Chapter 7

TheBondMarket

.1

Multiple Choice Questions

1.

Comparedtomoneymarketsecurities,capitalmarketsecuritieshave
(a) moreliquidity.
(b) longermaturities.
(c) loweryields.
(d) lessrisk.
Answer: B

2.

(I)Securitiesthathaveanoriginalmaturitygreaterthanoneyeararetradedincapital
markets.
(II)Thebestknowncapitalmarketsecuritiesarestocksandbonds.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

3.

(I)Securitiesthathaveanoriginalmaturitygreaterthanoneyeararetradedinmoney
markets.
(II)Thebestknownmoneymarketsecuritiesarestocksandbonds.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.

(d) Botharefalse.
Answer: D
4.

(I)Firmsandindividualsusethecapitalmarketsforlongterminvestments.(II)The
capitalmarketsprovideanalternativetoinvestmentinassetssuchasrealestateand
gold.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

5. Theprimaryreasonthatindividualsandfirmschoosetoborrowlongtermistoreduce
theriskthatinterestrateswill_________beforetheypayofftheirdebt.
(a) rise
(b) fall
(c) becomemorevolatile
(d) becomemorestable
Answer: A
6.

Afirmthatchoosestofinanceanewplantbyissuingmoneymarketsecurities
(a) mustincurthecostofissuingnewsecuritiestorolloveritsdebt.
(b) runstheriskofhavingtopayhigherinterestrateswhenitrollsoveritsdebt.
(c) incursboththecostofreissuingsecuritiesandtheriskofhavingtopayhigher
interestratesonthenewdebt.
(d) ismorelikelytoprofitifinterestratesrisewhiletheplantisbeingconstructed.
Answer: C

7.

Theprimaryreasonthatindividualsandfirmschoosetoborrowlongtermisto

(a) reducetheriskthatinterestrateswillfallbeforetheypayofftheirdebt.
(b) reducetheriskthatinterestrateswillrisebeforetheypayofftheirdebt.
(c) reducemonthlyinterestpayments,asinterestratestendtobehigheronshortterm
than
longtermdebtinstruments.
(d) reducetotalinterestpaymentsoverthelifeofthedebt.
Answer: B
8.

Afirmwillborrowlongterm
(a) iftheextrainterestcostofborrowinglongtermislessthantheexpectedcostof
risinginterestratesbeforeitretiresitsdebt.
(b) iftheextrainterestcostofborrowingshorttermduetorisinginterestratesdoesnot
exceedtheexpectedpremiumthatispaidforborrowinglongterm.
(c) ifshortterminterestratesareexpectedtodeclineduringthetermofthedebt.
(d) iflongterminterestratesareexpectedtodeclineduringthetermofthedebt.
Answer: A

9.

Theprimaryissuersofcapitalmarketsecuritiesinclude
(a) thefederalandlocalgovernments.
(b) thefederalandlocalgovernments,andcorporations.
(c) thefederalandlocalgovernments,corporations,andfinancialinstitutions.
(d) localgovernmentsandcorporations.
Answer: B

10.

Governmentsneverissuestockbecause
(a) theycannotsellownershipclaims.
(b) theConstitutionexpresslyforbidsit.
(c) both(a)and(b)oftheabove.

(d) neither(a)nor(b)oftheabove.
Answer: A
11. (I)Theprimaryissuersofcapitalmarketsecuritiesarefederalandlocalgovernments,
andcorporations.(II)Governmentsneverissuestockbecausetheycannotsellownership
claims.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
12.

(I)Theprimaryissuersofcapitalmarketsecuritiesarefinancialinstitutions.
(II)Thelargestpurchasersofcapitalmarketsecuritiesarecorporations.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: D

13.

Thedistributionofafirmscapitalbetweendebtandequityisits
(a) leverageratio.
(b) liabilitystructure
(c) acidratio.
(d) capitalstructure.

Answer: D
14.

Thelargestpurchasersofcapitalmarketsecuritiesare
(a) households.
(b) corporations
(c) governments.
(d) centralbanks.
Answer: A

15.

Individualsandhouseholdsfrequentlypurchasecapitalmarketsecuritiesthrough
financialinstitutionssuchas
(a) mutualfunds.
(b) pensionfunds.
(c) moneymarketmutualfunds.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: E

16.

(I)Therearetwotypesofexchangesinthesecondarymarketforcapitalsecurities:
organizedexchangesandoverthecounterexchanges.(II)Whenfirmssellsecurities
fortheveryfirsttime,theissueisaninitialpublicoffering.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

17. (I)Capitalmarketsecuritiesfallintotwocategories:bondsandstocks.(II)Longterm
bondsincludegovernmentbondsandlongtermnotes,municipalbonds,andcorporatebonds.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
18.

The_________valueofabondistheamountthattheissuermustpayatmaturity.
(a) market
(b) present
(c) discounted
(d) face
Answer: D

19.

The_________rateistherateofinterestthattheissuermustpay.
(a) market
(b) coupon
(c) discount
(d) funds
Answer: B

20.

(I)Thecouponrateistherateofinterestthattheissuerofthebondmustpay.
(II)Thecouponrateisusuallyfixedforthedurationofthebondanddoesnotfluctuate
withmarketinterestrates.
(a) (I)istrue,(II)false.

(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
21.

(I)Thecouponrateistherateofinterestthattheissuerofthebondmustpay.(II)The
couponrateonoldbondsfluctuateswithmarketinterestratessotheywillremain
attractivetoinvestors.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: A

22.

Treasurybondsaresubjectto_________riskbutarefreeof_________risk.
(a) default;interestrate
(b) default;underwriting
(c) interestrate;default
(d) interestrate;underwriting
Answer: C

23. ThepricesofTreasurynotes,bonds,andbillsarequoted
(a) asapercentageofthecouponrate.
(b) asapercentageofthepreviousdaysclosingvalue.
(c) asapercentageof$100facevalue.

(d) asamultipleoftheannualinterestpaid.
Answer: C
24.

ThesecuritywiththelongestmaturityisaTreasury
(a) note.
(b) bond.
(c) acceptance.
(d) bill.
Answer: B

25.

(I)Tosellanoldbondwheninterestrateshaverisen,theholderwillhavetodiscount
thebonduntiltheyieldtothebuyeristhesameasthemarketrate.(II)Theriskthatthe
valueofabondwillfallwhenmarketinterestratesriseiscalledinterestraterisk.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

26.

Tosellanoldbondwheninterestrateshave_________,theholderwillhaveto
_________thepriceofthebonduntiltheyieldtothebuyeristhesameasthemarket
rate.
(a) risen;lower
(b) risen;raise
(c) fallen;lower
(d) risen;inflate
Answer: A

27.

Mostofthetime,theinterestrateonTreasurynotesandbondsis_________thaton
moneymarketsecuritiesbecauseof_________risk.

(a) above;interestrate
(b) above;default
(c) below;interestrate
(d) below;default
Answer: A
28.

(I)InmostyearstherateofreturnonshorttermTreasurybillsisbelowthatonthe20
year
Treasurybond.(II)InterestratesonTreasurybillsaremorevolatilethanratesonlong
termTreasurysecurities.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

29. (I)BecauseinterestratesonTreasurybillsaremorevolatilethanratesonlongterm
securities,thereturnonshorttermTreasurysecuritiesisusuallyabovethatonlongerterm
Treasurysecurities.
(II)ATreasurySTRIPseparatestheperiodicinterestpaymentsfromthefinalprincipal
repayment.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
30.

WhichofthefollowingstatementsaboutTreasuryinflationindexedbondsisnottrue?
(a) Theprincipalamountusedtocomputetheinterestpaymentvarieswiththe
consumer
priceindex.
(b) Theinterestpaymentriseswheninflationoccurs.

(c) Theinterestrateriseswheninflationoccurs.
(d) Atmaturitythesecuritiespaythegreateroffacevalueorinflationadjusted
principal.
Answer: C
31.

Theinterestratesongovernmentagencybondsare
(a) almostidenticaltothoseavailableonTreasurysecuritiessinceitisunlikelythatthe
federalgovernmentwouldpermititsagenciestodefaultontheirobligations.
(b) significantlyhigherthanthoseavailableonTreasurysecuritiesduetotheirlow
liquidity.
(c) significantlylowerthanthoseavailableonTreasurysecuritiesbecauseagency
interestpaymentsaretaxexempt.
(d) significantlylowerthanthoseavailableonTreasurysecuritiesbecausetheinterest
rateriskonagencysecuritiesislowerthanthatonTreasurysecurities.
Answer: B

32.

(I)Municipalbondsthatareissuedtopayforessentialpublicprojectsareexemptfrom
federaltaxation.(II)Generalobligationbondsdonothavespecificassetspledgedas
securityoraspecificsourceofrevenueallocatedfortheirrepayment.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

33.

(I)Mostcorporatebondshaveafacevalueof$1000,payinterestsemiannually,and
canberedeemedanytimetheissuerwishes.(II)Registeredbondshavenowbeen
largelyreplacedbybearerbonds,whichdonothavecoupons.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: A

34. Thebondcontractthatstatesthelendersrightsandprivilegesandtheborrowers
obligationsiscalledthe
(a) bondsyndicate.
(b) restrictivecovenant.
(c) bondcovenant.
(d) bondindenture.
Answer: D
35.

Policiesthatlimitthediscretionofmanagersasawayofprotectingbondholders
interestsarecalled
(a) restrictivecovenants.
(b) debentures.
(c) sinkingfunds.
(d) bondindentures.
Answer: A

36.

Typically,theinterestrateoncorporatebondswillbe_________themorerestrictions
areplacedonmanagementthroughrestrictivecovenants,because_________.
(a) higher;corporateearningswillbelimitedbytherestrictions
(b) higher;thebondswillbeconsideredsaferbybondholders
(c) lower;thebondswillbeconsideredsaferbybuyers
(d) lower;corporateearningswillbehigherwithmorerestrictionsinplace
Answer: C

37.

Restrictivecovenantscan
(a) limittheamountofdividendsthefirmcanpay.

(b) limittheabilityofthefirmtoissueadditionaldebt.
(c) restricttheabilityofthefirmtoenterintoamergeragreement.
(d) doalloftheabove.
(e) doonly(a)and(b)oftheabove.
Answer: D
38.

(I)Restrictivecovenantsoftenlimittheamountofdividendsthatfirmscanpaythe
stockholders.
(II)Mostcorporateindenturesincludeacallprovision,whichstatesthattheissuerhas
therighttoforcetheholdertosellthebondback.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

39.

Callprovisionswillbeexercisedwheninterestrates_________andbondvalues
_________.
(a) rise;rise
(b) fall;rise
(c) rise;fall
(d) fall;fall
Answer: B

40. Arequirementinthebondindenturethatthefirmpayoffaportionofthebondissue
eachyear
iscalled
(a) asinkingfund.
(b) acallprovision.

(c) arestrictivecovenant.
(d) ashelfregistration.
Answer: A
41.

(I)Callablebondsmusthaveahigheryieldthancomparablenoncallablebonds.(II)
Convertiblebondsareattractivetobondholdersandsellforahigherpricethan
comparablenonconvertiblebonds.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

42.

Longtermunsecuredbondsthatarebackedonlybythegeneralcreditworthinessofthe
issuer
arecalled
(a) junkbonds.
(b) callablebonds.
(c) convertiblebonds.
(d) debentures.
Answer: D

43.

Asecuredbondisbackedby
(a) thegeneralcreditworthinessoftheborrower.
(b) aninsurancecompanysfinancialguarantee.
(c) theexpectedfutureearningsoftheborrower.
(d) specificcollateral.
Answer: D

44.

Financialguarantees
(a) areinsurancepoliciestobackbondissues.
(b) arepurchasedbyfinanciallyweakersecurityissuers.
(c) lowertheriskofthebondscoveredbytheguarantee.
(d) doalloftheabove.
(e) doonly(a)and(b)oftheabove.
Answer: D

45.

Corporatebondsarelessriskyiftheyare_________bondsandmunicipalbondsare
lessriskyiftheyare_________bonds.
(a) secured;revenue
(b) secured;generalobligation
(c) unsecured;revenue
(d) unsecured;generalobligation
Answer: B

46. Whichofthefollowingaretrueforthecurrentyield?
(a) Thecurrentyieldisdefinedastheyearlycouponpaymentdividedbythepriceof
thesecurity.
(b) Theformulaforthecurrentyieldisidenticaltotheformuladescribingtheyieldto
maturityforadiscountbond.
(c) Thecurrentyieldisalwaysapoorapproximationfortheyieldtomaturity.
(d) Alloftheabovearetrue.
(e) Only(a)and(b)oftheabovearetrue.
Answer: A

47.

Thenearerabondspriceistoitsparvalueandthelongerthematurityofthebondthe
moreclosely_________approximates_________
(a) currentyield;yieldtomaturity.
(b) currentyield;couponrate.
(c) yieldtomaturity;currentyield.
(d) yieldtomaturity;couponrate.
Answer: A

48.

Whichofthefollowingaretrueforthecurrentyield?
(a) Thecurrentyieldisdefinedastheyearlycouponpaymentdividedbythepriceof
thesecurity.
(b) Thecurrentyieldandtheyieldtomaturityalwaysmovetogether.
(c) Theformulaforthecurrentyieldisidenticaltotheformuladescribingtheyieldto
maturityforadiscountbond.
(d) Alloftheabovearetrue.
(e) Only(a)and(b)oftheabovearetrue.
Answer: E

49.

Thecurrentyieldisalessaccurateapproximationoftheyieldtomaturitythe
_________thetimetomaturityofthebondandthe_________thepriceisfrom/tothe
parvalue.
(a) shorter;closer
(b) shorter;farther
(c) longer;closer
(d) longer;farther
Answer: B

50.

Thecurrentyieldona$6,000,10percentcouponbondsellingfor$5,000is
(a) 5percent.

(b) 10percent.
(c) 12percent.
(d) 15percent.
Answer: C
51. Thecurrentyieldona$5,000,8percentcouponbondsellingfor$4,000is
(a) 5percent.
(b) 8percent.
(c) 10percent.
(d) 20percent.
(e) noneoftheabove.
Answer: C
52.

Foraconsol,thecurrentyieldisan_________oftheyieldtomaturity.
(a) underestimate
(b) overestimate
(c) approximatemeasure
(d) exactmeasure
Answer: D

53.

Whichofthefollowingaretrueoftheyieldonadiscountbasisasameasureofthe
interestrate?
(a) Itusesthepercentagegainonthefacevalueofthesecurity,ratherthanthe
percentagegainonthepurchasepriceofthesecurity.
(b) Itputstheyieldontheannualbasisofa360dayyear.

(c) Itignoresthetimetomaturity.
(d) Alloftheabovearetrue.
(e) Only(a)and(b)oftheabovearetrue.
Answer: E
54.

Theformulaforthemeasureoftheinterestratecalledtheyieldonadiscountbasisis
peculiarbecause
(a) itputstheyieldontheannualbasisofa360dayyear.
(b) itusesthepercentagegainonthepurchasepriceofthebill.
(c) itignoresthetimetomaturity.
(d) both(a)and(b)oftheabove.
(e) both(a)and(c)oftheabove.
Answer: A

55.

Theyieldonadiscountbasisofa180day$1,000Treasurybillsellingfor$950is
(a) 10percent.
(b) 20percent.
(c) 25percent.
(d) 40percent.
Answer: A

56. Theyieldonadiscountbasisofa90day$1,000Treasurybillsellingfor$950is
(a) 5percent.
(b) 10percent.

(c) 15percent.
(d) 20percent.
(e) noneoftheabove.
Answer: D
57.

Theyieldonadiscountbasisofa90day$1,000Treasurybillsellingfor$900is
(a) 10percent.
(b) 20percent.
(c) 25percent.
(d) 40percent.
Answer: D

58.

Theyieldonadiscountbasisofa180day$1,000Treasurybillsellingfor$900is
(a) 10percent.
(b) 20percent.
(c) 25percent.
(d) 40percent.
Answer: B

59.

Whenanoldbondsmarketvalueisaboveitsparvaluethebondissellingata
_________.Thisoccursbecausetheoldbondscouponrateis_________thecoupon
ratesofnewbondswith
similarrisk.
(a) premium;below
(b) premium;above
(c) discount;below
(d) discount;above

Answer: B

True/False
1.

Theprimaryissuersofcapitalmarketsecuritiesarelocalgovernmentsand
corporations.
Answer:

2.

Capitalmarketsecurutiesarelessliquidandhavelongermaturitiesthanmoneymarket
securities.
Answer:

3.

FALSE

Mostcorporatebondshaveafacevalueof$1000,aresoldatadiscount,andcanonly
beredeemedatthematuritydate.
Answer:

9.

TRUE

Mostmunicipalbondsarerevenuebondsratherthangeneralobligationbonds.
Answer:

8.

FALSE

Municipalbondsthatareissuedtopayforessentialpublicprojectsareexemptfrom
federaltaxation.
Answer:

7.

TRUE

Mostofthetime,theinterestrateonTreasurynotesisbelowthatonmoneymarket
securitiesbecauseoftheirlowdefaultrisk.
Answer:

6.

TRUE

Tosellanoldbondwhenrateshaverisen,theholderwillhavetodiscountthebond
untiltheyieldtothebuyeristhesameasthemarketrate.
Answer:

5.

TRUE

Governmentsneverissuestockbecausetheycannotsellownershipclaims.
Answer:

4.

FALSE

FALSE

Registeredbondshavenowbeenlargelyreplacedbybearerbonds,whichdonothave
coupons.
Answer:

FALSE

10.

Asinkingfundisarequirementinthebondindenturethatthefirmpayoffaportionof
thebondissueeachyear.
Answer:

11.

Debenturesarelongtermunsecuredbondsthatarebackedonlybythegeneral
creditworthinessoftheissuer.
Answer:

12.

TRUE

Afinancialguaranteeensuresthatthelender(bondpurchaser)willbepaidboth
principalandinterestintheeventtheissuerdefaults.
Answer:

14.

TRUE

Inaleveragedbuyout,afirmgreatlyincreasesitsdebtlevelbyissuingjunkbondsto
financethepurchaseofanotherfirmsstock.
Answer:

13.

TRUE

TRUE

Thecurrentyieldonabondisagoodapproximationofthebondsyieldtomaturity
whenthebondmaturesinfiveyearsorlessanditspricediffersfromitsparvaluebya
largeamount.
Answer:

FALSE

Essay
1.

Whatisthepurposeofthecapitalmarket?Howdocpaitalmarketsecuritiesdifferfrom
moneymarketsecuritiesintheirgeneralcharacteristics?

2.

Whatisabondindenture?

3.

Whatroledorestrictivecovenantsplayinbondmarkets?

4.

Whatisthedifferencebetweenageneralobligationandarevenuebond?

5.

WhatareTreasurySTRIPS?

6.

Whatisaconvertiblebond?Howdoestheconvertibilityfeatureaffectthebondsprice
and
interestrate?

7.

Whatisabondscurrentyield?Howdoescurrentyielddifferfromyieldtomaturity
andwhatdetermineshowclosethetwovaluesare?

8.

Distinguishbetweengeneralobligationandrevenuemunicipalbonds.

9.

Whatisacallablebond?Howdoesthecallabilityfeatureaffectthebondspriceand
interestrate?.

10.

Whattypesofrisksshouldbondholdersbeawareofandhowdotheseaffectbond
pricesandyields?