FIN E.C. #4
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.
A limitation of bond ratings is that they ____.
focus exclusively on default risk
Which of the following are true about a bond's face value?
It is also known as the par value. It is the principal amount repaid at maturity.
Which of the following are true of bonds?
They are normally interest-only loans They are issued by both corporations and governments
Junk bonds have the following features:
They are rated below investment grade bonds
Which of the following terms apply to a bond?
Time to maturity Par value Coupon rate
True or false: All else being equal, a one-year bond's price is less sensitive to interest rate changes as compared to that of a ten-year bond's price.
True
A bond's coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
To find the total bond value, add the present value of the amount paid at maturity to the _____ of the annual coupon payments.
annuity present value
A corporate bond's yield to maturity:
changes over time is usually not the same as a bond's coupon rate
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
The degree of interest rate risk depends on ____.
the sensitivity of the bond's price to interest rate changes
A debenture is a(n) _____ bond, for which no specific pledge of property is made.
unsecured
Crossover bonds can also be called _____ bonds.
5B
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
As an investor in the bond market, why should you be concerned about changes in interest rates?
Changes in interest rates cause changes in bond prices.
The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?
Coupon rate Time to maturity
What four variables are required to calculate the value of a bond?
Coupon rate Yield to maturity Time remaining to maturity Par value
What is a discount bond?
Discount bonds are bonds that sell for less than the face value.
Which of the following variables is NOT required to calculate the value of a bond?
Original issue price of bond
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
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
If you are holding two bonds - one with a 5% coupon rate and the other with an 8% coupon rate - which one is more sensitive to interest rate risk, all other things being equal?
The bond with a 5% coupon rate
True or false: Low-grade bonds may not be rated by major rating agencies.
True
A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a _________________.
call provision
When interest rates in the market rise, we can expect the price of bonds to ____.
decrease
A bond with a BB rating has a ______ than a bond with an BBB rating.
higher risk of default
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ____.
increases
A key difference between interest payments and dividend payments is?
interest is tax deductible dividends are not tax deductible
The bonds of a firm in financial distress may have a market value that is than the face value at maturity.
less
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
Equity represents a(n) interest of a firm.
ownership
A part of the indenture limiting certain actions during the term of the loan are termed ________.
protective covenants
Which type of debt is given preference in the event of default?
senior
True or false: Bond ratings are concerned only with the possibility of price changes.
False
A bond's payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
coupon
Debt cannot be subordinated to .
equity
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?
$60 in interest at the end of each year for 10 years and a $1,000 repayment of principal at the end of 10 years.
True or false: A debenture is a bond secured with collateral.
False
True or false: Bonds that have dropped into junk territory are called "trash" bonds.
False
True or false: The higher the coupon rate, the greater the interest rate risk, all other things being equal.
False
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
True or false: Longer-term bonds have greater interest rate sensitivity because a large portion of a bond's value comes from the face amount.
True
What is a corporate bond's yield to maturity (YTM)?
YTM is the prevailing market interest rate for bonds with similar features. YTM is the expected return for an investor who buys the bond today and holds it to maturity.
