Exam 2 Fin Concepts 6-9

12) A bond certificate includes ________. A) the terms of the bond B) the individual to whom payments will be made C) the yield to maturity of the bond D) the price of the bond

A

6) Why is the yield to maturity of a zero-coupon, risk-free bond that matures at the end of a given period the risk-free interest rate for that period? A) Since such a bond provides a risk-free return over that period, the Law of One Price guarantees that the risk-free interest rate equals the yield to maturity. B) Since a bondʹs price will converge on its face value as the bond approaches the maturity date, the Law of One Price dictates that the risk-free interest rate will reflect this convergence. C) Since interest rates will rise and fall in response to the movement in bond prices. D) Since there is, by definition, no risk in investing in such bonds, the return from such bonds is the best that can be expected from any investment over the period.

A

14) How are the cash flows of a coupon bond different from an amortizing loan?

A coupon bond pays interest over the life of the bond and returns the principal at the end of the term. Thus the cash flows are smaller over the life of the bond with a lump-sum payment at the end. In contrast, an amortizing loan has identical cash flows over its life with a part of the cash flow going toward interest and the balance as return of principal.

How are the cash flows of a zero-coupon bond different from those of a coupon bond?

A zero-coupon bond has only two cash flows over its life. The first one is associated with the issues borrowing the money and the second when the issuer returns the principal. A coupon bond, on the other hand, has several cash flows over its life. The first cash flow of both these types of bonds, zero-coupon and coupon are similar as they denote the issuer borrowing the money. However, for a coupon bond the subsequent cash flows over its life correspond to the interest payment promised by the issuer with a final payment equal to the return of principal.

11) Which of the following statements regarding bonds and their terms is FALSE? A) Bonds are securities sold by governments and corporations to raise money from investors today in exchange for a promised future payment. B) By convention, the coupon rate is expressed as an effective annual rate. C) Bonds typically make two types of payments to their holders. D) The time remaining until the repayment date is known as the term of the bond.

B

14) Which of the following statements regarding bonds and their terms is FALSE? A) The amount of each coupon payment is determined by the coupon rate of the bond. B) Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value. C) The zero-coupon bond has no periodic interest payments. D) Treasury bills are U.S. government bonds with a maturity of up to one year.

B

16) Which of the following statements regarding bonds and their terms is FALSE? A) The internal rate of return (IRR) of an investment in a zero-coupon bond is the rate of return that investors will earn on their money if they buy a default-free bond at its current price and hold it to maturity. B) The yield to maturity of a bond is the discount rate that sets the future value (FV) of the promised bond payments equal to the current market price of the bond. C) Financial professionals also use the term spot interest rates to refer to the default-free zero-coupon yields. D) When we calculate a bondʹs yield to maturity by solving the formula, Price of an n-period bond = Coupon (1 + YTM)1 + Coupon (1 + YTM)2 + ... + Coupon + Face (1 + YTM)n , the yield we compute will be a rate per coupon interval.

B

Which of the following statements regarding bonds and their terms is FALSE? A) One advantage of quoting the yield to maturity rather than the price is that the yield is independent of the face value of the bond. B) Unlike the case of bonds that pay coupons, for zero-coupon bonds, there is no formula to solve for the yield to maturity. C) Because we can convert any bond price into a yield, and vice versa, bond prices and yields are often used interchangeably. D) The internal rate of return (IRR) of a bond is given a special name, the yield to maturity (YTM).

B

13) Which of the following statements regarding bonds and their terms is FALSE? A) The bond certificate typically specifies that the coupons will be paid periodically until the maturity date of the bond. B) The bond certificate indicates the amounts and dates of all payments to be made. C) The only cash payments the investor will receive from a zero-coupon bond are the interest payments that are paid up until the maturity date. D) The face value of a bond is repaid at maturity.

C

3) How are investors in zero-coupon bonds compensated for making such an investment? A) Such bonds are purchased at their face value and sold at a premium on a later date. B) Such bonds make regular interest payments. C) Such bonds are purchased at a discount, below their face value. D) Such bonds have a lower face value as compared to other bonds of similar term.

C

13) Which of the following is true about the face value of a bond? A) It is the notional amount we use to compute coupon payments. B) It is the amount that is repaid at maturity. C) It is usually denominated in standard increments, such as $1,000. D) All of the above are true.

D

17) Which of the following statements regarding bonds and their terms is FALSE? A) Zero-coupon bonds are also called pure discount bonds. B) The internal rate of return (IRR) of an investment opportunity is the discount rate at which the net present value (NPV) of the investment opportunity is equal to zero. C) The yield to maturity for a zero-coupon bond is the return you will earn as an investor from holding the bond to maturity and receiving the promised face value payment. D) When prices are quoted in the bond market, they are conventionally quoted in increments of $1,000.

D

3)Which of the following best illustrates why a bond is a type of loan? A) The issuers of bonds make regular payments to bondholders. B) When a company issues a bond, the buyer of that bond becomes an owner of the issuing company. C) Funds raised are used to finance long-term projects. D) When an investor buys a bond from an issuer, the investor is giving money to the issuer, with the assurance that it will be repaid at a date in the future.

D

Bond traders generally quote bond yields rather than bond prices, since yield to maturity depends on the face value of the bond. T/F

False

Prior to its maturity date, the price of a zero-coupon bond is its face value.

False

The coupon value of a bond is the face value of the bond. T/F

False

Treasury bonds have original maturities from one to ten years, while Treasury notes have original maturities of more than ten years. T/F

False

A bond is said to mature on the date when the issuer repays its notional value. T/F

True

The only cash payment an investor in a zero-coupon bond receives is the face value of the bond on its maturity date. T/F

True

Under what situation can a zero-coupon bond be selling at par to its face value?

Unlike a coupon bond, a zero-coupon bond does not have a periodic cash flow with one lump-sum payment of the face value at its maturity. Consequently, a zero-coupon bond will be always selling at a price less than its face value and can never sell at par with its face value. If it does then the time value of money concepts will be violated, which never happens.

Under what situation can a zero-coupon bond be selling at a premium?

Unlike a coupon bond, a zero-coupon bond does not have a periodic cash flow with one lump-sum payment of the face value at its maturity. Consequently, a zero-coupon bond will be always selling at a price less than its face value. If it does then the time value of money concepts will be violated, which never happens.