Chapter 7 Finance

An 8% corporate bond that pays interest semi-annually was issued last year. Which 2 of the following most likely apply to this bond today if the current yield-to-maturity is 7%? I. a structure as an interest-only loan II. A current yield that equals the coupon rate III. A yield-to-maturity equal to the coupon rate IV. a market price that differs from the face value

A structure an an interest-only loan and a market price that differs from the face value

The break-even tax rate between a taxable corporate bond yielding 7 percent and a comparable nontaxable municipal bond yielding 5 percent can be expressed as:

0.05/(1 - t*) = 0.07.

Which one of the following bonds is the least sensitive to interest rate risk?

3 year; 6% coupon

Al is retired and enjoys his daily life. His one concern is that his bonds provide a steady stream of income that will continue to allow him to have the money he desires to continue his active lifestyle without lowering his present standard of living. Although he has sufficient principal to live on, he only wants to spend the interest income provided by his holdings and thus is concerned about the purchasing power of that income. Which one of the following bonds should best ease Al's concerns?

5 year TIPS

Mary is a retired widow who is financially dependent upon the interest income produced by her bond portfolio. Which one of the following bonds is the least suitable for her to own?

7 year income bond

Which of the following statements concerning bonds are correct? I. Bonds provide tax benefits to issuers. II. The risk of a firm financially failing increases when the firm issues bonds. III. Most long-term bond issues are referred to as unfunded debt. IV. All bonds are treated equally in a bankruptcy proceeding.

Bonds provide tax benefits to issuers and the risk of a firm financially failing increase when the firm issues bonds (only)

Which of the following are characteristics of premium bond? I. coupon rate < yield to maturity II. coupon rate > yield to maturity III. coupon rate < current yield IV. coupon rate > current yield

Coupon rate > yield to maturity Coupon rate > current yield

Which of the following relationships apply to a par value bond? I. coupon rate < yield-to-maturity II. current yield = yield-to-maturity III. market price = call price IV. market price = face value

Current yield = yield to maturity Market price = face value

Which one of the following relationships is stated correctly?

Decreasing the time to maturity increases the price of a discount bond, all else constant

Which of the following statements is correct concerning the term structure of interest rates? I. Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates. II. The term structure of interest rates includes both an inflation premium and an interest rate risk premium. III. The real rate of return has minimal, if any, affect on the slope of the term structure of interest rates. IV. The term structure of interest rates and the time to maturity are always directly related.

Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates, The term structure of interest rates include both an inflation premium and an interest rate risk premium, and the real rate of return has minimal, if any, affect on the slope of the term structure of interest rates (I, II, III only)

Which of the following increase the price sensitivity of a bond to changes in interest rates? I. increase in time to maturity II. decrease in time to maturity III. increase in coupon rate IV. decrease in coupon rate

Increase in time to maturity and decrease in coupon rate (only)

Texas Foods has a 6 percent bond issue outstanding that pays $30 in interest every March and September. The bonds are investment grade and sell at par. The bonds are callable at a price equal to the present value of all future interest and principal payments discounted at a rate equal to the comparable Treasury rate plus 0.50 percent. Which of the following correctly describe the features of this bond? I. bond rating of B II. "make whole" call price III. $1,000 face value IV. offer price of $1,000

Make whole call price, 1,000 face value, and offer price of 1000 (only)

The current yield is defined as the annual interest on a bond divided by which one of the following? (7.1)

Market price

A treasury yield curve plots Treasury interest rates relative to which one of the following?

Maturity

The specified date on which the principal amount of a bond is payable is referred to as which one of the following? (7.1)

Maturity

Which one of the following statements concerning bond ratings is correct?

Split rated bonds are called crossover bonds

Green Roof Inns is preparing a bond offering with a 6%, semiannual coupon and a face value of 1000. The bonds will be repaid in 10 years and will be sold at par. Given this, which one of the following statements is correct?

The bonds will sell at a premium if the market rate is 5.5 percent

An indenture is: (7.2)

The legal agreement between the bond issuer and the bondholders

A 6%, annual coupon bond is currently selling at a premium and matures in 7 years. The bond was originally issued 3 years ago at par. Which one of the following statements is accurate in respect to this bond today?

The yield to maturity is less than the coupon rate

Which of the following defines a note? I. secured II. unsecured III. Maturity less than 10 years IV. Maturity in excess of 10 years

Unsecured and Maturity less than 10 years

Currently, the bond market requires a return of 11.6% on the 10-year bonds issued by Winston Industries. The 11.6 percent is referred to as which one of the following? (7.1)

Yield to maturity

You own a bond that has 6% annual coupon and matures 5 years from now. You purchased this 10 year bond at par value when it was originally issued. Which one of the following statements applies to this bond if the relevant market interest rate is now 5.8 percent?

You will realize a capital gain on the bond if you sell it today

The taxability risk premium compensates bond holders for which one of the following?

a bond's unfavorable tax status

All else constant, a bond will sell at ___ when the coupon rate is ___ the yield to maturity.

a discount; less than

Bonds issued by the US government:

are considered to be free of default risk

Protective covenants:

are primarily designed to protect bondholders

A zero coupon bond:

has more interest rate risk than a comparable coupon bond

A bond that is payable to whomever has physical possession of the bond is said to be in: (7.2)

bearer form

Which one of the following is the price a dealer will pay to purchase a bond?

bid price

A call-protected bond is a bond that:

cannot be called during a certain period of time

A bond is quoted at a price of $989. This price is referred to as which one of the following?

clean price

You are trying to compare the present values of two separate streams of cash flows which have equivalent risks. One stream is expressed in nominal values and the other stream is expressed in real values. You decide to discount the nominal cash flows using a nominal annual rate of 8 percent. What rate should you use to discount the real cash flows?

comparable real rate

The interest rate risk premium is the:

compensation investors demand for accepting interest rate risk

Mary just purchased a bond which pays $60 a year in interest. What is this $60 called? (7.1)

coupon

The collar of a floating-rate bond refers to the minimum and maximum:

coupon rates

The Leeward Company just issued 15-year, 8%, unsecured bonds at par. These bonds fit the definition of which one of the following terms?

debenture

The Walther's company has a semi-annual coupon bond outstanding. An increase in the market rate of interest will have which one of the following effects on this bond?

decrease the market price

A "fallen angel" is a bond that has moved from:

investment grade to speculative grade

Which one of the following risk premiums compensates for the possibility of nonpayment by the bond issuer?

default risk

Pete paid $1,032 as his total cost of purchasing a bond. This price is referred to as the:

dirty price

Today, June 15, you want to buy a bond with a quoted price of 98.64. The bond pays interest on January 1 and July 1. Which one of the following prices represents your total cost of purchasing this bond today?

dirty price

A sinking fund is managed by a trustee for which one of the following purposes?

early bond redemption

A bond's coupon rate is equal to the annual interest divided by which one of the following? (7.1)

face value

Bert owns a bond that will pay him $75 each year in interest plus a $1000 principal payment at maturity. What is the $1,000 called? (7.1)

face value

A U.S. Treasury bond that is quoted at 100:11 is selling:

for 100 and 11/32nds percent of face value

Treasury bonds are:

generally issued as a semi-annual coupon bonds

A newly issued bond has a 7% coupon with a semi-annual interest payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be:

greater than 7 percent

Callable bonds generally:

have a sinking fund provision

Atlas Entertainment has 15-year bonds outstanding. The interest payments on these bonds are sent directly to each of the individual bondholders. These direct payments are a clear indication that the bonds can accurately be defined as being issued: (7.2)

in registered form

As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:

increases at a decreasing rate

Real rates are defined as nominal rates that have been adjusted for which one of the following?

inflation

The Fisher Effect primarily emphasizes the effects of _____ on an investor's rate of return.

inflation

Which one of the following premiums is compensation for expected future inflation?

inflation

"Cat" bonds are primarily designed to help:

insurance companies fund excessive claims

Which one of the following risks would a floating-rate bond tend to have less of as compared to a fixed-rate coupon bond?

interest rate risk

You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur?

long term; zero coupon

Last year, you purchased a "TIPS" at par. Since that time, both market interest rates and the inflation rate have increased by 0.25 percent. Your bond has most likely done which one of the following since last year?

maintained a fixed real rate of return

Which of the following are negative covenants that might be found in a bond indenture? I. The company shall maintain a current ratio of 1.10 or better. II. No debt senior to this issue can be issued. III. The company cannot lease any major assets without approval by the lender. IV. The company must maintain the loan collateral in good working order.

no debt senior to this issue can be issued and the company cannot lease any major assets without approval by the lender (only)

Interest rates that include an inflation premium are referred to as:

nominal rates

Last year, Lexington Homes issued $1 million in unsecured, non-callable debt. This debt pays an annual interest payment of $55 and matures 6 years from now. The face value is $1,000 and the market price is $1,020. Which one of these terms correctly describes a feature of this debt?

note

Municipal bonds:

pay interest that is federally tax-free

The items included in an indenture that limit certain actions of the issuer in order to protect bondholder's interests are referred to as the:

protective covenants

Which one of the following rates represents the change, if any, in your purchasing power as a result of owning a bond?

real rate

The difference between the price that a dealer is willing to pay and the price at which he or she will sell is called the:

spread

Which two of the following factors cause the yields on a corporate bond to differ from those on a comparable Treasury security? I. inflation risk II. interest rate risk III. taxability IV. default risk

taxability and default risk (III and IV only)

The pure time value of money is known as the:

term structure of interest rates

The liquidity premium is compensation to investors for:

the lack of an active market wherein a bond can be sold for its actual value

Which one of the following statements is correct?

the real rate must be less than the nominal rate given a positive rate of inflation

A 6-year, $1,000 face value bond issued by Taylor Tools pays interest semiannually on February 1 and August 1. Assume today is October 1. What will the difference, if any, be between this bond's clean and dirty prices today?

two month's interest

You want a bond from a dealer. Which one of the following prices will you pay?

Asked price

A bond that can be paid off early at the issuer's discretion is referred to as being which one of the following?

Callable

A $1,000 face value bond can be redeemed early at the issuer's discretion for $1,030, plus any accrued interest. The additional $30 is called which one of the following?

Call premium

The Fisher effect is defined as the relationship between which of the following variables?

Real rates, inflation rates, and nominal rates

Which of the following correctly describe U.S. Treasury bonds? I. have a "tick" size of 1/32 II. highly liquid III. quoted in dollars and cents IV. quoted at the dirty price

Have a "tick" size of 1/32 and highly liquid (only)

A bond has a market price that exceeds its face value. Which of the following features currently apply this this bond? I. discounted price II. premium price III. Yield to maturity that exceeds the coupon rate IV. yield to maturity that is less than the coupon rate

Premium price and yield to maturity that is less than the coupon rate

A deferred call provision is which one of the following?

Prohibition which prevents bond issuers from redeeming callable bonds prior to a specified date

Recently, you discovered a putable income bond that is convertible. If you purchase this bond, you will have the right to do which of the following? I. force the issuer to repurchase the bond prior to maturity II. choose when you wish to receive interest payments III. convert the bond into a TIPS IV. convert the bond into equity shares

force the issuer to repurchase the bond prior to maturity and convert the bond into equity shares (only)

Phil has researched TLM Technologies and believes the firm is poised to vastly increase in value. He wants to invest in this company. Phil has decided to purchase TLM Technologies bonds so that he can have a steady stream of interest income. However, he still wishes that he could share in the firm's success along with TLM's shareholders. Which one of the following bond features will help Phil fulfill his wish?

warrant

A bond that has only one payment, which occurs at maturity, defines which one of the following?

zero coupon