Chapter 6: Interest Rates and Bond Valuation

252GitmanPrinciplesofFinance,EleventhEdition
Chapter6
InterestRatesandBondValuation
.1
Learning Goals
1.
Describeinterestratefundamentals,thetermstructureofinterestrates,andriskpremiums.
2.
Reviewthelegalaspectsofbondfinancingandbondcost.
3.
Discussthegeneralfeatures,quotations,ratings,populartypes,andinternationalissuesofcorporate
bonds.
4.
Understandthekeyinputsandbasicmodelusedinthevaluationprocess.
5.
Applythebasicvaluationmodeltobondsanddescribetheimpactofrequiredreturnandtimeto
maturityonbondvalues.
6.
Explainyieldtomaturity(YTM),itscalculation,andtheprocedureusedtovaluebondsthatpay
interestsemiannually.
.2
True/False
1.
Realrateofinterestistheactualrateofinterestchargedbythesuppliersoffundsandpaidbythe
demanders.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:RealRateofInterest
2.
ThelongerthematurityofaTreasury(oranyother)security,thesmallertheinterestraterisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:InterestRateRisk
3.
Adownwardslopingyieldcurveindicatesgenerallycheapershorttermborrowingcoststhan
longtermborrowingcosts.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:TermStructureofInterestRates
4.
Thenominalrateofinterestistheratethatcreatesequilibriumbetweenthesupplyofsavingsand
thedemandforinvestmentfundsinaperfectworld,withoutinflation,wherefundssuppliersand
demandershavenoliquiditypreferenceandalloutcomesarecertain.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:1
Topic:NominalInterestRate
5.
Aninvertedyieldcurveisanupwardslopingyieldcurvethatindicatesgenerallycheapershortterm
borrowingcoststhanlongtermborrowingcosts.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:1
6.
AlthoughTreasurysecuritieshavenoriskofdefaultorilliquidity,theydosufferfrommaturity
risktheriskthatinterestrateswillchangeinthefutureandtherebyimpactlongermaturitiesmore
thanshortermaturities.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:RiskPremiums
7.
Liquiditypreferencetheorysuggeststhatforanygivenissuer,longterminterestratestendtobe
higherthanshorttermratesduetothelowerliquidityandhigherresponsivenesstogeneralinterest
ratemovementsoflongertermsecurities;causestheyieldcurvetobeupwardsloping.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:TermStructureTheories
8.
Thetermstructureofinterestratesisthegraphicalpresentationoftherelationshipbetweenthe
annualrateofinterestearnedonasecuritypurchasedonagivendayandheldtomaturityandthe
remainingtimetomaturity.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:1
9.
Aninvertedyieldcurveisadownwardslopingyieldcurvethatindicatesgenerallycheaperlong
termborrowingcoststhanshorttermborrowingcosts.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Chapter6InterestRatesandBondValuation254
10.
Ayieldcurvethatreflectsrelativelysimilarborrowingcostsforbothshortandlongtermloansis
calledanormalyieldcurve.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:1
11.
Upwardslopingyieldcurvesresultfromhigherfutureinflationexpectations,lenderpreferencesfor
shortermaturityloans,andgreatersupplyofshorttermasopposedtolongtermloansrelativeto
theirrespectivedemand.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
12.
Restrictivecovenantsarecontractualclausesinlongtermdebtagreementsthatplacecertain
operatingandfinancialconstraintsontheborrower.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:BondProvisions
13.
Standarddebtprovisionsspecifycertaincriteriaofsatisfactoryrecordkeepingandreporting,tax
payment,andgeneralbusinessmaintenanceonthepartofthelendingfirm.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
14.
Trusteeisapaidpartyrepresentingthebondissuerinthebondindenture.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:BondIndenture
15.
Restrictivecovenants,coupledwithstandarddebtprovisions,allowthelendertomonitorand
controltheborrowersactivitiesinordertoprotectitselfagainstincreasesinborrowerrisk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
16.
Thepurposeoftherestrictivedebtcovenantthatimposesfixedassetsrestrictionsistolimitthe
amountoffixedpaymentobligations.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
17.
Inapracticalsense,thelongerthetermofabond,thegreaterthedefaultriskassociatedwiththe
bond.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:RiskPremiums
18.
Thesizeofthebondofferingaffectstheinterestcostofborrowinginaninversemanner.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:RiskPremiums
19.
Tocarryoutthesinkingfundrequirement,thecorporationmakessemiannualorannualpayments
toatrustee,whousesthesefundstoretirebondsbypurchasingtheminthemarketplace.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:2
Topic:BondFeatures
20.
Debenturessuchasconvertiblebondsareunsecuredbondsthatonlycreditworthyfirmscanissue.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:3
Topic:BondTypes
21.
Callpremiumistheamountbywhichthecallpriceexceedsthemarketpriceofthebond.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:3
Topic:BondFeatures
22.
AbondissuedbyanAmericanCompanythatisdenominatedinSwissFrancsandsoldin
Switzerlandwouldbeanexampleofaforeignbond.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
23.
Stockpurchasewarrantsareinstrumentsthatgivetheirholdertherighttopurchaseacertainnumber
ofsharesofthefirmscommonstockatthemarketpriceoveracertainperiodoftime.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:BondFeatures
24.
Aforeignbondisabondissuedinahostcountrysfinancialmarket,inthehostcountryscurrency,
byaforeignborrower.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
25.
Putablebondsgivethebondholdersanoptiontosellthebondatapricehigherthanparvaluebythe
amountofoneyearinterestpaymentwhenandifthefirmtakesspecifiedactionssuchasbeing
acquired,acquiringanothercompany,orissuingalargeamountofadditionaldebt.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
26.
Sinceaputablebondgivesitsholdertherighttoputthebondatspecifiedtimesoractionsbythe
firm,thebondsyieldislowerthanthatofanonputablebond.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
27.
Highquality(highrated)bondsprovidelowerreturnsthanlowerquality(lowrated)bonds.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondRatings
28.
AEurobondisabondissuedbyaninternationalborrowerandsoldtoinvestorsincountrieswith
currenciesotherthanthecountryinwhichthebondisdenominated.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
29.
Callfeatureisafeatureincludedinalmostallcorporatebondsthatallowstheissuertorepurchase
bondsatthemarketpricepriortomaturity.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:BondFeatures
30.
Thereisaninverserelationshipbetweenthequalityorratingofabondandtherateofreturnitmust
providebondholders.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondRatings
31.
Sinkingfundrequirementisarestrictiveprovisionoftenincludedinabondindentureprovidingfor
periodicpaymentsrepresentingonlyinterestandalargelumpsumpaymentatthematurityofthe
loanrepresentingtheentireloanprincipal.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:BondFeatures
32.
Inabondindenture,subordinationisthestipulationthatsubsequentcreditorsagreetowaituntilall
claimsoftheseniordebtaresatisfied.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
33.
Bondholderswillconverttheirconvertiblebondsintosharesofstockonlywhentheconversion
priceisgreaterthanthemarketpriceofthestock.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
34.
Tosellacallablebond,theissuermustpayahigherinterestratethanonnoncallablebondsofequal
risk.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
35.
Theconversionfeatureofabondisafeaturethatisincludedinalmostallcorporatebondissuesthat
givestheissuertheopportunitytorepurchasebondsatastatedpricepriortomaturity.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
36.
Insubordinateddebentures,paymentofinterestisrequiredonlywhenearningsareavailable.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
37.
Aforeignbondisissuedinahostcountrysfinancialmarket,inthehostcountryscurrency,bya
foreignborrower.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
38.
Sincetheissuerofzero(orlow)couponbondscanannuallydeductthecurrentyearsinterest
accrualwithouthavingtoactuallypaytheinterestuntilthebondmatures(oriscalled),itscashflow
eachyearisincreasedbytheamountofthetaxshieldprovidedbytheinterestdeduction.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
39.
Themarketpriceofacallablebondwillnotgenerallyexceeditscallprice,exceptinthecaseofa
convertiblebond.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
40.
Floatingratebondsarebondsthatcanberedeemedatparattheoptionoftheirholdereitherat
specificdateafterthedateofissueandevery1to5yearsthereafterorwhenandifthefirmtakes
specifiedactionssuchasbeingacquired,acquiringanothercompany,orissuingalargeamountof
additionaldebt.
Answer: FALSE
LevelofDifficulty:4
LearningGoal:3
Topic:BondTypes
41.
Thevalueofanassetdependsonthehistoricalcashflow(s)uptothepresenttime.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:4
Topic:ValuationFundamentals
42.
Valuationistheprocessthatlinksriskandreturntodeterminetheworthofanasset.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:4
43.
Thevalueofanassetisdeterminedbydiscountingtheexpectedcashflowsbacktotheirpresent
value,usingthemarketreturnasdiscountrate.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:4
44.
Inthevaluationprocess,thehighertherisk,thegreatertherequiredreturn.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
45.
Thelevelofriskassociatedwithagivencashflowpositivelyaffectsitsvalue.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
46.
Interestrateriskisthechancethatinterestrateswillchangeandtherebychangetherequiredreturn
andbondvalue.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:5
Topic:BondPricing
47.
Thevalueofabondwithsemiannualinterestisgreaterthanabondwithannualinterest,everything
elsethesame.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:5
Topic:BondPricing
48.
Regardlessoftheexactcause,theimportantpointisthatwhentherequiredreturnisgreaterthanthe
couponinterestrate,thebondvaluewillbelessthanitsparvalue.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
49.
Increasesinthebasiccostoflongtermfundsorinriskwillraisetherequiredreturnonthebond.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:5
Topic:BondPricing
50.
Abondissaidtosellatapremiumwhentherequiredreturnandthebondvaluefallbelowthe
couponinterestrateandthepar,respectively.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:5
Topic:BondPricing
51.
Therequiredreturnonthebondislikelytodifferfromthestatedinterestrateforeitheroftwo
reasons:1)economicconditionshavechanged,causingashiftinthebasiccostoflongtermfunds,
or2)thefirmsriskhaschanged.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:5
Topic:YieldtoMaturity
52.
Yieldtomaturity(YTM)istherateinvestorsearniftheybuythebondataspecificpriceandholdit
untilmaturity.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:6
53.
Theyieldtomaturityonabondwithacurrentpriceequaltoitspar,orface,valuewillalwaysbe
equaltothecouponinterestrate.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
54.
Whentherequiredreturnequalsthecouponinterestrate,thebondsvaluewillremainatparuntilit
matures.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
55.
Whentherequiredreturnisdifferentfromthecouponinterestrateandisassumedtobeconstant
untilmaturity,thevalueofthebondwillapproachitsparvalueasthepassageoftimemovesthe
bondsvalueclosertomaturity.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
56.
Whenthebondvaluediffersfrompar,theyieldtomaturitywilldifferfromthecouponinterestrate.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
57.
Becauseariseininterestrates,andthereforetherequiredreturn,resultsinanincreaseinbondvalue,
bondholdersaretypicallymoreconcernedwithdroppinginterestrates.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:6
58.
Whenevertherequiredreturnisdifferentfromthecouponinterestrate,theamountoftimeto
maturityaffectsbondvalue,eveniftherequiredreturnremainsconstantuntilmaturity.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
59.
Theshortertheamountoftimeuntilabondsmaturity,themoreresponsiveisitsmarketvaluetoa
givenchangeintherequiredreturn.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:6
Topic:BondPricing
60.
Abondwithshortmaturityhaslessinterestrateriskthanabondwithlongmaturitywhenallother
featurescouponinterestrate,parvalue,andinterestpaymentfrequencyarethesame.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:BondPricing
61.
Therealrateofinterestisthecompensationpaidbytheborroweroffundstothelender;fromthe
borrowerspointofview,thecostofborrowingfunds.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
62.
Thenominalrateofinterestisequaltothesumoftherealrateofinterestplustheriskfreerateof
interest.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:NominalRateofInterest(Equation6.1)
63.
Theriskfreerateofinterestisequaltothesumoftherealrateofinterestplusaninflationrisk
premium.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:RiskFreeRateofInterest(Equation6.3)
64.
Thenominalrateofinterestisequaltothesumoftherealrateofinterestplusaninflationpremium
plusariskpremium.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:NominalRateofInterest(Equation6.1)
65.
Aninvertedyieldcurveisupwardslopingandindicatesgenerallycheaperlongtermborrowing
coststhanshorttermborrowingcosts.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
66.
Anormalyieldcurveisupwardslopingandindicatesgenerallycheapershorttermborrowingcosts
thanlongtermborrowingcosts.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
67.
Aninvertedyieldcurveisdownwardslopingandindicatesgenerallycheaperlongtermborrowing
coststhanshorttermborrowingcosts.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
68.
Between1978and2000,therateofreturnonU.S.treasurybillsalwaysexceededtherateof
inflationasmeasuredbytheconsumerpriceindex.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:RiskFreeRateofInterest
69.
Intheory,therateofreturnonU.S.treasurybillsshouldalwaysexceedtherateofinflationas
measuredbytheconsumerpriceindex.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
70.
Themarketsegmentationtheorysuggeststhattheshapeoftheyieldcurveisdeterminedbythe
supplyanddemandforloanswithineachmaturitysegment.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
71.
Theliquiditypreferencetheorysuggeststhattheshapeoftheyieldcurveisdeterminedbythe
supplyanddemandforloanswithineachmaturitysegment.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
72.
Theliquiditypreferencetheorysuggeststhatshorttermratesshouldbelowerthanlongtermrates.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
73.
Theexpectationstheorysuggeststhattheshapeoftheyieldcurvereflectsinvestorsexpectations
aboutfutureinflationrates.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
74.
ThereasonforadifferenceintheyieldbetweenaAaacorporatebondandanotherwiseidentical
Baabondistheriskpremium;therealinterestrateandtheinflationrateisthesameforboth.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:RiskPremiums
75.
AccordingtoMoodys,abondratedAshouldprovideinvestorswithahigheryieldthananotherwise
identicalbondratedAa.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:RiskPremiums
76.
Thepossibilitythattheissuerofabondwillnotpaythecontractualinterestorprincipalpaymentsas
schedulediscalledmaturityrisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:RiskPremiums
77.
Thepossibilitythattheissuerofabondwillnotpaythecontractualinterestorprincipalpaymentsas
schedulediscalleddefaultrisk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:RiskPremiums
78.
Restrictivecovenants,whicharealsoknownasstandarddebtprovisions,placeoperatingand
financialconstraintsontheborrower.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
79.
Inabondindenture,thetermsecurityinterestreferstothefactthatmostfirmsthatissuebondsare
requiredtoestablishsinkingfundprovisionstoprotectbondholders.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:BondIndenture
80.
Inabondindenture,thetermsecurityinterestreferstocollateralpledgedagainstthebond.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:BondIndenture
81.
Thelengthofthematurityonabondofferingaffectsitscost.Ingeneral,thelongerthematurity,the
higherthecost.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:CostofBonds
82.
Thelengthofthematurityonabondofferingaffectsitscost.Ingeneral,thelongerthematurity,the
lowerthecost.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:CostofBonds
83.
Acallfeatureinabondallowsbondholderstochangeeachbondintoastatednumberofsharesof
commonstock.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:BondFeatures
84.
Aconversionfeatureinabondallowsbondholderstochangeeachbondintoastatednumberof
sharesofcommonstock.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondFeatures
85.
Acallfeatureinabondallowstheissuertheopportunitytorepurchasebondsatastatedpriceprior
tomaturity.Thisoptionhasagreaterchanceofbeingexercised(tothedetrimentofthebondholder)
ifmarketinterestrateshavefallensincethebondwasissued.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:3
Topic:BondFeatures
86.
tomaturity.Thisoptionhasagreaterchanceofbeingexercised(tothebenefitofthebondholder)if
marketinterestrateshavefallensincethebondwasissued.
Answer: FALSE
LevelofDifficulty:4
LearningGoal:3
Topic:BondFeatures
87.
tomaturity.Thisoptionhasagreaterchanceofbeingexercised(tothedetrimentofthebondholder)
ifmarketinterestrateshaverisensincethebondwasissued.
Answer: FALSE
LevelofDifficulty:4
LearningGoal:3
Topic:BondFeatures
88.
Ingeneral,IBMbondswillexperiencegreatertradingactivity(intermsofthenumberofbonds
tradedonagivenday)comparedtoIBMstock.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:BondQuotations
89.
Ingeneral,IBMbondswillexperiencelesstradingactivity(intermsofthenumberofbondstraded
onagivenday)comparedtoIBMstock.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondQuotations
90.
AnybondratedaccordingtoMoodysCaathroughAaawouldbeconsideredinvestmentgradedebt.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:BondRatings
91.
AnybondratedaccordingtoMoodysBaorlowerwouldbeconsideredspeculativeorjunk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondRatings
92.
Asanoutstandingbondapproachesmaturity,thepriceofthebondwillalwaystrendtowardpar
valueuntil,atmaturity,thebondisworthitsfacevalue.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:BondRatings
.3
Multiple Choice Questions
1.
The_________rateofinterestcreatesequilibriumbetweenthesupplyofsavingsandthedemand
forinvestmentfunds.
(a) nominal
(b) real
(c) riskfree
(d) inflationary
Answer: B
LevelofDifficulty:1
LearningGoal:1
2.
The_________rateofinterestistheactualratechargedbythesupplierandpaidbythedemanderof
funds.
(a) nominal
(b) real
(c) riskfree
(d) inflationary
Answer: A
LevelofDifficulty:1
LearningGoal:1
Topic:NominalRateofInterest
3.
The_________istheannualrateofinterestearnedonasecuritypurchasedonagivendateandheld
tomaturity.
(a) termstructure
(b) yieldcurve
(c) riskfreerate
(d) yieldtomaturity
Answer: D
LevelofDifficulty:1
LearningGoal:1
4.
The_________is/areagraphicdepictionofthetermstructureofinterestrates.
(a) yieldcurve
(b) supplyanddemandfunctions
(c) riskreturnprofile
(d) aggregatedemandcurve
Answer: A
LevelofDifficulty:1
LearningGoal:1
5.
_________yieldcurvereflectshigherexpectedfutureratesofinterest.
(a) Anupwardsloping
(b) Aflat
(c) Adownwardsloping
(d) Alinear
Answer: A
LevelofDifficulty:1
LearningGoal:1
6.
_________yieldcurvereflectslowerexpectedfutureratesofinterest.
(a) Anupwardsloping
(b) Aflat
(c) Adownwardsloping
(d) Alinear
Answer: C
LevelofDifficulty:1
LearningGoal:1
7.
Generally,anincreaseinriskwillresultin_________requiredreturnorinterestrate.
(a) alower
(b) ahigher
(c) anunchanged
(d) anundetermined
Answer: B
LevelofDifficulty:1
LearningGoal:1
8.
Thenominalrateofinterestiscomposedof
(a) therealrateplusaninflationaryexpectation.
(b) therealrateplusariskpremium.
(c) theriskfreerateplusaninflationaryexpectation.
(d) theriskfreerateplusariskpremium.
Answer: D
LevelofDifficulty:2
LearningGoal:1
9.
The_________rateofinterestistypicallytherequiredrateofreturnonathreemonthU.S.
Treasurybill.
(a) nominal
(b) real
(c) riskfree
(d) premium
Answer: C
LevelofDifficulty:2
LearningGoal:1
10.
Generally,longtermloanshavehigherinterestratesthanshorttermloansbecauseof
(a) thegeneralexpectationofhigherfutureratesofinflation.
(b) lenderpreferencesforshorterterm,moreliquidloans.
(c) greaterdemandforlongtermratherthanshorttermloansrelativetothesupplyofsuchloans.
(d) alloftheabove.
Answer: D
LevelofDifficulty:2
LearningGoal:1
11.
Adownwardslopingyieldcurvethatindicatesgenerallycheaperlongtermborrowingcoststhan
shorttermborrowingcostsiscalled
(a) normalyieldcurve.
(b) invertedyieldcurve.
(c) flatyieldcurve.
(d) Noneoftheabove.
Answer: B
LevelofDifficulty:3
LearningGoal:1
12.
Anupwardslopingyieldcurvethatindicatesgenerallycheapershorttermborrowingcoststhan
longtermborrowingcostsiscalled
(c) flatyieldcurve.
(d) Noneoftheabove.
Answer: A
LevelofDifficulty:3
LearningGoal:1
13.
Ayieldcurvethatreflectsrelativelysimilarborrowingcostsforbothshorttermandlongtermloans
iscalled
(c) flatyieldcurve.
(d) Noneoftheabove.
Answer: C
LevelofDifficulty:3
LearningGoal:1
14.
Thetheorysuggestingthatforanygivenissuer,longterminterestratestendstobehigherthan
shorttermratesiscalled
(a) expectationhypothesis.
(b) liquiditypreferencetheory.
(c) marketsegmentationtheory.
(d) Noneoftheabove.
Answer: B
LevelofDifficulty:3
LearningGoal:1
15.
Theyieldcurveinaneconomicperiodofhighinflationwouldmostlikelybe
(a) upwardsloping.
(b) flat.
(c) downwardsloping.
(d) linear.
Answer: A
LevelofDifficulty:3
LearningGoal:1
16.
Theyieldcurveinaneconomicperiodoflowtomoderateinflationwouldmostlikelybe
(a) upwardsloping.
(b) flat.
(c) downwardsloping.
(d) linear.
Answer: C
LevelofDifficulty:3
LearningGoal:1
17.
Thethreetheoriescitedtoexplainthegeneralshapeoftheyieldcurveareallofthefollowingexcept
(a) expectationshypothesis.
(b) marketsegmentationtheory.
(c) liquiditypreferencetheory.
(d) securitymarketstheory.
Answer: D
LevelofDifficulty:3
LearningGoal:1
18.
Thetheorythatexplainsonlythetendencyfortheyieldcurvetobeupwardslopingis
(a) expectationshypothesis.
(b) liquiditypreferencetheory.
(c) marketsegmentationtheory.
(d) investorperceptiontheory.
Answer: B
LevelofDifficulty:3
LearningGoal:1
19.
Theriskpremiumconsistsofanumberofcomponents,includingallofthefollowingEXCEPT
(a) defaultrisk.
(b) inflationaryrisk.
(c) taxtreatmentrisk.
(d) liquidityrisk.
Answer: B
LevelofDifficulty:3
LearningGoal:1
Topic:RiskPremiums
20.
Atanytime,theslopeoftheyieldcurveisaffectedby
(a) inflationaryexpectations.
(b) liquiditypreferences.
(c) thecomparativeequilibriumofsupplyanddemandintheshorttermandlongtermmarket
segments.
(d) alloftheabove.
Answer: D
LevelofDifficulty:3
LearningGoal:1
21.
AllofthefollowingareexamplesoflongtermdebtEXCEPT
(a) bonds.
(b) linesofcredit.
(c) termloans.
(d) debentures.
Answer: B
LevelofDifficulty:1
LearningGoal:2
Topic:TypesofBonds
22.
Thelegalcontractsettingforththetermsandprovisionsofacorporatebondisa(n)
(a) indenture.
(b) debenture.
(c) loandocument.
(d) promissorynote.
Answer: A
LevelofDifficulty:1
LearningGoal:2
Topic:BondIndenture
23.
Thecostoflongtermdebtgenerally_________thatofshorttermdebt.
(a) islessthan
(b) isequalto
(c) isgreaterthan
(d) hasnorelationto
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:CostofBonds
24.
A_________isarestrictiveprovisiononabondwhichprovidesforthesystematicretirementofthe
bondspriortotheirmaturity.
(a) redemptionclause
(b) sinkingfundrequirement
(c) conversionfeature
(d) subordinationclause
Answer: B
LevelofDifficulty:1
LearningGoal:2
25.
A_________isacomplexandlengthylegaldocumentstatingtheconditionsunderwhichabond
hasbeenissued.
(a) bonddebenture
(b) warrant
(c) sinkingfund
(d) bondindenture
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:BondIndenture
26.
_________isapaidindividual,corporation,orcommercialbanktrustdepartmentthatactsasathird
partytoabondindenturetoensurethattheissuerdoesnotdefaultonitscontractualresponsibilities
tothebondholders.
(a) Atrustee
(b) Aninvestmentbanker
(c) Abondissuer
(d) Abondratingagency
Answer: A
LevelofDifficulty:1
LearningGoal:2
Topic:BondIndenture
27.
Ifabondpays$1,000plusinterestatmaturity,$1,000iscalledthe
(a) statedvalue.
(b) marketvalue.
(c) parvalue.
(d) longtermvalue.
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:BondFeatures
28.
AllofthefollowingareexamplesofrestrictivedebtcovenantsEXCEPT
(a) prohibitiononsellingaccountsreceivable.
(b) supplyingthecreditorwithauditedfinancialstatements.
(c) constraintonsubsequentborrowing.
(d) prohibitiononenteringcertaintypesofleasearrangements.
Answer: B
LevelofDifficulty:2
LearningGoal:2
29.
AllofthefollowingareexamplesofrestrictivedebtcovenantsEXCEPT
(a) limitingthefirmsannualcashdividendpayments.
(b) supplyingauditedfinancialrecords.
(c) prohibitingcombinationswithotherfirms.
(d) managementrestrictionstomaintainingcertainkeyemployees.
Answer: B
LevelofDifficulty:2
LearningGoal:2
30.
AllofthefollowingareexamplesofstandarddebtprovisionsEXCEPT
(a) maintainingallfacilitiesingoodworkingorder.
(b) payingtaxesandliabilitieswhendue.
(c) maintainingsatisfactoryaccountingrecords.
(d) limitingtheannualdividendpayment.
Answer: D
LevelofDifficulty:3
LearningGoal:2
31.
Anexampleofastandarddebtprovisionisthe
(a) limitingofthecorporationsannualcashdividendpayments.
(b) requirementtopaytaxesandotherliabilitieswhendue.
(c) restrictingthecorporationfromdisposingoffixedassets.
(d) constraintsonsubsequentborrowing.
Answer: B
LevelofDifficulty:3
LearningGoal:2
32.
Adebtinstrumentindicatingthatacorporationhasborrowedacertainamountofmoneyand
promisestorepayitinthefutureunderclearlydefinedtermsiscalled
(a) discountbond.
(b) corporatebond.
(c) bondindenture.
(d) treasurybond.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:BondTypes
33.
Themajorfactor(s)affectingthecost,orinterestrate,onabondis(are)its
(a) maturity.
(b) sizeoftheoffering.
(c) issuerrisk.
(d) basiccostofmoney.
(e) Alloftheabove.
Answer: E
LevelofDifficulty:3
LearningGoal:2
Topic:CostofBonds
34.
Thepurposeoftherestrictivedebtcovenantthatrequiresmaintainingaminimumlevelofnet
workingcapitalisto
(a) protectthelenderbycontrollingtheriskandmarketabilityoftheborrowerssecurityinvestment
alternatives.
(b) limittheamountoffixedpaymentobligations.
(c) ensureacashshortagedoesnotcauseaninabilitytomeetcurrentobligations.
(d) preventliquidationofassetsthroughlargesalaryincreasesofkeyemployees.
Answer: C
LevelofDifficulty:3
LearningGoal:2
35.
Thepurposeoftherestrictivedebtcovenantthatprohibitsborrowersfromenteringintocertaintypes
ofleasesisto
(a) protectthelenderbycontrollingtheriskandmarketabilityoftheborrowerssecurity
investmentsalternatives.
Answer: B
LevelofDifficulty:3
LearningGoal:2
36.
Thepurposeoftherestrictivedebtcovenantthatimposesfixedassetsrestrictionsisto
(a) protectthelenderbycontrollingtheriskandmarketabilityoftheborrowerssecurityinvestment
alternatives.
(d) preventthefirmfromliquidation,acquisition,orencumbranceofcapitalassets.
Answer: D
LevelofDifficulty:3
LearningGoal:2
37.
Thepurposeoftherestrictivedebtcovenantthatprohibitsthesaleofaccountsreceivableisto
(a) assurethelenderthattheborrowedfundsareputtotheuseforwhichtheywereintended.
(c) ensurethatacashshortagedoesnotcauseaninabilitytomeetcurrentobligations.
Answer: C
LevelofDifficulty:3
LearningGoal:2
38.
Thepurposeoftherestrictivedebtcovenantthatrequiresthatsubsequentborrowingbesubordinated
totheoriginalloanisto
(a) ensurethatcertainkeyemployeesaremaintained.
(d) protectthelenderbymaintainingitspositioninthepriorityofclaimsintheeventofliquidation.
Answer: D
LevelofDifficulty:3
LearningGoal:2
39.
_________isastipulationinalongtermdebtagreementthatsubsequentorlessimportantcreditors
agreetowaituntilallclaimsofthe_________aresatisfiedbeforehavingtheirclaimssatisfied.
(a) Subordination;commonstockholders
(b) Subordination;seniordebt
(c) Thecombinationrestriction;seniordebt
(d) Theseniordebt;commonstockholders
Answer: B
LevelofDifficulty:3
LearningGoal:2
40.
Violationofanystandardorrestrictiveprovisionbytheborrowergivesthelendertherighttodoall
ofthefollowingEXCEPT
(a) alterthetermsoftheinitialagreement,forexampleacceleratethematuritydate.
(b) demandimmediaterepayment.
(c) increasetheinterestrate.
(d) seizetheloancollateral.
Answer: D
LevelofDifficulty:3
LearningGoal:2
41.
Tocompensatefortheuncertaintyoffutureinterestratesandthefactthatthelongerthetermofa
loanthehighertheprobabilitythattheborrowerwilldefault,thelendertypically
(a) chargesahigherinterestrateonlongtermloans.
(b) reservestherighttochangethetermsoftheloanatanytime.
(c) includesexcessivelyrestrictivedebtprovisions.
(d) reservestherighttodemandimmediatepaymentatanytime.
Answer: A
LevelofDifficulty:3
LearningGoal:2
Topic:CostofBonds
42.
Thesizeoftheloananditscostofborrowingare
(a) notrelated.
(b) inverselyrelated.
(c) independent.
(d) correlated.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:CostofBonds
43.
ThemajorfactorsaffectingthecostoflongtermdebtincludeallofthefollowingEXCEPT
(a) restrictivecovenants.
(b) loanmaturity.
(c) loansize.
(d) thebasiccostofmoney.
Answer: A
LevelofDifficulty:3
LearningGoal:2
Topic:CostofBonds
44.
The_________featurepermitstheissuertorepurchasebondsatastatedpricepriortomaturity.
(a) call
(b) conversion
(c) put
(d) capitalization
Answer: A
LevelofDifficulty:1
LearningGoal:3
Topic:BondFeatures
45.
The_________featureallowsthebondholdertochangeeachbondintoastatednumberofsharesof
stock.
(a) call
(b) conversion
(c) put
(d) capitalization
Answer: B
LevelofDifficulty:1
LearningGoal:3
Topic:BondFeatures
46.
Anothernameforalowordeep/zerodiscountedbondisa
(a) junkbond.
(b) floatingratebond.
(c) zerocouponbond.
(d) subordinateddebenture.
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:BondTypes
47.
A_________givespurchasersinflationprotection.
(a) zerocouponbond
(b) junkbond
(c) floatingratebond
(d) incomebond
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:BondTypes
48.
_________becamepopularvehicleusedtofinancemergersandtakeovers.
(a) Incomebonds
(b) Junkbonds
(c) Floatingratebonds
(d) Convertibledebentures
Answer: B
LevelofDifficulty:1
LearningGoal:3
Topic:BondTypes
49.
_________allowtheholdertopurchaseacertainnumberofsharesofthefirmscommonstockata
specifiedpriceoveracertainperiodoftimeandareoccasionallypartofadebtagreement.
(a) Rights
(b) Stockpurchasewarrants
(c) Debentures
(d) Putsandcalls
Answer: B
LevelofDifficulty:1
LearningGoal:3
Topic:BondFeatures
50.
_________issecuredbyrealestate.
(a) Anincomebond
(b) Adebenture
(c) Amortgagebond
(d) Asubordinateddebenture
Answer: C
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
51.
_________isissuedwithaverylowcouponandsellssignificantlybelowitsparvalue.
(a) Anincomebond
(b) Adeep/zerocouponbond
(c) Amortgagebond
(d) Asubordinateddebenture
Answer: B
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
52.
On_________,thestatedinterestrateisadjustedperiodicallywithinstatedlimitsinresponseto
changesinspecifiedmoneyorcapitalmarketrates.
(a) afloatingratebond
(b) adeep/zerodiscountbond
(c) amortgagebond
(d) anequipmenttrustcertificate
Answer: A
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
53.
_________arecommonlyissuedinthereorganizationofafailedorfailingfirm.
(a) Floatingratebonds
(b) Incomebonds
(c) Mortgagebonds
(d) Equipmenttrustcertificates
Answer: B
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
54.
_________bondsarecharacterizedbyinterestpaymentsthatarerequiredonlywhenearningsare
availablefromwhichtomakesuchpayment.
(a) Floatingrate
(b) Income
(c) Mortgage
(d) Junk
Answer: B
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
55.
_________aredebtratedBaorlowerbyMoodysorBBorlowerbyStandard&Poorsandare
commonlyusedbyrapidlygrowingfirmstoobtaingrowthcapital,mostoftentofinancemergers
andtakeoversofotherfirms,particularlyduringthe1980s.
(a) Subordinateddebentures
(b) Mortgagebonds
(c) Junkbonds
(d) Equipmenttrustcertificates
Answer: C
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
56.
Convertiblebondsarenormally
(a) debentures.
(b) incomebonds.
(c) subordinateddebentures.
(d) mortgagebonds.
Answer: A
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
57.
Adebentureis
(a) alengthylegaldocumentstatingtheconditionsunderwhichabondhasbeenissued.
(b) asecuredbondthatissecuredbyunspecifiedassets.
(c) abondsecuredbyspecificasset.
(d) anunsecuredbondthatonlycreditworthyfirmscanissue.
Answer: D
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
58.
_________aresecuredbystockand/orbondsthatareownedbytheissuer.
(a) Mortgagebonds
(b) Equipmenttrustcertificates
(c) Collateraltrustbonds
(d) Subordinateddebentures
Answer: C
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
59.
_________arebondsthathaveashortmaturity,typicallyonetofiveyears,andwhichcanbe
redeemedorrenewedforasimilarperiodattheoptionoftheirholders.
(a) Floatingratebonds
(b) Extendiblenotes
(c) Putablebonds
(d) Junkbonds
Answer: B
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
60.
Paymentofinterestrequiredonlywhenearningsaremadeavailablefromwhichtomakeapayment
ischaracteristicofa(n)
(a) floatingratebond.
(b) incomebond.
(c) mortgagebond.
(d) equipmenttrustcertificate.
Answer: B
LevelofDifficulty:2
LearningGoal:3
Topic:BondTypes
61.
Afeaturethatallowsbondholderstochangeeachbondintoastatednumberofsharesofcommon
stockiscalled
(a) stockpurchasewarrants.
(b) callfeature.
(c) conversionfeature.
(d) Noneoftheabove.
Answer: C
LevelofDifficulty:2
LearningGoal:3
Topic:BondFeatures
62.
Afeaturethatgivestheissuertheopportunitytorepurchasebondsatastatedpricepriortomaturity
iscalled
(b) callfeature.
(d) Noneoftheabove.
Answer: B
LevelofDifficulty:2
LearningGoal:3
Topic:BondFeatures
63.
Aninstrumentthatgivetheirholderstherighttopurchaseacertainnumberofsharesofthefirms
commonstockataspecifiedpriceoveracertainperiodoftimeiscalled
(b) callfeature.
(d) Noneoftheabove.
Answer: A
LevelofDifficulty:2
LearningGoal:3
Topic:BondFeatures
64.
Theriskinessofpubliclytradedbondissuesisratedbyindependentagencies.Accordingto
Moodysratingsystem,anAaabondandaCaabondare_________and_________,respectively.
(a) speculative;investmentgrade
(b) primequality;mediumgrade
(c) primequality;speculative
(d) mediumgrade;lowestgrade
Answer: C
LevelofDifficulty:3
LearningGoal:3
Topic:BondRatings
65.
Aputablebondgivesthebondholder
(a) therighttosellthebondbacktothecorporationattheoriginalpurchaseprice.
(b) therighttosellthebondbacktothecorporationatastatedpremium.
(c) therighttosellthebondbacktothecorporationatthecurrentmarketvalue.
(d) therighttosellthebondbacktothecorporationatpar.
Answer: D
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
66.
Thesignificantportionofthereturnonazerocouponbondisintheformof
(a) interestandgaininvalue.
(b) interest.
(c) gaininvalue.
(d) taxreduction.
Answer: C
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
67.
Inutilizinga_________theissuercanannuallydeductthecurrentyearsinterestaccrualwithout
havingtoactuallypaytheinterestuntilthebondmatures.
(a) junkbond
(b) zerocouponbond
(c) floatingratebond
(d) extendiblenotes
Answer: B
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
68.
Highrisk,highyieldjunkbondshavedeclinedinpopularityduringtheearly1990sdueto
(a) thedeclineinmergersandtakeovers,whichthesebondswereusedtofinance.
(b) thedecliningneedofgrowthcapital.
(c) thestabilizingofinterestrates.
(d) anumberofmajordefaultsonthesebonds.
Answer: D
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
69.
_________areclaimsthatarenotsatisfieduntilthoseofthecreditorsholdingcertain(senior)debts
havebeenfullysatisfied.
(a) Convertibledebentures
(b) Subordinateddebentures
(c) Mortgagebonds
(d) Collateraltrustbonds
Answer: B
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
70.
Bondsthatcanberedeemedatparattheoptionoftheirholderseitheratspecificdateafterthedate
ofissueandevery1to5yearsthereafterorwhenandifthefirmtakesspecifiedactionssuchas
beingacquired,acquiringanothercompany,orissuingalargeamountofadditionaldebtarecalled
(a) zerocouponbonds.
(b) junkbonds.
(c) floatingratebonds.
(d) putablebonds.
Answer: D
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
71.
Thedecisiontorefundacallablebond
(a) shouldbemadeonlyifinterestrateshaveincreased.
(b) isanetworkingcapitaldecision.
(c) isacapitalbudgetingdecision.
(d) isafinancingdecision.
Answer: C
LevelofDifficulty:3
LearningGoal:3
Topic:BondTypes
72.
Theprocessthatlinksriskandreturninordertodeterminetheworthofanassetistermed
(a) evaluation.
(b) valuation.
(c) discounting.
(d) variablegrowth.
Answer: B
LevelofDifficulty:1
LearningGoal:4
73.
Atypeoflongtermfinancingusedbybothcorporationsandgovernmententitiesis
(a) commonstock.
(b) bonds.
(c) preferredstock.
(d) retainedearnings.
Answer: B
LevelofDifficulty:1
LearningGoal:4
Topic:BondBasics
74.
Bondsare
(a) aseriesofshorttermdebtinstruments.
(b) aformofequityfinancingthatpaysinterest.
(c) longtermdebtinstruments.
(d) ahybridformoffinancingusedtoraiselargesumsofmoneyfromadiversegroupoflenders.
Answer: C
LevelofDifficulty:1
LearningGoal:4
Topic:BondBasics
75.
Thelesscertainacashflow,the_________therisk,andthe_________thevalueofthecashflow.
(a) lower;higher
(b) lower;lower
(c) higher;lower
(d) higher;higher
Answer: C
LevelofDifficulty:2
LearningGoal:4
76.
_________ofallfuturecashflowsanassetisexpectedtoprovideoverarelevanttimeperiodisthe
valueoftheasset.
(a) Thefuturevalue
(b) Thepresentvalue
(c) Thestatedvalue
(d) Thesum
Answer: B
LevelofDifficulty:2
LearningGoal:4
77.
Thereturnexpectedfromanassetisfullydefinedbyits
(a) riskandcashflow.
(b) cashflowandtiming.
(c) discountrate.
(d) beta.
Answer: B
LevelofDifficulty:2
LearningGoal:4
78.
Thekeyinputstothevaluationprocessinclude
(a) returnsandrisk.
(b) returns,timing,andrisk.
(c) cashflowsanddiscountrate.
(d) returns,discountrate,andrisk.
Answer: B
LevelofDifficulty:3
LearningGoal:4
79.
Inthepresentvaluemodel,riskisgenerallyincorporatedintothe
(a) cashflows.
(b) timing.
(c) discountrate.
(d) totalvalue.
Answer: C
LevelofDifficulty:3
LearningGoal:4
80.
The_________valueofabondisalsocalleditsfacevalue.Bondswhichsellatlessthanfacevalue
arepricedata_________,whilebondswhichsellatgreaterthanfacevaluesellata_________.
(a) discount;par;premium
(b) premium;discount;par
(c) par;discount;premium
(d) coupon;premium;discount
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:BondBasics
81.
Corporatebondstypicallyhave
(a) afacevalueof$5,000.
(b) amarketpriceof$1,000.
(c) aspecifiedcouponratepaidannually.
(d) aparvalueof$1,000.
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:BondBasics
82.
Thevalueofabondisthepresentvalueofthe
(a) dividendsandmaturityvalue.
(b) interestanddividendpayments.
(c) maturityvalue.
(d) interestpaymentsandmaturityvalue.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
83.
Whentherequiredreturnisconstantandequaltothecouponrate,thepriceofabondasit
approachesitsmaturitydatewill
(a) remainconstant.
(b) increase.
(c) decrease.
(d) changedependingonwhetheritisadiscountorpremiumbond.
Answer: A
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
84.
Themarketpriceofoutstandingissuesoftenvariesfromparbecause
(a) thematuritydatehaschanged.
(b) thecouponratehaschanged.
(c) themarketrateofinteresthaschanged.
(d) oldbondssellforlessthannewbonds.
Answer: C
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
85.
Thepriceofabondwithafixedcouponrateandthemarketrequiredreturnhavearelationshipthat
isbestdescribedas
(a) varying.
(b) constant.
(c) direct.
(d) inverse.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
86.
Iftherequiredreturnislessthanthecouponrate,abondwillsellat
(a) par.
(b) adiscount.
(c) apremium.
(d) bookvalue.
Answer: C
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
87.
Whentherequiredreturnisconstantbutdifferentfromthecouponrate,thepriceofabondasit
approachesitsmaturitydatewill
(a) remainconstant.
(b) increase.
(c) decrease.
(d) approachpar.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
88.
Iftherequiredreturnisgreaterthanthecouponrate,abondwillsellat
(a) par.
(b) adiscount.
(c) apremium.
(d) bookvalue.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
89.
TheABCcompanyhastwobondsoutstandingthatarethesameexceptforthematuritydate.Bond
Dmaturesin4years,whileBondEmaturesin7years.Iftherequiredreturnchangesby15percent
(a) BondDwillhaveagreaterchangeinprice.
(b) BondEwillhaveagreaterchangeinprice.
(c) thepriceofthebondswillbeconstant.
(d) thepricechangeforthebondswillbeequal.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:BondPricing
90.
Afirmhasanissueof$1,000parvaluebondswitha12percentstatedinterestrateoutstanding.The
issuepaysinterestannuallyandhas10yearsremainingtoitsmaturitydate.Ifbondsofsimilarrisk
arecurrentlyearning8percent,thefirmsbondwillsellfor_________today.
(a) $1,000
(b) $805.20
(c) $851.50
(d) $1,268.20
Answer: D
LevelofDifficulty:3
LearningGoal:5
Topic:BondPricing(Equation6.7andEquation6.7a)
91.
Whenvaluingabond,thecharacteristicsofthebondthatremainfixedareallofthefollowing
EXCEPTthe
(a) couponrate.
(b) price.
(c) facevalue.
(d) interestpayment.
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:BondPricing
92.
Afirmhasanissueof$1,000parvaluebondswitha9percentstatedinterestrateoutstanding.The
issuepaysinterestannuallyandhas20yearsremainingtoitsmaturitydate.Ifbondsofsimilarrisk
arecurrentlyearning11percent,thefirmsbondwillsellfor_________today.
(a) $1,000
(b) $716.67
(c) $840.67
(d) $1,123.33
Answer: C
LevelofDifficulty:3
LearningGoal:5
93.
HewittPackingCompanyhasanissueof$1,000parvaluebondswitha14percentannualcoupon
interestrate.Theissuehastenyearsremainingtothematuritydate.Bondsofsimilarriskare
currentlysellingtoyielda12percentrateofreturn.ThecurrentvalueofeachHewittbondis
_________.
(a) $791.00
(b) $1,000
(c) $1,052.24
(d) $1,113.00
Answer: D
LevelofDifficulty:3
LearningGoal:5
94.
Abondwillsell_________whenthestatedrateofinterestexceedstherequiredrateofreturn,
_________whenthestatedrateofinterestislessthantherequiredreturn,and_________whenthe
statedrateofinterestisequaltotherequiredreturn.
(a) atapremium;atadiscount;equaltotheparvalue
(b) atapremium;equaltotheparvalue;atadiscount
(c) atadiscount;atapremium;equaltotheparvalue
(d) equaltotheparvalue;atapremium;atadiscount
Answer: A
LevelofDifficulty:3
LearningGoal:5
Topic:BondPricing
95.
Ifacorporatebondisissuedwithacouponratethatvariesdirectlywiththerequiredreturn,theprice
ofthebondwill
(a) equalthefacevalue.
(b) belessthanthefacevalue.
(c) begreaterthanthefacevalue.
(d) begreaterthanorlessthanthefacevaluedependingonhowinterestratesvary.
Answer: A
LevelofDifficulty:4
LearningGoal:5
Topic:BondPricing
96.
Calculatethevalueofa$1,000bondwhichhas10yearsuntilmaturityandpaysquarterlyinterestat
anannualcouponrateof12percent.Therequiredreturnonsimilarriskbondsis20percent.
(a) $656.77
(b) $835.45
(c) $845.66
(d) $2,201.08
Answer: A
LevelofDifficulty:4
LearningGoal:5
97.
Interestrateriskandthetimetomaturityhavearelationshipthatisbestcharacterizedas
(a) constant.
(b) varying.
(c) direct.
(d) inverse.
Answer: C
LevelofDifficulty:1
LearningGoal:6
Topic:BondPricing
98.
Foraninvestorwhoplanstopurchaseabondmaturinginoneyear,theprimaryconsideration
shouldbe
(a) interestraterisk.
(b) changesintheriskoftheissue.
(c) yieldtomaturity.
(d) couponrate.
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:BondPricing
99.
Theyieldtomaturityonabondwithapriceequaltoitsparvaluewill
(a) belessthanthecouponrate.
(b) bemorethanthecouponrate.
(c) alwaysbeequaltothecouponrate.
(d) bemoreorlessthanthecouponratedependingontherequiredreturn.
Answer: C
LevelofDifficulty:3
LearningGoal:6
100. Whatistheapproximateyieldtomaturityfora$1,000parvaluebondsellingfor$1,120that
maturesin6yearsandpays12percentinterestannually?
(a) 8.5percent
(b) 9.4percent
(c) 12.0percent
(d) 13.2percent
Answer: B
LevelofDifficulty:3
LearningGoal:6
Topic:YieldtoMaturity(Equation6.7andEquation6.7a)
101. MugwumpIndustrieshasissuedabondwhichhasa$1,000parvalueanda15percentannual
couponinterestrate.Thebondwillmatureintenyearsandcurrentlysellsfor$1,250.Usingthis
information,theyieldtomaturityonMugwumpsbondis_________.
(a) 10.79percent
(b) 11.39percent
(c) 12.19percent
(d) 13.29percent
Answer: A
LevelofDifficulty:3
LearningGoal:6
102. Whatistheyieldtomaturity,tothenearestpercent,forthefollowingbond:currentpriceis$908,
couponrateis11percent,$1,000parvalue,interestpaidannually,eightyearstomaturity?
(a) 11percent
(b) 12percent
(c) 13percent
(d) 14percent
Answer: C
LevelofDifficulty:4
LearningGoal:6
103. Alistryingtodecidewhichoftwobondstobuy.BondHisa10percentcoupon,10yearmaturity,
$1,000par,January1,2000issuepayingannualinterest.BondFisa10percentcoupon,10year
maturity,$1,000par,January1,2000issuepayingsemiannualinterest.Themarketrequiredreturn
foreachbondis10percent.Whenusingpresentvaluetodeterminethepricesofthebonds,Alwill
findthat
(a) thereisnodifferenceinprice.
(b) thepriceofFisgreaterthanH.
(c) thepriceofHisgreaterthanF.
(d) heneedsmoreinformationbeforedeterminingtheprices.
Answer: A
LevelofDifficulty:4
LearningGoal:6
104. Whatisthecurrentpriceofa$1,000parvaluebondmaturingin12yearswithacouponrateof
14percent,paidsemiannually,thathasaYTMof13percent?
(a) $604
(b) $1,090
(c) $1,060
(d) $1,073
Answer: C
LevelofDifficulty:4
LearningGoal:6
105. NicoNelson,amanagementtraineeatalargeNewYorkbasedbankistryingtoestimatethereal
rateofreturnexpectedbyinvestors.Henotesthatthe3monthTbillcurrentlyyields3percentand
hasdecidedtousetheconsumerpriceindexasaproxyforexpectedinflation.Whatistheestimated
realrateofinterestiftheCPIiscurrently2percent?
(a) 5%
(b) 1%
(c) 3%
(d) 2%
Answer: B
LevelofDifficulty:3
LearningGoal:1
Topic:RealRateofInterest(Equation6.1)
106. Considerthefollowingreturnsandyields:U.S.Tbill8%,5yearU.S.Tnote7%,IBMcommon
stock15%,IBMAAACorporateBond12%and10yearU.S.Tbond6%.Basedonthis
information,theshapeoftheyieldcurveis
(a) upwardsloping.
(b) downwardsloping.
(c) flat.
(d) normal.
Answer: B
LevelofDifficulty:3
LearningGoal:1
107. WhatisthenominalrateofreturnonanIBMbondiftherealrateofinterestis3percent,the
inflationriskpremiumis2percent,theU.S.Tbillrateis5percent,thematurityriskpremiumon
theIBMbondis3percent,thedefaultriskpremiumontheIBMbondis2percent,andtheliquidity
riskpremiumonthebondis1percent?
(a) 16%
(b) 13%
(c) 11%
(d) 9%
Answer: C
LevelofDifficulty:3
LearningGoal:1
Table6.1
Usethefollowinginformationtoanswerquestions#108through#110.
EST
Company Coupon
Maturity
LastPrice LastYield Spread
Ford(F)
11.0
July31,2009
65.50
?
104
EST
UST
10
108. Onthistradingday,thenumberofMcLeodbondswhichchangedhandswas(Table6.1)
(a) 5,100.
(b) 51,000.
(c) 510,000.
(d) 5,100,000.
Answer: D
LevelofDifficulty:2
LearningGoal:3
Topic:CorporateBondQuotes
VOL.
(000s)
5,100
109. Assumethisbondsfacevalueis$1,000.Whatisthebondscurrentmarketprice(Table6.1)?
(a) $65.00
(b) $655.00
(c) $650.00
(d) $6,550.00
Answer: B
LevelofDifficulty:2
LearningGoal:3
110. Whatisthelastyieldforthisbond(Table6.1)?
(a) 11.0%
(b) 14.2%
(c) 16.8%
(d) 18.9%
Answer: C
LevelofDifficulty:2
LearningGoal:3
111. NicoCorpissuedbondsbearingacouponrateof12percent,paycouponssemiannually,have3
yearsremainingtomaturity,andarecurrentlypricedat$940perbond.Whatistheyieldto
maturity?
(a) 12.00%
(b) 13.99%
(c) 14.54%
(d) 15.25%
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:SemiAnnualYieldtoMaturity(Equation6.7andEquation6.7a)
112. Nicoboughtaninvestmentoneyearagoandjustcalculatedhisreturnoninvestment.Hefoundthat
hispurchasingpowerhadincreasedby15percentasaresultofhisinvestment.Ifinflationduring
theyearwas4percent,thenNicos_________.
(a) realreturnoninvestmentismorethan15percent
(b) nominalreturnoninvestmentismorethan15percent
(c) nominalreturnoninvestmentislessthan11percent
(d) realreturnoninvestmentisequalto4percent
Answer: B
LevelofDifficulty:3
LearningGoal:1
Topic:SemiAnnualYieldtoMaturity(Equation6.1andEquation6.2)
113. JiaHuaEnterpriseswantstoissuesixty20year,$1,000parvalue,zerocouponbonds.Ifeachbond
ispricedtoyield7percent,howmuchwillJiaHuareceive(ignoringissuancecosts)whenthebonds
arefirstsold?
(a) $11,212
(b) $12,393
(c) $15,505
(d) $18,880
(e) $20,000
Answer: C
LevelofDifficulty:3
LearningGoal:5
114. OnJanuary1,2002,ZhengCorporationwillissuenewbondstofinanceitsexpansionplans.Inits
effortstopricetheissue,ZhengCorporationhasidentifiedacompanyofsimilarriskwithan
outstandingbondissuethathasan8percentcouponratethatisdueJanuary1,2017.Thisfirms
bondscurrentlyaresellingfor$1,091.96.Ifinterestispaidsemiannuallyforbothbonds,whatmust
thecouponrateofthenewbondsbeinorderfortheissuetosellatpar?
(a) 5.75%
(b) 6.00%
(c) 6.50%
(d) 7.00%
Answer: D
LevelofDifficulty:4
LearningGoal:5
.4
Essay Questions
1.
Arecordcollectorhasagreedtosellherentirecollectiontoahistoricalmuseuminthreeyearsata
priceof$100,000.Thecurrentriskfreerateis7percent.Atwhatpriceshouldshevalueher
collectiontoday?
Answer: $100,000(0.816)$81,600
LevelofDifficulty:1
LearningGoal:4
Topic:ValuationFundamentals(Equation6.5andEquation6.6)
2.
Acorporatefinancialanalystmustcalculatethevalueofanassetwhichproducesyearendannual
cashflowsof$0thefirstyear,$2,000thesecondyear,$3,000thethirdyear,and$2,500thefourth
year.Assumingadiscountrateof15percent,whatisthevalueofthisasset?
Answer: UsingPVIF(15,n):
$0(0.870)$2,000(0.756)$3,000(0.658)$2,500(0.572)
$0$1,512$1,974$1,430$4,916
LevelofDifficulty:2
LearningGoal:4
3.
Whatisthevalueofanassetwhichpays$200ayearforthenext5yearsandcanbesoldfor$1,500
attheendoffiveyearsfromnow?Assumethattheopportunitycostis10percent.
Answer: P200(PVIFA)1,500(PVIF)
200(3.791)1,500(0.621)$1,689.70
LevelofDifficulty:3
LearningGoal:4
Table6.2
Bond
L
M
N
ParValue($)
1000
100
500
AnnualCoupon
InterestRate(%)
9
10
18
Yearsto
Maturity
5
8
17
Required
Return(%)
6
10
15
4.
(a) CalculatethecurrentvalueofBondL.(SeeTable6.2)
(b) Whatwillhappentothevalue/priceasthebondapproachesmaturity?
Answers:
(a) $90(4.212)$1,000(0.747)$1,126.08
(b) Thebondpricewilldecreaseandcomeclosertopar.
LevelofDifficulty:2
LearningGoal:5
5.
CalculatethecurrentvalueofBondM.(SeeTable6.2)
Answer: Annualcouponinterestraterequiredrateofreturn
Therefore,valueparvalue$100
LevelofDifficulty:2
LearningGoal:5
6.
CalculatethecurrentvalueofBondMifthetimeofmaturityissixyears.(SeeTable6.2)
Answer: Thebondisatpar,or$100,becausetheannualcouponinterestrateisequaltotherequired
rateofreturn.
LevelofDifficulty:2
LearningGoal:5
7.
(a) CalculatethecurrentvalueofBondN.(SeeTable6.2)
(b) Whatwillhappentovalue/priceasthebondapproachesmaturity?
Answers:
(a) $90(6.047)$500(0.093)$590.73
(b) Thebondpricewilldecreaseandcomeclosertopar.
LevelofDifficulty:2
LearningGoal:5
8.
HewittPackingCompanyhasanissueof$1,000parvaluebondswitha14percentcouponinterest
rateoutstanding.Theissuepaysinterestsemiannuallyandhas10yearsremainingtoitsmaturity
date.Bondsofsimilarriskarecurrentlysellingtoyielda12percentrateofreturn.Whatisthevalue
oftheseHewittPackingCompanybonds?
Answer: B$70(11.470)$1,000(.312)$1,114.90
LevelofDifficulty:3
LearningGoal:5
9.
Toexpanditsbusiness,theKingstonOutletfactorywouldliketoissueabondwithparvalueof
$1,000,couponrateof10percent,andmaturityof10yearsfromnow.Whatisthevalueofthebond
iftherequiredrateofreturnis1)8percent,2)10percent,and3)12percent?
Answers: Couponpayment1,0000.10$100
1)B100(PVIFA8%,10)1,000(PVIF8%,10)
100(6.710)1,000(0.463)$1,134.00
2)B$1,000sincecouponrateandrequiredrateofreturnareequal.
3)B100(PVIFA12%,10)1,000(PVIF12%,10)
100(5.650)1,000(0.322)$887
LevelofDifficulty:3
LearningGoal:5
10.
Tofinanceanewlineofproduct,theWestchesterCompanyhasissued$1,000,000bondwithapar
valueof$1,000,couponrateof8percent,andmaturityof30years.Computethepriceofthebondif
theopportunitycostis11percent.
Answer: Couponpayment1,0000.08$80
B80(PVIFA11%,30)1,000(PVIF11%,30)
80(8.694)1,000(0.044)$739.52
LevelofDifficulty:3
LearningGoal:5
11.
Peterhasrecentlyinherited$10,000andisconsideringpurchasing10bondsoftheLucky
Corporation.Thebondhasaparvalueof$1,000with10percentcouponrateandwillmaturein
10years.DoesPeterhaveenoughmoneytobuy10bondsiftherequiredrateofreturnis9percent?
Answer: No.Sincetherequiredrateofreturn(9percent)islessthanthebondscouponrate(10
percent),thebondspriceisgreaterthanitsparvalue($1,000).Thus,thetotalpriceof10
bondsisgreaterthan$10,000.
LevelofDifficulty:3
LearningGoal:5
12.
FancyFood,Inc.hasissuedabondwithparvalueof$1,000,acouponrateof9percentthatispaid
semiannually,andthatmaturesin10years.Whatisthevalueofthebondiftherequiredrateof
returnis12percent?
Semiannualcouponpayment90/2$45
P45(PVIFA6%,20)1,000(PVIF6%,20)
45(11.470)1,000(0.312)$828.15
LevelofDifficulty:3
LearningGoal:5
13.
TheH&HComputerCompanyhasanoutstandingissueofbondwithaparvalueof$1,000,paying
12percentcouponratesemiannually.Thebondwasissued25yearsagoandhas5yearsto
maturity.Whatisthevalueofthebondassuming14percentrateofinterest?
Semiannualcouponpayment120/2$60
P60(PVIFA7%,10)1,000(PVIF7%,10)
60(7.024)1,000(0.508)$929.44
LevelofDifficulty:3
LearningGoal:5
14.
DellCampingEquipment,Inc.justissueda10percent,25yearbondwitha$1,000parvaluethat
paysinterestsemiannually.
(a) Howmuchcantheinvestorexpectinannualinterest(indollars)?
(b) Howmuchcantheinvestorexpectininteresteverysixmonths(indollars)?
(c) Howmuchcantheinvestorexpectinparvalueattheendofthe25thyear?
Answers:
(a) $100
(b) $50
(c) $1,000
LevelofDifficulty:1
LearningGoal:6
15.
DrawagraphofatypicalTreasuryyieldcurveanddiscusswhyitusuallytakesthatshape.
Answer: Thestudentshoulddrawanormal,upwardslopingyieldcurveasshowninthetext.
Factorsimpactingtheshapeoftheyieldcurvearetheriskfreerate,theinflationpremium,
andtheinterestrateriskpremium.
LevelofDifficulty:2
LearningGoal:1
16.
Explainliquidity,defaultrisk,andmaturityriskpremiums.
Answer: Liquidityproblemsexistinthinlytradedbonds,defaultriskisthelikelihoodthe
corporationwilldefaultonitsbondobligations,andthematuritypremiumreflectsthefact
thatlongertermbondspossessgreaterinterestrateriskandsensitivitythanshorterterm
bonds..Ifanyoftheseexist,investorswilldemandtobecompensatedfortheriskby
demandingayieldpremiumtoownthebonds.
LevelofDifficulty:3
LearningGoal:2
Topic:RiskPremiums

Chapter 6: Interest Rates and Bond Valuation

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252GitmanPrinciplesofFinance,EleventhEdition

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