Chapter 7
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? A. 8 percent B. EAR of 8 percent compounded monthly C. comparable risk-free rate D. comparable real rate E. You cannot compare the present values of these two streams of cash flows.
comparable real rate
9. A bond that is payable to whomever has physical possession of the bond is said to be in: A. new-issue condition. B. registered form. C. bearer form. D. debenture status. E. collateral status.
Bearer Form
A sinking fund is managed by a trustee for which one of the following purposes? A. paying interest payments B. early bond redemption C. converting bonds into equity securities D. paying preferred dividends E. reducing coupon rates
Early bond redemption
A bond's coupon rate is equal to the annual interest divided by which one of the following? A. call price B. current price C. face value D. clean price E. dirty price
Face Value
30. A Treasury yield curve plots Treasury interest rates relative to which one of the following? A. market rates B. comparable corporate bond rates C. the risk-free rate D. inflation E. maturity
Maturity
The collar of a floating-rate bond refers to the minimum and maximum: A. call periods. B. maturity dates. C. market prices. D. coupon rates. E. yields to maturity.
coupon rates
. 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: A. 0.05/(1 - t*) = 0.07. B. 0.05 - (1 - t*) = 0.07. C. 0.07 + (1 - t*) = 0.05. D. 0.05 (1 - t*) = 0.07. E. 0.05 (1 + t*) = 0.07.
0.05/(1 - t*) = 0.07.
Which one of the following bonds is the least sensitive to interest rate risk? A. 3-year; 4 percent coupon B. 3-year; 6 percent coupon C. 5-year; 6 percent coupon D. 7-year; 6 percent coupon E. 7-year; 4 percent coupon
3 year; 6 percent coupon
Which one of the following risks would a floating-rate bond tend to have less of as compared to a fixed-rate coupon bond? A. real rate risk B. interest rate risk C. default risk D. liquidity risk E. taxability risk
interest rate risk
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? A. 6-year, putable, high coupon bond B. 5-year TIPS C. 10-year AAA coupon bond D. 5-year municipal bond E. 7- year income bond
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? A. 6-year, putable, high coupon bond B. 5-year TIPS C. 10-year AAA coupon bond D. 5-year floating rate bond E. 7- year income bond
7-year income bond
A bond is quoted at a price of $1,011. This price is referred to as the: A. Call price B. Face Value C. Clean price D. Dirty price E. Maturity Price
Clean price
US Treasury Bonds: A. Are highly illiquid B. Are quoted as a percentage of par C. Are quoted at the dirty price D. Pay interest that is federally tax-empt E. Must be held until maturity
B. Are quoted as a percentage of par
Which one of these statements is correct? A. Most long-term bond issues are referred to as unfunded debt B. Bonds provide tax benefits to issuers C. The risk of a firm financially failing decreases when a firm issues bonds D. All bonds are treated equally in a bankruptcy proceeding E. A debenture is a senior secured debt
B. Bonds provide tax benefits to issuers
Which one of the following is the price a dealer will pay to purchase a bond? A. call price B. asked price C. bid price D. bid-ask spread E. par value
Bid Price
A call-protected bond is a bond that: A. is guaranteed to be called. B. can never be called. C. is currently being called. D. is callable at any time. E. cannot be called during a certain period of time.
Cannot be called during a certain period of time
22. A bond is quoted at a price of $989. This price is referred to as which one of the following? A. call price B. face value C. clean price D. dirty price E. wholesale price
Clean Price
Sue is considering purchasing a bond that will only return its principal at maturity if the stock market declines. However, if the stock market increases in value during the bond term, at maturity, she will receive both the bond principal and a percentage of the stock market gain. What type of bond is this? A. Nono bond B. Put bond C. contingent, callable bond D. structure note E. Sukuk
D. structured note
10. The Leeward Company just issued 15-year, 8 percent, unsecured bonds at par. These bonds fit the definition of which one of the following terms? A. note B. discounted C. zero-coupon D. callable E. debenture
Debenture
40. Which one of the following relationships is stated correctly? A. The coupon rate exceeds the current yield when a bond sells at a discount. B. The call price must equal the par value. C. An increase in market rates increases the market price of a bond. D. Decreasing the time to maturity increases the price of a discount bond, all else constant. E. Increasing the coupon rate decreases the current yield, all else constant.
Decreasing the time to maturity increases the price of a discount bond, all else constant
31. Which one of the following risk premiums compensates for the possibility of nonpayment by the bond issuer? A. default risk B. taxability C. liquidity D. inflation E. interest rate risk
Default Risk
Which one of the following premiums is compensation for the possibility that a bond issuer may not pay a bond's interest or principal payments as expected? A. Default Risk B. Taxability C. Liquidity D. Inflation E. Interest Rate Risk
Default Risk
23. Pete paid $1,032 as his total cost of purchasing a bond. This price is referred to as the: A. quoted price. B. spread price. C. clean price. D. dirty price. E. call price.
Dirty price
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 A. I and II only B. I and IV only C. II and III only D. II and IV only E. I, II, and III only
I and II only
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. A. II and III only B. I and II only C. III and IV only D. II and IV only E. I, II, and III only
I and II only
43. 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 A. II only B. I and III only C. I and IV only D. II and III only E. II and IV only
I and IV only
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 A. I and III only B. I and IV only C. II and III only D. III and IV only E. I, II, and IV only
I and IV only
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. A. I and II only B. II and IV only C. I, II, and III only D. II, III, and IV only E. I, II, and IV only
I, II and III only
. 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. A. I and II only B. II and III only C. III and IV only D. II, III, and IV only E. I, II, and III only
II and III only
11. Which of the following defines a note? I. secured II. unsecured III. maturity less than 10 years IV. maturity in excess of 10 years A. III only B. I and III only C. I and IV only D. II and III only E. II and IV only
II and III only
39. 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 A. I and II only B. I and III only C. II and IV only D. I, II, and III only E. II, III, and IV only
II and IV only
A bond has a market price that exceeds its face value. Which of the following features currently apply to 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
II and IV only
Which of the following are characteristics of a premium bond? I. coupon rate < yield-to-maturity II. coupon rate > yield-to-maturity III. coupon rate < current yield IV. coupon rate > current yield A. I only B. I and III only C. I and IV only D. II and III only E. II and IV only
II and IV only
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 A. I and II only B. III and IV only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV
III and IV only
Which one of the following premiums is compensation for expected future inflation? A. default risk B. taxability C. liquidity D. inflation E. interest rate risk
Inflation
The current yield is defined as the annual interest on a bond divided by which one of the following? A. Coupon B. Face Value C. Market pRice D. Call price E. Dirty Price
Market Price
Interest rates that include an inflation premium are referred to as: A. annual percentage rates. B. stripped rates. C. effective annual rates. D. real rates. E. nominal rates.
Nominal rates
A deferred call provision is which one of the following? A. requirement that a bond issuer pay the current market price, plus accrued interest, should the firm decide to call a bond B. ability of a bond issuer to delay repaying a bond until after the maturity date should the issuer so opt C. prohibition placed on an issuer which prevents that issuer from ever redeeming bonds prior to maturity D. prohibition which prevents bond issuers from redeeming callable bonds prior to a specified date E. requirement that a bond issuer pay a call premium which is equal to or greater than one year's coupon should that issuer decide to call a bond
Prohibition which prevents bond issuers from redeeming callable bonds prior to a specified date
The pure time value of money is known as the: A. liquidity effect. B. Fisher effect. C. term structure of interest rates. D. inflation factor. E. interest rate factor.
Term structure of interest rates
77. Which one of the following statements is FALSE concerning the term structure of interest rates? A. Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates. B. The term structure of interest rates includes both an inflation premium and an interest rate risk premium. C. The term structure of interest rates and the time to maturity are always directly related. D. The real rate of return has minimal, if any, affect on the slope of the term structure of interest rates. E. The interest rate risk premium increases as the time to maturity increases.
The Term structure of interest rates and the time to maturity are always directly related
Green Roof Inns is preparing a bond offering with a 6 percent, semiannual coupon and a face value of $1,000. The bonds will be repaid in 10 years and will be sold at par. Given this, which one of the following statements is correct? A. The bonds will become discount bonds if the market rate of interest declines. B. The bonds will pay 10 interest payments of $60 each. C. The bonds will sell at a premium if the market rate is 5.5 percent. D. The bonds will initially sell for $1,030 each. E. The final payment will be in the amount of $1,060.
The bonds will sell at a premium if the market rate is 5.5 percent
An indenture is: A. another name for a bond's coupon. B. the written record of all the holders of a bond issue. C. a bond that is past its maturity date but has yet to be repaid. D. a bond that is secured by the inventory held by the bond's issuer. E. the legal agreement between the bond issuer and the bondholders
The legal agreement between the bond issuer and the bondholders.
A 6 percent, 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? A. The face value of the bond today is greater than it was when the bond was issued. B. The bond is worth less today than when it was issued. C. The yield-to-maturity is less than the coupon rate. D. The coupon rate is greater than the current yield. E. The yield-to-maturity equals the current yield.
The yield-to-maturity is less than the coupon rate
Currently, the bond market requires a return of 11.6 percent on the 10-year bonds issued by Winston Industries. The 11.6 percent is referred to as which one of the following? A. coupon rate B. face rate C. call rate D. yield to maturity E. interest rate
Yield to Maturity
You own a bond that has a 6 percent 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? A. The current yield-to-maturity is greater than 6 percent. B. The current yield is 6 percent. C. The next interest payment will be $30. D. The bond is currently valued at one-half of its issue price. E. You will realize a capital gain on the bond if you sell it today.
You will realize a capital gain on the bond if you sell it today
A bond that has only one payment, which occurs at maturity, defines which one of the following? A. debenture B. callable C. floating-rate D. junk E. zero coupon
Zero Coupon
All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to maturity. A. a premium; less than B. a premium; equal to C. a discount; less than D. a discount; higher than E. par; less than
a discount; less than
Protective covenants: A. apply to short-term debt issues but not to long-term debt issues. B. only apply to privately issued bonds. C. are a feature found only in government-issued bond indentures. D. only apply to bonds that have a deferred call provision. E. are primarily designed to protect bondholders.
are primarily designed to protect bondholders
You want to buy a bond from a dealer. Which one of the following prices will you pay? A. Call price B. auction price c. bid price d. asked price e. bid-ask spread
asked price
The Walthers 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? A. increase the coupon rate B. decrease the coupon rate C. increase the market price D. decrease the market price E. increase the time period
decrease the market 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? A. clean price B. dirty price C. asked price D. quoted price E. bid price
dirty price
A U.S. Treasury bond that is quoted at 100:11 is selling: A. for 11 percent more than par value. B. at an 11 percent discount. C. for 100.11 percent of face value. D. at par and pays an 11 percent coupon. E. for 100 and 11/32nds percent of face value.
for 100 and 11/32nd percent of face value
Treasury bonds are: A. issued by any governmental agency in the U.S. B. issued only on the first day of each fiscal year by the U.S. Department of Treasury. C. bonds that offer the best tax benefits of any bonds currently available. D. generally issued as semi-annual coupon bonds. E. totally risk-free.
generally issued as semi-annual coupon bonds
A newly issued bond has a 7 percent coupon with semiannual interest payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be: A. 3.5 percent. B. greater than 3.5 percent but less than 7 percent. C. 7 percent. D. greater than 7 percent. E. Answer cannot be determined from the information provided.
greater than 7 percent
A zero coupon bond: A. is sold at a large premium. B. pays interest that is tax deductible to the issuer when paid. C. can only be issued by the U.S. Treasury. D. has more interest rate risk than a comparable coupon bond. E. provides no taxable income to the bondholder until the bond matures.
has more interest rate risk than a comparable coupon bond
. Callable bonds generally: A. grant the bondholder the option to call the bond anytime after the deferment period. B. are callable at par as soon as the call-protection period ends. C. are called when market interest rates increase. D. are called within the first three years after issuance. E. have a sinking fund provision.
have a sinking fund provision
As a bond's time to maturity increases, the bond's sensitivity to interest rate risk: A. increases at an increasing rate. B. increases at a decreasing rate. C. increases at a constant rate. D. decreases at an increasing rate. E. decreases at a decreasing rate.
increases at a decreasing rate
The Fisher Effect primarily emphasizes the effects of _____ on an investor's rate of return. A. default B. market C. interest rate D. inflation E. maturity
inflation
"Cat" bonds are primarily designed to help: A. municipalities survive economic recessions. B. corporations respond to overseas competition. C. the federal government cope with huge deficits. D. corporations recover from involuntary reorganizations. E. insurance companies fund excessive claims.
insurance companies fund excessive claims
A "fallen angel" is a bond that has moved from: A. being publicly traded to being privately traded. B. being a long-term obligation to being a short-term obligation. C. having a yield-to-maturity in excess of the coupon rate to having a yield-to- maturity that is less than the coupon rate. D. senior status to junior status for liquidation purposes. E. investment grade to speculative grade.
investment grade to speculative grade
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? A. short-term; low coupon B. short-term; high coupon C. long-term; zero coupon D. long-term; low coupon E. long-term; high coupon
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? A. decreased in value due to the change in inflation rates B. experienced an increase in its bond rating C. maintained a fixed real rate of return D. increased in value in response to the change in market rates E. increased in value due to a decrease in time to maturity
maintained a fixed real rate of return
. 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? A. semi-annual coupon B. discount bond C. note D. trust deed E. collateralized
note
Municipal bonds: A. are totally risk-free. B. generally have higher coupon rates than corporate bonds. C. pay interest that is federally tax-free. D. are rarely callable. E. are free of default-risk.
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: A. trustee relationships. B. bylaws. C. legal bounds. D. "plain vanilla" conditions. E. protective covenants.
protective covenants
Which one of the following rates represents the change, if any, in your purchasing power as a result of owning a bond? A. risk-free rate B. realized rate C. nominal rate D. real rate E. current rate
real rate
The Fisher effect is defined as the relationship between which of the following variables? A. default risk premium, inflation risk premium, and real rates B. nominal rates, real rates, and interest rate risk premium C. interest rate risk premium, real rates, and default risk premium D. real rates, inflation rates, and nominal rates E. real rates, interest rate risk premium, and nominal rates
real rates, inflation rates, and nominal rates
Which one of the following statements concerning bond ratings is correct? A. Investment grade bonds are rated BB or higher by Standard & Poor's. B. Bond ratings assess both interest rate risk and default risk. C. Split rated bonds are called crossover bonds. D. The highest rating issued by Moody's is AAA. E. A "fallen angel" is a term applied to all "junk" bonds.
split rated bonds are called crossover bonds
The yields on a corporate bond differ from those on a comparable Treasury security primarily because of: A. Interest rate risk and taxes B. taxes and default risk C. default and interest rate risk D. liquidity and inflation rate risks E. default, inflation, and interest rate risks
taxes and default risk
The liquidity premium is compensation to investors for: A. purchasing a bond in the secondary market. B. the lack of an active market wherein a bond can be sold for its actual value. C. acquiring a bond with an unfavorable tax status. D. redeeming a bond prior to maturity. E. purchasing a bond that has defaulted on its coupon payments.
the lack of an active market wherein a bond can be sold for its actual value
Which one of the following statements is correct? A. The risk-free rate represents the change in purchasing power. B. Any return greater than the inflation rate represents the risk premium. C. Historical real rates of return must be positive. D. Nominal rates exceed real rates by the amount of the risk-free rate. E. The real rate must be less than the nominal rate given a positive rate of inflation.
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? A. no difference B. one month's interest C. two month's interest D. four month's interest E. five month's interest
two month's interest
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? A. put provision B. positive covenant C. warrant D. crossover rating E. call provision
warrant
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 A. I and III only B. III and IV only C. I, III, and IV only D. II, III, and IV only E. I, II, III, and IV
II, III, and IV only
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: A. at par. B. in registered form. C. in street form. D. as debentures. E. as callable.
In registered form
Hot Foods has an investment-grade bond issue outstanding that pays $30 semiannual interest payments. The bonds sell at par and 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 .50 percent. Which one of the following correctly describes this bond? A. The bond rating is B. B. Market value is less than face value C. The coupon rate is 3 percent D. It has a "make whole" call price E. Variable Interest Payments are variable
It has a make whole" call price
Which one of the following risk premiums compensates for the inability to easily resell a bond prior to maturity? A. Default Risk B. Taxability C. Liquidity D. Inflation E. Interest rate risk
Liquidity
Which one of these is most apt to be included in a bond's indenture one year after the bond has been issued? A. Current Yield B. Written record of all the current bond holders C. List of collateral used as bond security D. Current market price E. Price at which a bondholder can resell the bond to another bondholder
List of collateral used as bond security
Which bond would you generally expect to have the highest yield? A. Risk free treasury bond B. Nontaxable, highly liquid bond C. Long term, high quality, tax-free bond D. Short term, inflation-adjusted bond E. Long-term, taxable junk bond
Long-term, taxable junk bond
A corporate bond with a 6 percent coupon was issued last year. Which one of these would apply to this bond today if the current yield to maturity is 7 percent? A. The bond is currently selling at a premium B. The current yield exceeds the coupon rate C. The bond is selling at par value D. The current yield exceeds the yield to maturity E. The coupon rate has increased to 7 percent
The current yield exceeds the coupon rate
. Bonds issued by the U.S. government: A. are considered to be free of interest rate risk. B. generally have higher coupons than those issued by an individual state. C. are considered to be free of default risk. D. pay interest that is exempt from federal income taxes. E. are called "munis".
are considered to be free of default risk