝟏𝟒 𝟎.𝟎𝟒 = $𝟓𝟑. 𝟓
19. A firm's stock is expected to pay a $3 annual dividend next year, the current stock price is $60, and the expected growth rate in dividends is 8%. Using the Gordon approach, what is the expected return? (Pick the closest answer.) a. 5% b. 8% c. 13.4% d. 13%
Answer: d p 263-264 and Equation 10.6 𝐫𝐬 = 𝐃𝟏 𝐏𝟎 + 𝐠 = $𝟑 $𝟔𝟎 + 𝟖% = 𝟓% + 𝟖% = 𝟏𝟑%
1. During periods of economic expansion, firms usually rely more on internal sources of funds.
F
24. Zero coupon bonds are not suited for tax-exempt accounts such as IRAs or pension funds.
F
30. Real assets are claims against the income or assets of individuals, businesses, and governments.
F
32. Most bonds currently issued in the United States today are bearer bonds.
F
3. Long term business funds are obtained by issuing commercial paper and corporate bonds.
F p 232 commercial paper is a source of short-term financing for businesses
4. Private placements must be approved by the Securities and Exchange Commission (SEC).
F p 232 public placements must be approved by the SEC
10. Mortgage bonds are secured by home mortgages.
F p 238 backed by specifically pledged property of a firm
13. Callable bonds can be redeemed prior to maturity by the firm.
T
14. Eurodollar bonds are dollar-denominated bonds that are sold outside the United States.
T
15. Yankee bonds are U.S. dollar-denominated bonds that are issued in the United States by a foreign issuer.
T
16. Global bonds usually are denominated in U.S. dollars and have offering sizes that typically exceed $1 billion
T
18. Callable preferred stock gives the corporation the right to retire the preferred stock at its option.
T
2. Most of the annual funds raised from security issues come from corporate bond sales.
T
20. The bond issuer does not necessarily know who is receiving interest payments on bearer bonds.
T
25. Inflation-protected Treasury notes have a principal value that changes in accordance with the consumer price index (CPI).
T
26. A bond will sell at a discount if its required return or discount rate is greater than its coupon rate.
T
28. Credit risk is another term for default risk.
T
29. Financial assets are claims against the income or assets of individuals, businesses, and governments.
T
31. Most bonds currently issued in the United States today are registered bonds.
T
33. Subordinate debentures are bonds whose claims are junior to the claims of those holding debenture bonds.
T
34. Many callable bonds possess a call deferment period which is a specified period of time after the issue during which the bonds cannot be called.
T
37. Common stock possesses the lowest claim on the assets and cash flow of the firm.
T
38. The par value of a common stock is an accounting and legal concept that bears no relationship to a firm's stock price or book value.
T
41. Convertible preferred stock has a special provision that makes it possible to convert it to common stock of the corporation, generally at the stockholder's option.
T
43. There is an inverse relation between debt instrument prices and nominal interest rates in the marketplace.
T
5. Firms issue more bonds than equities.
T
6. A debt holder may force the firm to abide by the terms of the debt contract even if the result is reorganization or dissolution of the firm.
T
7. Bondholders have priority claims over equity holders to a firm's assets and cash flows.
T
8. Bond covenants are the best way for bondholders to protect themselves against dubious management actions.
T
9. Bond issues of a single firm can have different bond ratings if their security provisions differ.
T
14. Which of the following types of bonds have the lowest bondholder security risk? a. closed-end mortgage bond b. subordinated debenture c. open-end mortgage bond d. all the above would have the same risk
a
4. Which type of bond is currently prohibited from being issued in the United States? a. bearer bonds b. unregulated debentures c. tax avoidance bonds d. income bonds
a
40. Bond ratings are paid for by: a. the issuing firm b. the trustee c. the investment banker d. none of the above
a
43. The three types of risk faced by investors in domestic bonds include all of the following EXCEPT: a. exchange rate risk b. credit risk c. interest rate risk d. reinvestment rate risk
a
46. An example of asset securitization is: a. a first mortgage bond b. a debenture (unsecured) c. a subordinated debenture (unsecured because it is subordinate to a bond that is unsecured) d. all the above
a
48. Putable bonds are sometimes referred to as: a. retractable bonds b. callable bonds c. convertible bonds d. none of the above
a
53. Which of the following bonds can be redeemed prior to maturity by the firm? a. callable bonds b. convertible bonds c. putable bonds d. retractable bonds
a
54. A bond's value is the same as its principal amount when the coupon rate is: a. the same as the required rate of return b. higher than the required rate of return c. lower than the required rate of return d. lower than the inflation rate
a
8. A document which is administered by a trustee, and includes in great detail the various provisions of the loan agreement is called the: a. trust indenture (definition) b. debenture c. bond covenant (bond indenture MAY include covenants) d. bearer bond
a
11. A bond that can be changed into a specified number of shares of the issuer's common stock is called a: a. retractable bond (another name for a putable bond) b. convertible bond c. callable bond d. collateralized bond
b
15. Which of the following types of stocks have the lowest risk to shareholders? a. common stock b. cumulative preferred stock c. non-cumulative preferred stock d. callable preferred stock
b
23. According to the Gordon dividend model, which of the following variables would not affect a stock's price? a. the firm's expected growth rate in dividends b. the number of shares outstanding c. the shareholder's required return d. all the above affect stock price
b
33. Which of the following statements is most correct? a. A closed-end mortgage bond is one that allows the same assets to be used as security in future bond issues. b. Covenants in a trust indenture restrict or limit the actions the firm can take. c. Retractable bonds can be redeemed prior to maturity by the firm. d. All of the above are correct.
b
41. A speculative (junk) bond issue as rated under Standard & Poor's would be rated ______ or below: a. AAb. BB+ c. CCC d. CC
b
42. A (n) _____________ gives the bondholder a claim to specific assets (identified through serial numbers) such as railroad cars or airplanes. a. first mortgage bond b. equipment trust certificate c. inventory bond d. collateralized bond
b
51. The terms or covenants of a bond contract are set out in which of the following documents? a. debenture b. trust indenture c. mortgage d. negative pledge clause
b
55. When the market interest rate is the same as the coupon rate for a particular quality of bond, the bond will be priced: a. below its par value b. at its par value c. above its par value d. The bond price cannot be determined
b
7. Which of the following is not an advantage of owning debt securities? a. high claim on cash flows of a firm b. highest return of corporate securities (equity holders usually receive higher returns) c. high claim on assets of in liquidation d. none of the above
b
9. An individual or organization that represents the bondholders to ensure the indenture's provisions are respected by the bond issuer is called a (n): a. trust indenture b. trustee c. investment banker d. trust organization
b
10. All of the following represent bonds secured by real assets except a (n): a. closed-end mortgage bond b. equipment trust certificate c. debenture d. open-end mortgage bond
c
13. Dollar-denominated bonds that are issued in the United States by a foreign issuer are called: a. Eurodollar bonds b. foreign bonds c. Yankee bonds d. global bonds
c
17. Most American bonds pay coupon interest a. monthly b. quarterly c. semi-annually d. annually e. none of the above
c
3. U.S. firms are continuing to raise more funds overseas include all of the following EXCEPT: a. it makes sense to raise funds in the county where a firm has a facility b. financing costs are sometimes lower overseas c. foreign underwriters often have more experience than U.S. underwriters d. issuers avoid the costly SEC approval process
c
34. Which of the following statements is false? a. Preferred stock that is both cumulative and convertible is a popular financing choice for investors purchasing shares of stock in small firms with high growth potential. b. Bond issues of a single firm can have different bond ratings if their security provisions differ. c. Yankee bonds are dollar-denominated bonds that are sold outside the United States. d. All of the above statements are correct.
c
35. To accurately compare the rate of return on one investment with another, they should be: a. equal in size or dollar amount b. measured over different time periods c. measured over equal time periods d. held for more than one year
c
50. A sinking fund: a. is a special fund set up to pay of the creditors of bankrupt firms b. requires specific approval by the firm's board of directors c. requires the issuer to retire a bond issue incrementally over time d. none of the above
c
12. A bond that allows investors to force the issuer to redeem the bond prior to maturity is called a: a. convertible bond b. callable bond c. debenture bond d. putable bond
d
18. Which of the following is considered to be the most risky? a. U.S. government bonds b. mortgage bonds c. corporate bonds d. common stocks
d
36. An unrated bond: a. is perceived as having lower than average risk b. are termed as "debentures" c. generally has a lower yield than rated bonds d. none of the above
d
37. The following factors may affect a bond rating: a. security provisions b. indenture provisions c. expected trends of industry operations d. all the above e. none of the above
d
38. Which of the following constitute default on a bond? a. nonpayment of par value b. nonpayment of coupon c. violation of the indenture d. all the above e. none of the above
d
39. Which of the following are not bond rating agencies? a. Standard and Poor's b. Fitch's c. Moody's d. all the above are rating agencies e. none of the above are rating agencies
d
44. Which of the following risks would not be faced by investors in domestic bonds? a. credit (or default) risk b. interest rate risk c. reinvestment rate (or rollover) risk d. exchange rate risk
d
5. Preferred stock can have which of the following characteristics? It can be: a. cumulative b. non-cumulative c. convertible d. all of the above
d
52. Which of the following bond types would describe unsecured obligations that depend on the general credit strength of the corporation? a. closed-end mortgage bonds b. mortgage bonds c. equipment trust certificates d. debenture bonds
d
6. Private placements: a. are sold to the general public b. have expedited SEC scrutiny c. require public disclosure of the firm's financial information d. none of the above
d
27. You are considering buying a 10-year, $1,000 par value bond issued by IBM. The coupon rate is 8% annually, with interest being paid semiannually. The first interest payment will be received six months from today. If you expect to earn a 10% rate of return on this bond, what is the maximum price you should be willing to pay for this IBM bond? (Pick the closest answer.) a. $189.93 b. $875.38 c. $898.54 d. $911.46
earn 10% annual rate of return → 5% semiannually, PMT = (1/2)(8%)($1,000) = $40 semiannually N = 2(10) = 20 semiannual periods Answer: b p 255-259 and slide 27-29 END MODE FV 1,000 N 20 PMT 40 I/Y 5 → PV = $875.38
