Managerial Finance Chapter 6
You invest in a bond paying 6% interest paid semiannually with a face value of $1,000. The bond matures in 8 years and similar bonds yield 5%. What is the current value of the bond?
$1,065.28
Suppose a bond's clean price is $1,050, and the bond currently has accrued interest of $30. What is the dirty price?
$1,080
A corporation issues 50,000 bonds at $1,000 each. The bonds mature in 5 years and have a coupon rate of 7%. What will the total annual interest expense be for the corporation?
$3.5 million
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
The model that precisely specifies the relationship between the nominal rate and the real rate is
1+R=(1+r)*(1+h)
The term structure of interest rates describes
1. the relationship between nominal rates and time to maturity 2. the pure time value of money
What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?
10%
What is the current yield on a $1,000 par value bond that sells for $900 if the coupon rate is 10%?
11.11%
If the rate of inflation is 3% and the real rate of return is 9%, the nominal rate is approximately ______%
12%
What will your after tax yield be on a corporate bond that is currently priced to yield 7% if you are in the 25% tax bracket?
5.25%
What is a premium bond?
A bond that sells for more than face value
What are municipal bonds?
Bonds that have been issued by state or local governments
What are "fallen angel" bonds?
Bonds that have dropped from investment grade to junk bond status
What is a bond's accrued interest?
It is interest that has been earned but not yet received by the current bondholder
What does a treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
What are the cash flows involved in the purchase of a 5-year zero-coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5%.
Pay $800 today and receive $1,000 at the end of 5 years
what is the equation for approximating the nominal rate of return?
R=r+h
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
What does the clean price for a bond represent?
The quoted price excluding accrued interest
The US government borrows money by issuing
Treasury notes and treasury bonds
a bond's coupon payment is
a fixed amount of interest that is paid annually or semiannually by issuer to its bondholders
if bonds for AT&T are quoted at 115, they can be purchased
at 115% of par value plus accrued interest
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 bid-ask spread represents the
dealer's profit
A limitation of bond ratings is that they
focus exclusivity on default risk
If a bond is selling at discount from its par value, the YTM must be ____ the coupon rate.
greater than
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows
increases
What is the nominal rate of return on an investment
it is the actual percentage change in the dollar value of an investment adjusted for inflation
What is the definition of a bonds time to maturity?
it is the number of years until the face value is paid off
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
The interest rate risk premium is the additional compensation demanded by investors for holding ____ bonds.
longer-term
When using trial and error to compute the yield to maturity (YTM) for 6 percent coupon bond that trades at a premium, the process can be shortened if the initial guess is ______ 6 percent.
lower than
A part of the indenture limiting certain actions during the term of the loan are termed
protective covenants
What are the 2 major forms of long-term debts?
public issue and private placed
The term Structure of interest rates examines the
relationship between short-term and long-term interest rates
If you are holding 2 identical bonds, expect that 1 matures in 10 years and the other matures in 5 years, which bonds price will be more sensitive to interest rate risk?
the 10 year bond
If you are holding 2 bonds - 1 with 5% coupon rate and other with a 8% coupon rate - which one is more sensitive to interest rate risk, all other things being equal?
the bond with a 5% 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
Junk bonds have the following features:
they are rated below investment grade bonds
If a $1,000 par value bond is trading at a premium, the bond is:
trading for more than $1,000 in the market
the price you actually pay to purchase a bond will generally exceed the clean price
true
Most of the time, a floating-rate bond's coupon adjusts
with a lag to some base rate
What four variables are required to calculate the value of a bond?
-time remaining to maturity -par value -yield to maturity -coupon rate
A firm decides to raise money by issuing 5 million bonds with a par value of $5,000 each for 10 years at a coupon rate of 7 percent. At the time of issue, the bonds were sold for $5,500 each. What will the par value of the bonds be in year 5?
$5,000 per bond
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
assume a bond has a $1,000 par value, a coupon rate of 6%, annual interest payments, and 7 years to maturity. If the yield on similar bonds is 8%, what is the current market value of this bond?
$895.87
A corporate bond's yield to maturity:
- is usually not the same as a bond's coupon rate - changes over time
which of the following are true about a bond's face value?
-It is the principal amount repaid at maturity -it is also known as the par value
What are some features of the OTC market for bonds?
-OTC dealers are connected electronically -the OTC has no designated physical location
what are 2 unique features of a US federal government bond?
-US treasury issues are considered to be default-free -US treasury issues are exempt from stat income takes
What are the 2 unique features of a US federal government bond?
-US treasury issues are exempt from state income taxes -US treasury issues are considered to be default-free
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
which of the following are bonds that have actually been issued?
-a CoCo bond -a punt bond -a convertible bond
Which of the following are common shapes for the term structure of interest rates?
-humped -downward sloping -upward sloping
what is the real rate of return
-it is a rate of return that has been adjusted for inflation -it is a percentage change in buying power
Which of the following are true about a bonds face value?
-it is also known as the par value -it it the principal amount repaid at maturity
Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact treasury bond yields?
-liquidity premium -default risk premium
Bonds are classified based on the collateral provided to protect bondholders in case of default. Which of the following are unsecured forms of debt?
-notes -debentures (in the US)
Which three components determine the shape of the term structure of interest rates?
-real interest rate -inflation premium -interest rate risk premium
Which of the following are features of municipal bonds?
-the interest on municipal bonds is exempt from federal taxes -the interest on municipal bonds is, in some case, exempt from state taxes in the state of issue. -they are issued by state and local governments
What are the three components that influence the Treasury yield curve?
-the real rate of return -the interest rate risk premium -expected future inflation
which of the following are usually included in a bond's indenture?
-the repayment arrangements -the total amount of bonds issued
Which of the following terms apply to a bond?
-time to maturity -par value -coupon rate
The sensitivity of a bond's price to interest rate changes is dependent on which of the following 2 variables
-time to maturity -coupon rate
the sensitivity of a bonds price to interest rate changes is dependent on which of the following 2 variables?
-time to maturity -coupon rate
If you are holding a municipal bond that is trading at par value to yield 6%, by how much will your after-tax yield change if your federal income tax bracket increases from 15% to 20%. Assume there are no state or local taxes.
0%
If you are in the 20% federal income tax bracket, what is you after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes
5%
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
A bond with a BB rating has a ___ than a bond with an BBB rating.
higher risk of default
Why is the bond market less transparent than the stock market?
many bond transactions are negotiated privately
Which one of the following is the most important sources of risk from owning bonds?
market interest rate fluctuations