Managerial Finance Chapter 6
Which of the following are not plain vanilla bonds?
Convertible Bonds Zero-coupon Bonds Floating-rate Bonds
Investors looking to minimize risk will hold which type of debt?
senior
A bond that is priced above its face value is said to sell for
a premium
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
The interest payments to the bondholder are called the
coupon
A bond can also be called a:
debenture note
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
A change in interest rate has the greatest effect on the present value of:
distant cash flows
The payment made when a bond matures is called the bond's:
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
When a firm puts up collateral assets to back up a loan, the debt is said to be:
secured
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
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
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%
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.
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
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
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
The return on a bond that sells at a premium is ____ (greater or less) than the current yield.
less
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 price of a bond can be quoted as a _____ of face value.
percentage
