FINC Ch6 Smartbook
Which of the following are steps bondholders can take to minimize default risk?
Protective covenants Security Seniority
Which debt is paid first in the event of bankruptcy?
Senior Debt
Which of the following sell bonds?
State and local governments U.S. Treasury Corporations
A bond that is priced below its face value is said to sell for
a discount
A bond that is priced above its face value is said to sell for
a premium
The current yield on a bond is equal to
annual coupon payment divided by bond price
A $100,000 bond quoted at 120% will sell for
$120,000 Reason: $100,000 x 1.20 = $120,000
A company issues a $5,000 bond that matures in 5 years with a coupon rate of 6% and a current interest rate of 6%. The bond will sell for
$5,000 Reason: When the bond coupon rate and the interest rate are the same, the bond will sell for face value. No calculations are necessary.
A company issues a $1,000 bond with a coupon rate of 6% that matures in 5 years. The current interest rate is 7%. How much will the bond issue sell for?
$959 Reason: Present value of the interest payments = $1,000 x .06 = 60 x [1-(1/(1.07)^5]/.07 = $246.0118462 Present value of the face amount of the bond = $1,000/(1.07)^5 = $712.9861795 Add the present value of the interest to the present value of the face of the bond = $958.998
Marley Corporation's bonds have four years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 5%. If the price of the bond is $841.51, the yield to maturity is _____. (Use trial and error to calculate yield).
10% Reason: First, calculate the coupon payment: $1,000 x .05 = $50. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $841.51. You will see that by doing trial and error on the 4 given yields in the multiple choice question (5%, 8%, 10%, and 12%), the correct yield is 10%: $841.51 = $50/(1+.1) + $50/(1+.1)22+ $50/(1+.1)33+ $1,050/(1.1)4
An individual invested $1,000 in a bond with a coupon payment of $12. The price of the bond increased to $1,400. What is the rate of return on this bond?
41.2% Reason: Rate of return=(coupon income + price change)/investment= ($12+$400)/$1,000=.412 or 41.2%
Mortor's Corporation sold 6 year bonds for $1,072.62, with a face value of $1,000 and a coupon rate of 8%. The annual yield to maturity is
6.5% Reason: First, calculate the coupon payment: $1,000 x .08 = $80. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $1,072.62. You will see that by doing trial and error on the 4 given yields in the multiple choice question (6%, 6.5%, 7%, and 7.5%), the correct yield is 6.5%: $1,072.62 = $80/(1+.065) + $80/(1+.065)22+ $80/(1+.065)33+ $80/(1.+.065)44+ $80/(1 + .065)55+ $1,080/(1+.065)6
If the nominal rate of interest is 10% and the rate of inflation is 3%, the real interest rate is ____.
6.8% Reason: 1 + real interest rate = (1 +.1)/(1 +.03) = 1.068 - 1 = .068 or 6.8%
You pay $1,200 for a bond and receive an annual coupon payment of $100. The current yield on the bond is _____.
8.33% Reason: Current yield= annual coupon payment/bond price = $100/$1,200 = .0833 or 8.33%
Which of the following are not plain vanilla bonds?
Floating-rate Bonds Zero-coupon Bonds Convertible Bonds
The price of a bond is equal to the
PV(coupon) plus PV(face value)
What is the term used in finance to represent simple, standard, and common?
Plain vanilla
Even when the yield curve of a long-term bond is upward-sloping some investors prefer short-term bonds. Which of the following reasons would explain why this statement is true?
Prices of long-term bonds fluctuate more than prices of short-term bonds Short-term investors can profit if interest rates rise
The U.S. Treasury issues ___________, which adjust nominal cash flows based on the consumer price index.
TIPS Reason: Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds that adjust nominal cash flows based on changes in the consumer price index.
The _________ measures the return to investors if they buy a bond at the asked price and hold it to maturity.
asked yield to maturity
The purchaser of a bond pays the ______ price, whereas the investor who already owns the bond and sells it receives the ________ price.
asked, bid
Corporate debt depends on the value and the risk of the firm's
assets
Governments and corporations borrow money by selling _______ to investors.
bonds
Secured debt is tied to specific assets, called ______.
collateral
Which type of bond generally offers the highest yield?
corporate
The interest payments to the bondholder are called the
coupon
A bond's _______ is fixed, but the present value is affected by changes in the ________.
coupon payment, interest rate
The _______ is the annual interest payment on a bond, expressed as a percentage of face value.
coupon rate
Limitation or subordination of new debt is a form of a protective _____ on existing debt.
covenant
Bonds are defined as
debt securities
The additional yield on a bond that investors require for bearing default risk is known as
default premium
The risk that a bond issuer may not pay on its bonds in known as
default risk
The payment made when a bond matures is called the bond's:
face value
When the coupon rate of a bond is equal to the current interest rate, the bond will sell for
face value
When interest rates rise, bond prices
fall
If interest rates fall, the rate of return on a bond will be _____ the yield to maturity.
greater than
The banking crisis of 2007-2009 shows that investors prefer ________ in bonds; therefore, heavily traded bonds offer ________ yields.
higher liquidity, lower
When the interest rate is lower than the coupon rate on a bond, the price of the bond will be:
higher than face value Reason: Take, for example, a 5 year, $1,000 bond offering a 10% coupon. If the interest rate is less than the coupon rate - for example, if the interest rate is 5%, the PV of the bond would be: $100/(1.05)^1 + $100/(1.05)^2 + $100/(1.05)^3 + $100/(1.05)^4 + $1,100/(1.05)^5 = $1,216.47 - a higher price than the $1,000 face value.
Long-term bond prices are more sensitive than short-term bond prices to
increases in interest rates
Which type of bond links coupon payments to inflation?
indexed bonds
Because the _____ rate is uncertain, so is the _______ rate of interest offered on bonds.
inflation, real
The __________ on government bonds provide a benchmark for all interest rates.
interest rates
Bonds rated Baa or above by Moody's or BBB or above by Standard & Poors are known as
investment grade bonds
Bonds rated Ba or below by Moody's or BB and below by Standard & Poors are known as
junk bonds
If interest rates rise, the rate of return on a bond will be _____ the yield to maturity.
less than
When the interest rate is higher than a bond's coupon rate, the bond will be priced at:
less than face value Reason: Take, for example, a 5 year, $1,000 bond offering a 10% coupon. If the interest rate is higher than the coupon rate - for example, if the interest rate is 12%, the PV of the bond would be: $100/(1.12)^1 + $100/(1.12)^2 + $100/(1.12)^3 + $100/(1.12)^4 + $1,100/(1.12)^5 = $927.90 - a lower price than the $1,000 face value.
The yield to maturity assumes the bond is held to _____.
maturity
A bond can also be called a:
note debenture
The price of a bond can be quoted as a _____ of face value.
percentage
Conditions imposed on borrowers to protect lenders from unreasonable risk are known as
protective covenants
The total income per period per dollar invested is known as the
rate of return
When interest rates fall, bond prices
rise
When a firm puts up collateral assets to back up a loan, the debt is said to be:
secured
Investors looking to minimize risk will hold which type of debt?
senior
The difference between the bid price and the asked price of a bond is the _______.
spread
For bonds priced at face value, the rate of return is
the coupon rate
A graph of the yield curve shows the bond yield to maturity on the _____ axis and the time to maturity on the _____ axis.
vertical, horizontal
A plot drawn to show the relationship between bond yields and maturity is known as the
yield curve
A measure of return that takes account of both coupon payments and change in a bond's value over its life is a standard measure known as
yield to maturity
The discount rate that makes the present value of the bond's payments equal to its price is known as the
yield to maturity
The discount rate that makes the present value of the bond's payments equal to its price is known as the Multiple choice question. yield to maturity
yield to maturity
