Finance ch 7
Which of the following are common protective covenants?
-The firm cannot merge with any other firm-The firm must limit dividends to equity holders-The firm must maintain working capital at or above a specified level
if you purchase a bond costing $1,143 with a par value of $1,000 that pays a semi-annual coupon of 5%, how much will each coupon payment be
$25
a corporation issues 50,000 bonds at $1000 each. The bonds mature in 5 years and have a coupon rate of 7 percent. what will be the total annual interest expenses for the corporation
$3.5 million
how much can a corporation expect to receive per bond if it sells 10 yr zero coupon bonds with a face value of $1000 if the market rate of interest is 9%?
$414.64
what are the 2 unique features of a US federal gov bond
-US treasury issues are considered to be a default-free -US issues are exempt from state income taxes
if you are in the 15 percent federal tax bracket, what will be your aftertax yield on a US treasury bond that is currently priced at par and yielding 5 percent
4.25
if you are in the 25 percent federal tax bracket, what will be your aftertax yield on a U.S treasury bond that is currently priced at par and yielding 5 percent
4.25 .05 (1-.15)= 4.25
what is the real rate of return if the nominal rate is 7 percent and the rate of inflation is 2 percent
4.9
why is the bond market less transparent than the stock market
Many bond transactions are negotiated privately
what are some features of the OTC market for bonds
OTC dealers are connected electronically The OTC has no designated physical location
Cat bond
Protect insurance companies from natural disasters
Put bond
Protect insurance companies from natural disasters
what are the three components of the treasury yield curve
Real rate of return, expected future inflation, and the interest rate risk premium.
the amount by which the call price exceeds the par value of the bond is called
The call premium
what does the clean price for a bond represent
The quoted price excluding accrued interest
which of the following are features of municipal bonds?
They are issued by state and local governmentsThe interest on municipal bonds is, in some cases, exempt from state taxes in the state of issueThe interest on municipal bonds in exempt from fed
which of these correctly identify difference between U.S treasury bonds and corporate bonds?
Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk Treasury bonds are issued by the US gov't while corporate bonds are issued by the corporations
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 reason that interest rate risk is greater for _______ team bonds than for _______ term bonds is that the change in rates has greater effect on the present value of the _____ than on the present value of the ________
long; short; face value; coupon payments
the interest rate risk premium is the additional compensation demanded by investors for holding _____ bonds
longer-term
a sinking fund is one type of
repayment provision
the fisher effect decomposes the nominal rate into
the inflation rate and the real rate
what does a Moody's bond rating of C typically indicate
the issuer is in default
if you own corporate bonds, you will be concerned about interest rate risk as it affects
the market price of the bonds
if you invest in a $1000 corporate bond that has a 9 percent coupon and makes semi-annual payments, you can expect to receive
$45 every 6 months
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 $1000 repayment of principal at the end of 10 years
what is the price of a US treasury bond that is listed at 90 if the par value is $1000
$900
what is the value of a bond if the present value of the interest cash flows is $200 and the present value of the par value to be received when the bond matures is $750
$950
Which three of the following common shapes for the term structure of interest rates?
- Downward sloping- Upward sloping- Humps
what are 3 important features of treasury notes and bonds?
- Highly liquid- Default-free- Taxable
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
All junk bonds typically have which of these features?
- Less than investment-grade rating- High probability of default
which of the following terms apply to a bond?
- Par value,- Coupon rate- Time to maturity
which of these are required to calculate the current value of a bond?
- Par value- Time remaining to maturity- Coupon rate- Applicable market rate
which of the following institutions issue bonds that are traded in the bond market?
- State governments- The federal government- Public corporations
Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?
- The asked price- The bid price
when the US government wants to borrow money for the long-term (more than one year) it issues
- Treasury notes- Treasury bonds
which of the following are usually included in a bond's indenture?
-The repayment arrangements-The total amount of bonds issued
what are the two unique features of a U.S federal government bond
-U.S treasury issues are considered to be default-free -U.S treasury issues are exempt from state income taxes
which of the following is true about interest rate risk?
-all else equal, the longer the time to maturity, the greater the interest rate risk. -all else equal, the lower the coupon rate, the greater the interest rate risk.
A corporate bond's yield to maturity:
-changes over time -can be greater than, equal to, or less than the bond's coupon rate
what are the 3 components of the nominal rate of return
-compensation for the inflation effect on the original investment -real rate of return -compensation for the inflation effect on the investment earnings
what information is needed to compute a bond's yield-to-maturity
-coupon rate -time to maturity -the bond's current price
as a general rule, which of the following are true of debt and equity
-equity represents an ownership interest -the max reward for owning debt is fixed
what six factors determine the yield on a bond
-expected future inflation-default risk-Real rate of return-taxability-interest rate risk- liquidity
what are the sources of information for generating bond ratings
-info collected by bond rating agency -info from the corporation being rated
what are the source of information for generating bond ratings
-information from the corporation being rated -information collected by bond rating agency
which 6 factors determine the yield on a bond
-real rate of return -taxability -expected future inflation -interest rate risk -default risk -liquidity
as a general rule, which of the following are true of debt and equity
-the max reward for owning debt is fixed -equity represents an ownership interest
what are some reasons why the bond market is so big
-various state and local governments also participate in the bond market -many corporations have multiple bond issues outstanding -federal government borrowing activity in the bond market is enormous
Place the following bonds in order of security as defined in the U.S
1) Mortgage bonds2) Debentures
What is the coupon rate on a bond that has a par value of $1000, a market value of $1100, and a coupon interest payment of $100 per year?
10%
what is the current yield on a $1000 par value bond that sells for $900 if the coupon rate is 10 percent
11.11%. Current yield equals annual amount divided by PV (aka Price of bond). First myltiply .10 X $1000 to get payment. It's already annualized at $100.So, $100/$900= .11111=11.11%
at what tax rate will you be indifferent between a muni that yields 7% and a comparable corporate bond yielding 9%? assume no state taxes
22.2
find the YTM on a 20 year, $1000 par value bond that pays coupons of 4.5% semi-annually and currently sells for $1104.89
3.75
if you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? ignore state and local taxes
5%. Interest income from the Muni is exempt from the federal income tax so the after-tax yield equals the before tax yield.
what will your aftertax yield be on a corporate bond that is currently priced to yield 7% if you are in the 25 percent tax bracket
5.25(yield) X (1 - tax rate).07 X (1 - .25).07 X .75= 5.25`
what is the effective annual rate on a bond with a yield to maturity of 6 percent that pays semiannual interest
6.09
if an investment appreciates by 7 percent while the rate of inflation is 2 percent, what is the nominal rate of return?
7
what is a premium bond
A bond that sells for more than face value
Structured note
Based on financial securities, commodities, or currencies
what are municipal bonds
Bonds that have been issued by state or local governments
Convertible bond
Can be exchanged for shares of stock
why does a bond's value fluctuate over time?
The coupon rate and par value are fixed, while market interest rates change.
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
What is the definition of a bond's time to maturity?
What is the definition of a bond's time to maturity? It is the number of years until the face value is due to be repaid
A bond has a quoted price of $984.63, a face value of $1,000, a semi-annual coupon of $20, and a maturity of 10 years. Match its current yield and its YTM below.
YTM= 4.19%Current yield= 4.06%
a bond's ytm will exceed its current yield when the bond is selling at
a discount
the price that represents what a dealer is willing to pay for a security is
bid price
when an investor sells a bond, the price received by a dealer is always the
bid price
secondary markets in sukuk are extremely illiquid because most sukuk are
bought and held to maturity
How has TRACE improved transparency in the corporate bond market?
corporate bond dealers are now required to report trade information through TRACE
if a bond is rated Baa by Moody's and BB by standard & Poor's, the bond will be regarded as an _______ bond
crossover
the bid-ask spread represents the
dealer's profit
If the liquidity of a bond increases than the bonds you will what?
decrease
which of these risks is addressed by bond ratings
default risk
which of these risks is addressed by bond ratings?
default risk
the liquidity premium compensates investors based on a bond's
degree of marketability
a limitation of bond ratings is that they
focus exclusively on default risk
if you were classified as high income/high tax bracket investor, you might find municipal bonds an attractive investment because
income from municipal bonds to exempt from federal taxes
according to the approximation formula for the nominal rate of return (R), the nominal rate will ________ if inflation (h) increases
increase
assume you own a bond currently valued at $989. if the market rate of interest drops, the bond's current market value will
increase
as the time to maturity increases, the interest rate risk premium
increases at a decreasing rate
a bond's yield to maturity considers the interest earnings and the change in the bond's price while the current yield considers
interest earnings only
the relationship between bond price and the market rate of interest is
inverse; if the market rate of interest rises, bond prices will fall
which of the following is true about a multi-year typical bond's coupon
it is a fixed annuity payment
what will happen to the default risk premium during periods of economic uncertainty
it will increase
A market is considered transparent if ______________.
its prices and trading volume are easily observe
what are the cash flows involved in the purchase of a 5-year zero-coupon bond that has a par value of $1000 if the current price is $800? assume the market rate of interest is 5%?
pay $800 today and receive $1000 at the end of 5 years
what are the two major forms of long-term debt
public issue and privately placed
if a given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ______ rate
real
the term structure of interest rates examines the
relationship between short-term and long-term interest rates
the taxability premium is the additional compensation demanded on
taxable bonds
suppose you own a 30 yr bond issued by GE and a 2 yr bond issued by PG with identical coupon rates and par values. which bond will you decrease in value more as interest rates rise
the GE bond will lose more because it has a longer maturity
which is the largest security market in the world in terms of trading volume
the US treasuries market
how is the real rate of return different from the nominal rate of return?
the real rate of return is adjusted for the effect of inflation whereas nominal rate is not adjusted for the effect of inflation
the degree of interest rate risk depends on
the sensitivity of the bond's price to interest rate changes
the coupon rate on an original issue discount bond will be
very low
Most of the time, a floating-rate bond's coupon adjusts ___.
with a lag to some base rate
a treasury yield curve depicts the
yields for different maturities of treasury securities
how significant is the inflation premium on the shape of the term structure of interest rates
-very significant -more significant than the real rates of return
how is a zero coupon bond different from a conventional bond?
-zero coupon bonds are always issued at a discount -zero coupon bonds make no interest payments
what are "fallen angel" bonds
Bonds that have dropped from investment grade to junk bond status
which of these is included in the calculation of a bond's yield to maturity?
Coupon rate, current price, and par value.
what is a discount bond
Discount bonds are bonds that sell for less than face value
which of the following is not a difference between debt and equity
Equity is publicly traded while debt is not.
what is accrued interest
Interest that has been accumulated since the last interest payment date
what is a real rate of return?
It is a rate return that has been adjusted to remove inflation