Fundamentals of Corporate Finance 9th Canadian Edition By Ross - Test Bank
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Fundamentals of Corporate Finance 9th Canadian Edition By Ross - Test Bank

Fundamentals of Corporate Finance 9th Canadian Edition By Ross - Test Bank   Instant Download - Complete Test Bank With Answers     Sample Questions Are Posted Below   Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) This morning, Alicia bought a ten-year 7% coupon …

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Fundamentals of Corporate Finance 9th Canadian Edition By Ross – Test Bank

 

Instant Download – Complete Test Bank With Answers

 

 

Sample Questions Are Posted Below

 

Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) This morning, Alicia bought a ten-year 7% coupon bond that pays interest annually. She paid $994 for a $1,000 bond. If the market interest rate on this type of bond declines to 6.5% tonight, how much will Alicia receive for her first interest payment?
A) $35.00 B) $69.58 C) $32.31 D) $70.00 E) $65.00
Answer: D
Explanation: A)
B)
C)
D)
E)
2) What is the market value of a bond that will pay a total of 40 semi-annual coupons of $50 each over the remainder of its life? Assume the bond has a $1,000 face value and an 8% yield to maturity.
A) $1,215.62
B) $634.86
C) $1,197.93
D) $1,135.90
E) $642.26
Answer: C
Explanation: A)
B)
C)
D)
E)
3) An account managed by the bond trustee for early bond redemption payments is called a:
A) Call provision.
B) Sinking fund.
C) Collateral payment account.
D) Par value fund.
E) Deed in trust account.
Answer: B
Explanation: A)
B)
C)
D)
E)
1)
2)
3)
1
4) If investors are uncertain that a corporate bond issuer will make all of the bond payments as promised, the investors will demand a higher yield in the form of:
A) An increased inflation premium.
B) An increased real rate of interest.
C) An increased default risk premium.
D) An increased liquidity risk premium.
E) An increased interest rate risk premium.
Answer: C
Explanation: A)
B)
C)
D)
E)
5) The newly issued bonds of the Wynslow Corp. offer a 6% coupon with semi-annual interest payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be:
A) Equal to 6%.
B) Equal to 12%.
C) Greater than 3% but less than 4%.
D) Greater than 6% but less than 7%.
E) Equal to 3%.
Answer: D
Explanation: A)
B)
C)
D)
E)
6) Curtis bought an 8.5% annual coupon bond at par. One year later, he sold the bond at a quoted price of 98. During the year, market interest rates rose and inflation was 3%. What real rate of return did Curtis earn on this investment?
A) 6.50% B) 6.70% C) 3.40% D) 6.40% E) 3.50%
Answer: C
Explanation: A)
B)
C)
D)
E)
4)
5)
6)
2
7) Floating-rate bonds frequently specify a minimum and maximum for the:
A) Maturity date.
B) Market price.
C) Coupon rate.
D) Yield to maturity.
E) Call period.
Answer: C
Explanation: A)
B)
C)
D)
E)
8) Which one of the following bonds has the greatest interest rate risk?
A) 5-year; 7% coupon
B) 9-year; 9% coupon
C) 5-year; 9% coupon
D) 9-year; 7% coupon
E) 7-year; 7% coupon
Answer: D
Explanation: A)
B)
C)
D)
E)
9) Which one of the following statements is correct concerning bond classifications?
A) A mortgage security is a bond issued solely by a home builder.
B) A callable bond can be repurchased by the issuer prior to the initial maturity date.
C) A note is a bond which has an original maturity date longer than 10 years.
D) A debenture is a long-term bond secured by the fixed assets of a firm.
E) A subordinated bond receives preferential treatment over all other bonds in a bankruptcy.
Answer: B
Explanation: A)
B)
C)
D)
E)
10) ________ is the highest rating given by DBRS that is NOT considered investment grade.
A)A B)C C)BBB D)BB E)B
Answer: D
Explanation: A)
B)
C)
D)
E)
7)
8)
9)
10)
3
11) The market price of a bond is equal to the present value of the:
A) Face value minus the present value of the annuity payments.
B) Face value plus the present value of the annuity payments.
C) Annuity payments plus the future value of the face amount.
D) Annuity payments minus the face value of the bond.
E) Face value plus the future value of the annuity payments.
Answer: B
Explanation: A)
B)
C)
D)
E)
12) One basis point is equal to:
A) 10%. B) .10%. C) 100%. D) 1.0%. E) .01%.
Answer: E
Explanation: A)
B)
C)
D)
E)
13) A $1,000 face value zero coupon bond is quoted at a price of 43.30. What is the amount you would pay to purchase this bond?
A) $430.30
B) $433.00
C) $43.30
D) $956.70
E) $1,043.30
Answer: B
Explanation: A)
B)
C)
D)
E)
11)
12)
13)
4
14) Which one of the following statements concerning floating-rate bonds is correct?
A) Floating-rate bonds are issued by the government but not by corporations.
B) The market price of a floating-rate bond will always equal par.
C) The market price of a floating-rate bond is less volatile than that of a comparable fixed rate bond.
D) Floating-rate bonds have coupon rates that generally can vary without limitations.
E) Floating-rate bonds generally contain a put provision at a pre-specified premium price.
Answer: C
Explanation: A)
B)
C)
D)
E)
15) Which one of the following is correct concerning bond prices?
A) The price of a short-term bond is more sensitive to interest rate changes than the price of a Long-term bond.
B) The price of a zero coupon bond is less sensitive to interest rate changes than the price of a coupon bond.
C) Movements in bond prices are directly related to movements in the market rate of interest.
D) All else equal, a 12% bond will sell at a higher price than a 10% bond.
E) Bond prices tend to fluctuate more the less time to maturity.
Answer: D
Explanation: A)
B)
C)
D)
E)
16) Which of the following would NOT be listed on the face of a bond?
A) The coupon interest rate.
B) The market price of the bond.
C) The coupon payment to be made.
D) The maturity date.
E) The name of the issuer.
Answer: B
Explanation: A)
B)
C)
D)
E)
14)
15)
16)
5
17) The legal document that includes the basic terms and details of a bond is called the:
A) Marketing form.
B) Indenture agreement.
C) Registration form.
D) Call provision.
E) Debenture agreement.
Answer: B
Explanation: A)
B)
C)
D)
E)
18) The zero coupon bonds of Markco, Inc. have a market price of $394.47, a face value of $1,000, and a yield to maturity of 6.87%. How many years is it until this bond matures?
A) 10 years B) 7 years C) 14 years D) 21 years E) 18 years
Answer: C
Explanation: A)
B)
C)
D)
E)
19) The bonds of B.F. Fabricators pay a 10% coupon, have a 9.64% yield to maturity, and have a face value of $1,000. The current rate of inflation is 3.2%. What is the actual real rate of return on these bonds?
A) 6.24% B) 6.18% C) 6.41% D) 6.44% E) 6.20%
Answer: A
Explanation: A)
B)
C)
D)
E)
20) The written, legally binding agreement between the corporate borrower and the lender detailing the terms of a bond issue is called the:
A) Covenant.
B) Indenture.
C) Call provision.
D) Form 5140.
E) Terms of trade.
Answer: B
Explanation: A)
B)
C)
D)
E)
17)
18)
19)
20)
6
21) Elise’s Crafts needs $225,000 today to purchase some new equipment. The firm is a planning on issuing 10-year zero coupon bonds. The current market rate of interest is 6.5%. How many bonds must Elise’s Crafts sell to raise the money they need?
A) 423 B) 225 C) 467 D) 450 E) 391
Answer: A
Explanation: A)
B)
C)
D)
E)
22) Martha owns a 7% coupon bond that has 13 years to maturity. The bond pays interest annually and is currently selling for $1,034.50. What is the yield to maturity on this bond?
A) 6.88% B) 6.50% C) 6.77% D) 6.66% E) 6.60%
Answer: E
Explanation: A)
B)
C)
D)
E)
23) The rate of return required by investors in the market for owning a bond is called the:
A) Coupon.
B) Face value.
C) Maturity.
D) Yield to maturity.
E) Coupon rate.
Answer: D
Explanation: A)
B)
C)
D)
E)
24) The specified date on which the principal amount of a bond is repaid is called the bond’s:
A) Coupon.
B) Face value.
C) Maturity.
D) Yield to maturity.
E) Coupon rate.
Answer: C
Explanation: A)
B)
C)
D)
E)
21)
22)
23)
24)
7
25) Which of the following items does NOT generally appear in The National Post corporate bond quote?
A) Yield to maturity.
B) Current yield.
C) Maturity date.
D) Price.
E) Coupon rate.
Answer: B
Explanation: A)
B)
C)
D)
E)
26) Which one of the following is the correct bond pricing equation?
A) Bond value = {C}{[1 – 1/(1 + r)t]/r} + F/(1 + r)t
B) Bond value = {C}{[1 + 1/(1 + r)t]/r} + [F – (1 + rt)/r]
C) Bond value = {C}{[1 – 1/(1 + r)]/rt} + F – 1/(1 + r)t]/r
D) Bond value = {C}{[1 + 1/(1 + r)]/rt} + F/(1 + r)
E) Bond value = {C}{[1 + 1/(1 + r)t]/r} + F/(1 + r)t
Answer: A
Explanation: A)
B)
C)
D)
E)
27) Interest rates or rates of return on investment that have not been adjusted for the effects of inflation are called:
A) Stripped rates.
B) Nominal rates.
C) Coupon rates.
D) Effective rates.
E) Real rates.
Answer: B
Explanation: A)
B)
C)
D)
E)
25)
26)
27)
8
28) Culpepper Supply has a bond issue outstanding that pays a 7.5% coupon and matures in 14 years. The bonds have a par value of $1,000 and a market price of $942.90. Interest is paid semiannually. What is the yield to maturity?
A) 9.45% B) 8.19% C) 7.67% D) 7.50% E) 8.60%
Answer: B
Explanation: A)
B)
C)
D)
E)
29) When investors believe that inflation is going to decline in the future the term structure of interest rates will:
A) Decrease as the time to maturity gets longer.
B) Be humped.
C) Rise in a linear manner over a period of time.
D) Be higher in the long term than in the short term.
E) Rise at an increasing rate over a period of time.
Answer: A
Explanation: A)
B)
C)
D)
E)
30) A 10-year, 8% coupon bond pays interest annually. The bond has a face value of $1,000. What is the percentage change in the price of this bond if the market yield rises to 9% from the current rate of 8.5%?
A) – 4.23% B) – 4.08% C) – 2.98% D) – 3.24% E) – 3.71%
Answer: D
Explanation: A)
B)
C)
D)
E)
31) The Fisher effect is used to:
A) Compute the effective annual rate.
B) Eliminate the effects of semi-annual compounding.
C) Compute the real rate of return.
D) Determine the compounded annual rate of return.
E) Determine the annual yield of a zero coupon bond.
Answer: C
Explanation: A)
B)
C)
D)
E)
28)
29)
30)
31)
9
32) Sensitivity to interest rate risk is directly dependent on:
A) The present value and the future value.
B) The yield and the coupon rate.
C) Time to maturity and the coupon rate.
D) The coupon rate and the future value
E) The future value and the yield.
Answer: C
Explanation: A)
B)
C)
D)
E)
33) The form of bond issue in which the registrar of the company records ownership of each bond, with relevant payments made directly to the owner of record, is called:
A) Registered form.
B) Bearer form.
C) Collateral form.
D) Debenture form.
E) New-issue form.
Answer: A
Explanation: A)
B)
C)
D)
E)
34) The total interest paid on a zero coupon bond is equal to:
A) The face value minus the market price on the maturity date.
B) The face value minus the issue price.
C) $1,000 minus the par value.
D) Zero.
E) $1,000 minus the face value.
Answer: B
Explanation: A)
B)
C)
D)
E)
32)
33)
34)
10
35) Suppose you purchase a zero coupon bond with face value $1,000, maturing in 20 years, for $214.51. If the yield to maturity on the bond remains unchanged, what will the price of the bond be five years from now?
A) $680.58
B) $387.52
C) $1,000.00
D) $315.20
E) $410.91
Answer: D
Explanation: A)
B)
C)
D)
E)
36) The price a dealer is willing to pay for a security held by an investor is called the:
A) Auction price.
B) Bid price.
C) Ask price.
D) Equilibrium price.
E) Bid-ask spread.
Answer: B
Explanation: A)
B)
C)
D)
E)
37) The Fisher effect defines the relationship between:
A) Nominal and real rates of return.
B) A bond’s rating and its real rate of return.
C) The yield to maturity and the yield to call.
D) Inflation and the yield to maturity.
E) The market value and face value of a bond.
Answer: A
Explanation: A)
B)
C)
D)
E)
35)
36)
37)
11
38) The outstanding bonds of Jacksen Global Freight carry an 8% coupon and have a current market price of $1,054. The bonds have a face value of $1,000. What is the current yield on these bonds?
A) 2.47% B) 8.00% C) 3.80% D) 4.00% E) 7.59%
Answer: E
Explanation: A)
B)
C)
D)
E)
39) The bonds offered by Glenwood Studios are callable in 4 years at a quoted price of 106. What is the amount of the call premium on a $1,000 par value bond?
A) $60 B) $30 C) $40 D) $70 E) $50
Answer: A
Explanation: A)
B)
C)
D)
E)
40) Lady Products, Inc. just issued 10-year, 8% coupon bonds at par. Outstanding Limbaugh Corp. bonds, which have a maturity of 10 years, sell at a premium to par and are viewed by investors as having the same risk as the Lady bonds. Therefore, it must be true that:
A) The Limbaugh bonds pay coupons more often than twice a year.
B) The coupon rate on the Limbaugh bonds is higher than that on the Lady bonds.
C) The coupon payment on the Limbaugh bonds is lower than that on the Lady bonds.
D) The yield on Limbaugh bonds is higher than the yield on Lady bonds.
E) The coupon rate on the Limbaugh bonds is equal to that on the Lady bonds.
Answer: B
Explanation: A)
B)
C)
D)
E)
41) A general claim on property that is not otherwise pledged is called a:
A) Debenture.
B) Collateral bond.
C) Registered bond.
D) Mortgage bond.
E) Bearer bond.
Answer: A
Explanation: A)
B)
C)
D)
E)
38)
39)
40)
41)
12
42) A(n) ________ is secured only by the reputation of the issuing firm.
A) Straight bond.
B) Bearer bond.
C) Registered bond.
D) Debenture.
E) Unfunded bond.
Answer: D
Explanation: A)
B)
C)
D)
E)
43) Dizzy Corp. bonds bearing a coupon rate of 15%, pay coupons semiannually, have two years remaining to maturity, and are currently priced at $980 per bond. What is the yield to maturity?
A) 15.99% B) 16.25% C) 16.21% D) 16.57% E) 15.00%
Answer: C
Explanation: A)
B)
C)
D)
E)
44) Which one of the following statements concerning bond ratings is correct?
A) Investment grade bonds include only those bonds receiving one of the highest three bond ratings.
B) All bonds receive the same rating classification from all rating agencies.
C) Standard and Poor’s and Value Line are the primary bond rating agencies.
D) Bond ratings evaluate the expected price volatility of a bond issue.
E) Bond ratings are solely an assessment of the creditworthiness of the bond issuer.
Answer: E
Explanation: A)
B)
C)
D)
E)
45) Party Time, Inc. has a 6% coupon bond that matures in 11 years. The bond pays interest semi-annually. What is the market price of a $1,000 face value bond if the yield to maturity is 12.9%?
A) $605.92 B) $600.34 C) $580.86 D) $947.87 E) $434.59
Answer: B
Explanation: A)
B)
C)
D)
E)
42)
43)
44)
45)
13
46) What would you pay for a bond that pays an annual coupon of $35, has a face value of $1,000, matures in seven years, and has a yield to maturity of 8%?
A) $910.14 B) $976.38 C) $765.71 D) $875.34 E) $900.18
Answer: C
Explanation: A)
B)
C)
D)
E)
47) Margaret wants to compute the present value of a six year semi-annual 8% coupon bond that has a 9% yield to maturity. Which one of the following is correct?
A) The amount of each interest payment is $80.
B) The present value is assumed to be $1,000.
C) The number of interest payments is twelve.
D) The current price of the bond will be greater than the par value.
E) The bond is selling at a premium.
Answer: C
Explanation: A)
B)
C)
D)
E)
48) Today, you want to sell a zero coupon bond you currently own. The bond matures in 9 years. How much will you receive for your bond if the market yield to maturity is currently 8.88%? Ignore any accrued interest.
A) $465.02 B) $468.10 C) $496.93 D) $678.73 E) $676.39
Answer: A
Explanation: A)
B)
C)
D)
E)
49) The Exley Company bonds are currently selling for $1,041.30. These bonds mature in seven years, pay semi-annual interest and have a yield to maturity of 6.75%. What is the coupon rate?
A) 7.00% B) 7.25% C) 6.50% D) 6.75% E) 7.50%
Answer: E
Explanation: A)
B)
C)
D)
E)
46)
47)
48)
49)
14
50) When using a financial calculator to compute the yield-to-maturity of a semi-annual 50)
coupon bond, the:
A) Coupon rate is the discount rate.
B) Call premium is the present value.
C) Market price is the future value.
D) Number of payments is the number of years to maturity.
E) Face value is the future value.
Answer: E
Explanation:A)
B)
C)
D)
E)
51) J&J Enterprises wants to issue eighty 20-year, $1,000 zero-coupon bonds. If each bond is 51)
to yield 8%, how much will J&J receive (ignoring issuance costs) when the bonds are
first sold?
A) $18,880B) $20,000C) $12,393D) $11,212E) $17,164
Answer: E
Explanation:A)
B)
C)
D)
E)
52) 52)
On this trading day, the Imperial Oil bond is:
A) Selling at a premium.
B) Selling at its face value.
C) Likely to increase in value as it approaches maturity.
D) Selling at a discount.
E) None of these.
Answer: A
Explanation: A)
B)
C)
D)
E)
15
53) Norwegian Adventures offers a 6.5% coupon bond with annual payments. The yield to maturity is 6.71% and the maturity date is 7 years from today. What is the market price of this bond if the face value is $1,000?
A) $988.57
B) $811.63
C) $981.31
D) $1,193.35
E) $692.07
Answer: A
Explanation: A)
B)
C)
D)
E)
54) Ajax Corporation issued 10,000 units of $1,000 face value bonds that mature in 20 years and have a 4% coupon rate that is paid semi-annually. If the bonds were sold at 103.5% of their face value, calculate the yield to maturity at the end of year 4.
A) 3.71% B) 3.64% C) 3.58% D) 3.75% E) 3.50%
Answer: A
Explanation: A)
B)
C)
D)
E)
55) Which one of the following is correct concerning bonds and bondholders?
A) A bondholder can never force a company into bankruptcy.
B) A bond can be sold privately and never offered to the public.
C) A bondholder is a partial owner of a corporation.
D) A bondholder has the right to vote on key corporate decisions.
E) The interest paid on a bond is not tax deductible as a business expense.
Answer: B
Explanation: A)
B)
C)
D)
E)
53)
54)
55)
16
56) Your broker offers you the opportunity to purchase a bond with coupon payments of $90 per year and a face value of $1,000. If the yield to maturity on similar bonds is 8%, this bond should:
A) Sell at a discount.
B) Sell for either a premium or a discount but it’s impossible to tell which.
C) Sell for par value.
D) Sell for the same price as the similar bond regardless of their respective maturities.
E) Sell at a premium.
Answer: E
Explanation: A)
B)
C)
D)
E)
57) The Fisher formula is expressed as:
A) 1 + r = (1 – R) (1 + h).
B) 1 + R = (1 + r) (1 + h).
C) 1 + R = (1 – r) (1 + h).
D) 1 + r = (1 + R) (1 + h).
E) 1 + h = (1 + r) (1 + R).
Answer: B
Explanation: A)
B)
C)
D)
E)
58) Gerry Industries has some 8% coupon bonds on the market that are selling at $989, pay interest semi-annually, and mature in fifteen years. The company would like to issue $1 million in new fifteen-year bonds. What coupon rate should be applied to the new bonds if Gerry Industries wants to sell them at par? (Use values in the dollar.)
A) 8.26% B) 8.13% C) 8.00% D) 8.33% E) 7.87%
Answer: B
Explanation: A)
B)
C)
D)
E)
56)
57)
58)
17
59) The unsecured debts of a firm with maturities greater than 10 years are most literally called:
A) Notes.
B) Debentures.
C) Unfunded liabilities.
D) Bonds.
E) Sinking funds.
Answer: B
Explanation: A)
B)
C)
D)
E)
60) ABC Corporation has 4-year, 5% annual coupon bonds outstanding. Given a 6.5% yield to maturity, determine the duration of these bonds.
A) 2.90 B) 4.02 C) 2.52 D) 3.02 E) 4.52
Answer: A
Explanation: A)
B)
C)
D)
E)
61) ________ is the rating given to income bonds on which no interest is being paid.
A)C B)F C)A D)D E)B
Answer: D
Explanation: A)
B)
C)
D)
E)
62) For a bond selling at par, the yield to maturity must be ________.
A) Greater than the coupon rate.
B) Greater than the face value.
C) Equal to the coupon rate.
D) Greater than the required rate of return.
E) Less than the coupon rate.
Answer: C
Explanation: A)
B)
C)
D)
E)
59)
60)
61)
62)
18
63) Zane Industrial Products wants to raise $22 million to expand their business. To accomplish this, they plan to sell 30-year, $1,000 face value, zero coupon bonds. The bonds will be priced to yield 7.25%. What is the approximate minimum number of bonds the company must sell to raise the money they need? (Use values in the dollar.)
A) 161,333 B) 155,400 C) 179,615 D) 168,242 E) 174,198
Answer: C
Explanation: A)
B)
C)
D)
E)
64) The call provision found on most publicly issued bonds are advantageous to the
________ because ________.
A) Issuer; they can issue these bonds with relatively lower coupon rates than bonds without a call provision
B) Buyer; these bonds typically have lower coupon rates
C) Issuer; it allows issuing firms to purchase back the bonds if interest rates move favourably
D) Buyer; it allows buyers to sell back their bonds to the issuer if interest rates move up
E) Government; issuing companies and buyers have to pay higher taxes on these bonds
63)
64)
Answer: C
Explanation: A)
B)
C)
D)
E)
65) Which of the following is a basic component that affects the slope of the term structure 65)
of interest rates?
A) Default risk premium.
B) Real rate of interest.
C) Inflation premium.
D) Taxability premium.
E) Liquidity premium.
Answer: C
Explanation: A)
B)
C)
D)
E)
19
66) J&J Enterprises wants to issue 20-year, $1,000 face value zero-coupon bonds. If each bond is to yield 8%, what is the minimum number of bonds J&J must sell if they wish to raise $2 million from the sale? (Use values in the dollar; ignore issuance costs.)
A) 9,322 B) 16,159 C) 4,290 D) 13,880 E) 10,164
Answer: A
Explanation: A)
B)
C)
D)
E)
67) Alpha Manufacturing offers a zero coupon bond with a 12.25% yield to maturity. The bond matures in 13 years. What is the current price if the face value is $1,000?
A) $244.09 B) $241.41 C) $243.06 D) $222.63 E) $234.18
Answer: D
Explanation: A)
B)
C)
D)
E)
68) Dhalia Corporation issued $100 million bonds that mature in 30 years and have a 5% coupon rate that is paid annually. If the bonds were sold to yield 3.4%, determine the price of the bonds at the end of year 15.
A) $107,244,589
B) $118,559,603
C) $103,202,658
D) $126,658,944
E) $105,659,506
Answer: B
Explanation: A)
B)
C)
D)
E)
69) The semi-annual, ten-year bonds of Adep, Inc. are selling at par and have an effective annual yield of 4.295%. What is the amount of each interest payment on a $1,000 Adep bond?
A) $21.48 B) $21.25 C) $42.95 D) $21.50 E) $42.50
Answer: B
Explanation: A)
B)
C)
D)
E)
66)
67)
68)
69)
20
70) A 15-year, 6% coupon bond pays interest annually. The bond has a face value of $1,000. What is the change in the price of this bond if the market yield to maturity rises to 6.5% from the current rate of 6.25%?
A) 2.43% increase
B) 2.50% decrease
C) 2.37% increase
D) 2.43% decrease
E) 2.37% decrease
Answer: E
Explanation: A)
B)
C)
D)
E)
71) The price a dealer is willing to accept for selling a security to an investor is called the:
A) Bid-ask spread.
B) Ask price.
C) Auction price.
D) Bid price.
E) Equilibrium price.
Answer: B
Explanation: A)
B)
C)
D)
E)
72) Jackson Central has a 6-year, 8% annual coupon bond with a $1,000 par value. Earls Enterprises has a 12-year, 8% annual coupon bond with a $1,000 par value. Both bonds currently have a yield to maturity of 6%. Which of the following statements are correct if the market yield increases to 7%?
A) The Earls bond will decrease in value by 7.56%.
B) The Earls bond will decrease in value by $50.68.
C) The Jackson bond will increase in value by 4.61%.
D) Both bonds would decrease in value by 4.61%.
E) The Earls bond will increase in value by $88.25.
Answer: A
Explanation: A)
B)
C)
D)
E)
70)
71)
72)
21
73) The market price of a bond is $1,236.94, it has 14 years to maturity, a $1,000 face value, and pays an annual coupon of $100. What is the yield to maturity?
A) 7.25% B) 3.18% C) 4.26% D) 6.11% E) 5.37%
Answer: A
Explanation: A)
B)
C)
D)
E)
74) XYZ Co. zero-coupon bonds have a face value of $1,000 and mature in 18 years. They currently sell for $179.86 today. By what percentage will the market price rise if the market’s required return falls by half?
A) 137% B) 175% C) 231% D) 131% E) 99%
Answer: D
Explanation: A)
B)
C)
D)
E)
75) As the yield to maturity increases, the:
A) Lower the coupon rate desired by that investor.
B) Longer the time to maturity.
C) Amount the investor is willing to pay to buy a bond decreases.
D) Lower the rate of return desired by the investor.
E) Higher the price the investor offers to buy a bond.
Answer: C
Explanation: A)
B)
C)
D)
E)
76) The outstanding bonds of Frank’s Welding provide a real rate of return of 2.87%. The current rate of inflation is 4.64%. What is the nominal rate of return on these bonds?
A) 7.46% B) 7.71% C) 7.51% D) 7.64% E) 7.33%
Answer: D
Explanation: A)
B)
C)
D)
E)
73)
74)
75)
76)
22
77) ________ included in the bond indenture to protect bondholders from certain actions by the company.
A) A description of dedicated capital is.
B) Debentures are.
C) Articles of incorporation are.
D) Indentures are.
E) Covenants are.
Answer: E
Explanation: A)
B)
C)
D)
E)
78) If investors are uncertain that they will be able to sell a corporate bond quickly, the investors will demand a higher yield in the form of a(n) ________.
A) Default risk premium.
B) Increased real rate of interest.
C) Interest rate risk premium.
D) Liquidity risk premium.
E) Inflation premium.
Answer: D
Explanation: A)
B)
C)
D)
E)
79) A bond which, at the election of the holder, can be swapped for a fixed number of shares of common stock at any time prior to the bond’s maturity is called a ________ bond.
A) Putable
B) Warrant
C) Callable
D) Zero coupon
E) Convertible
Answer: E
Explanation: A)
B)
C)
D)
E)
77)
78)
79)
23
80) A firm intends to take on a significant amount of new debt in order to fund the purchase of a close competitor. However, before it can complete the transaction, the firm must call one of its outstanding bond issues. It is plausible that the called bonds:
A) Are backed by the corporation’s fixed assets.
B) Can be called at a price that is very near par.
C) Have a higher interest rate than the new bonds will.
D) Have an inferior tax status than the new bonds will.
E) Have covenants which restrict such increase in debt.
Answer: E
Explanation: A)
B)
C)
D)
E)
81) J&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 7%. If the bond has a life of 30 years, pays annual coupons, and the yield to maturity is 6.8%, what will the bond sell for?
A) $1,087.25
B) $975.18
C) $1,000.00
D) $1,025.32
E) $1,111.81
Answer: D
Explanation: A)
B)
C)
D)
E)
82) If investors require a 7% nominal return and the expected inflation rate is 3%, what is the expected real return?
A) 3.00% B) 3.88% C) 1.04% D) 4.00% E) 10.21%
Answer: B
Explanation: A)
B)
C)
D)
E)
80)
81)
82)
24
83) A debenture is: 83)
A) An agreement whereby actions of the issuer are limited for the protection of the bondholders.
B) A secured bond which is backed by specifically-named collateral.
C) A bond which pays payments to whoever has physical possession of the bond.
D) Unsecured debt which generally has a maturity of 10 years or more.
E) The legal agreement between a bond’s issuer and the bondholders.
Answer: D
Explanation: A)
B)
C)
D)
E)
84) The bonds offered by Fast Moving Pumps are callable in 4 years at a quoted price of 84)
101.5. What is the amount of the call premium on a $1,000 face value bond?
A) $.15B) $15.00C) $1.50D) $.015E) $150.00
Answer: B
Explanation:A)
B)
C)
D)
E)
85) 85)
Assume this bond’s face value is $1,000. Then the current market price of this bond is
________.
A) $10,612.00
B) $1,055.30
C) $1000.00
D) $987.50
E) $1061.20
Answer: E
Explanation: A)
B)
C)
D)
E)
25
86) The rate that is computed by dividing the annual interest payment by the face value of a bond is called the:
A) Coupon rate.
B) Market rate.
C) Yield to maturity.
D) Discount rate.
E) Yield to call.
Answer: A
Explanation: A)
B)
C)
D)
E)
87) The difference between the clean price and the dirty price of a bond is:
A) The rounding difference created when bonds are quoted in 64ths.
B) The amount of interest that is in default.
C) The accrued interest.
D) The difference between the current rate and the original coupon rate of a variable bond.
E) The dealer’s spread.
Answer: C
Explanation: A)
B)
C)
D)
E)
88) All else the same, the existence of a ________ will increase the required return on a bond.
A) Call provision.
B) Sinking fund.
C) Conversion feature.
D) Protective covenant.
E) Trust deed.
Answer: A
Explanation: A)
B)
C)
D)
E)
86)
87)
88)
26
89) The principal amount of a bond that is repaid at the end of the loan term is called the bond’s:
A) Coupon.
B) Face value.
C) Maturity.
D) Yield to maturity.
E) Coupon rate.
Answer: B
Explanation: A)
B)
C)
D)
E)
90) A bond that makes no coupon payments (and thus is initially priced at a deep discount to par value) is called a ________ bond.
A) Floating rate.
B) Treasury.
C) Municipal.
D) Junk.
E) Zero coupon.
Answer: E
Explanation: A)
B)
C)
D)
E)
91) You plan on depositing $10,000 a year in real terms into your investment account for the next four years. The relevant nominal discount rate is 7.5% and the inflation rate is 4.2%. What are these deposits worth in today’s dollars?
A) $37,023.03
B) $36,787.78
C) $38,021.21
D) $38,504.19
E) $36,418.02
Answer: A
Explanation: A)
B)
C)
D)
E)
89)
90)
91)
27
92) Gabriel Corporation has outstanding $1,000, 8% semi-annual coupon bonds. The bonds have fourteen years remaining to maturity. If the current price for these bonds is $1,118.74, what is the annualized yield to maturity?
A) 6.12% B) 6.68% C) 5.85% D) 5.67% E) 6.00%
Answer: B
Explanation: A)
B)
C)
D)
E)
93) You purchased an investment which will pay you $15,000, in real dollars, a year for the next three years. The nominal discount rate is 8% and the inflation rate is 3.6%. What is the present value of these payments?
A) $44,008.16
B) $42,607.19
C) $43,333.33
D) $41,431.91
E) $43,711.14
Answer: D
Explanation: A)
B)
C)
D)
E)
94) Which of the following will a bond indenture will not include?
A) Maturity date.
B) Protective covenants.
C) Yield to Maturity.
D) Security or collateral.
E) Sinking fund provision.
Answer: C
Explanation: A)
B)
C)
D)
E)
92)
93)
94)
28
95) 95)
For this coupon bond:
A) The yield to maturity is 9.875%.
B) The yield to maturity is 0%.
C) The coupon yield is 6.12%.
D) The yield to maturity is 5.53%.
E) The coupon yield is 5.53%.
Answer: D
Explanation: A)
B)
C)
D)
E)
96) An ask price of 98.73 means that you can ________ a $1,000 face value bond for
________.
A) Sell; $98.73
B) Sell; $987.30
C) Swap; $98.73
D) Buy; $98.73
E) Buy; $987.30
Answer: E
Explanation: A)
B)
C)
D)
E)
97) Westover Ridge offers a 9% coupon bond with semiannual payments and a yield to maturity of 11.68%. The bonds mature in 16 years. What is the market price per bond if the face value is $1,000?
A) $863.08
B) $807.86
C) $1,322.88
D) $1,453.10
E) $916.26
Answer: B
Explanation: A)
B)
C)
D)
E)
96)
97)
29
98) The term “structure of interest rates” reflects the:
A) Interest rate risk premium applicable to bonds of varying maturities.
B) Nominal interest rates applicable to coupon bonds of varying maturities.
C) Pure time value of money for various lengths of time.
D) Pure inflation adjustment applied to bonds of various maturities.
E) Actual risk premium being paid for corporate bonds of varying maturities.
Answer: C
Explanation: A)
B)
C)
D)
E)
99) This morning, Marty bought a 4% coupon bond at par value. The bond pays semi-annual interest and has twenty years to maturity. By what percentage will the price of Marty’s bond change if market interest rates rise by 1.5% tonight?
A) 18.06% B) -8.19% C) 4.10% D) 8.19% E) -18.06%
Answer: E
Explanation: A)
B)
C)
D)
E)
100) A corporate bond is quoted at a current price of 103.68. What is the market price if the face value is $5,000?
A) $5,103.68
B) $4,785.00
C) $5,184.00
D) $5,210.68
E) $4,822.53
Answer: C
Explanation: A)
B)
C)
D)
E)
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
101) Provide an appropriate definition of “maturity date.” 101)
Answer: Specified date at which the principal amount of a bond is paid.
Explanation:
102) Provide an appropriate definition of “coupon rate.” 102)
Answer: The rate of interest paid to bondholders based on indenture.
Explanation:
98)
99)
100)
30
103) Elaborate on why long-term bonds have greater interest rate sensitivity.
Answer: The reason longer-term bonds have greater interest rate sensitivity is that a large portion of a bond’s value comes from the $1,000 face amount. The present value of this amount isn’t greatly affected by a small change in interest rates if it is to be received in one year. If it is to be received in 30 years, however, even a small change in the interest rate can have a significant effect once it is compounded for 30 years. The present value of the face amount becomes much more volatile with a longer-term bond as a
result.
Explanation:
104) Elaborate on what does an AAA credit rating signifies.
Answer: AAA signifies the highest credit quality. The capacity for the payment of financial obligations is exceptionally high and unlikely to be adversely affected by future events.
103)
104)
Explanation:
105) Provide an appropriate definition of “inflation premium.”
Answer: The portion of a nominal interest rate that represents compensation for
expected future inflation.
Explanation:
106) Provide a graphical representation of an upward sloping term structure of interest rates.
105)
106)
Answer:
Explanation:
107) Provide an appropriate definition of “registered form.” 107)
Answer: Registrar of company records ownership of each bond; payment is made directly to the owner of record.
Explanation:
31
108) Provide an appropriate definition of retractable bond. 108)
Answer: Bond that may be sold back to the issuer at a pre-specified price before
maturity.
Explanation:
109) Provide an appropriate definition of “indenture.” 109)
Answer: The indenture is the written agreement between the corporation (the
borrower) and its creditors.
Explanation:
110) Provide an appropriate definition of “Fisher effect.” 110)
Answer: The relationship between nominal returns, real returns, and inflation.
Explanation:
111) Elaborate on what an AA credit rating signifies. 111)
Answer: AA signifies superior credit quality. The capacity for the payment of
financial obligations is considered high. Credit quality differs from AAA
only to a small degree. Unlikely to be significantly vulnerable to future
events.
Explanation:
112) Provide an appropriate definition of a term structure of interest rates. 112)
Answer: The relationship between nominal interest rates on default-free, pure
discount securities and time to maturity; that is, the pure time value of
money.
Explanation:
113) Elaborate on what a B credit rating signifies. 113)
Answer: B signifies highly speculative credit quality. There is a high level of
uncertainty as to the capacity to meet financial obligations.
Explanation:
114) Provide an appropriate definition of “clean price.”
Answer: The price of a bond net of accrued interest; this is the price that is typically
quoted.
Explanation:
115) In addition to interest rate risk and the real rate, what other factors can bond yields be affected by?
Answer: Bond factors can also be affected by the following: Bond provisions
Default risk
Expected future inflation The lack of liquidity
114)
115)
Explanation:
32
116) Provide an appropriate definition of “yield to maturity.” 116)
Answer: The market interest rate that equates a bond’s present value of interest
payments and principal repayment with its price.
Explanation:
117) What do you know about the relationship between the coupon rate and the YTM 117)
for premium bonds? What about for discount bonds? For bonds selling at par value?
Answer: If the coupon rate is higher than the required return on a bond, the bond will sell at a premium, since it provides periodic income in the form of coupon payments in excess of that required by investors on other similar bonds. If the coupon rate is lower than the required return on a bond, the bond will sell at a discount since it provides insufficient coupon payments compared to that required by investors on other similar bonds. For premium bonds, the coupon rate exceeds the YTM; for discount bonds, the YTM exceeds the coupon rate; and for bonds selling at par, the YTM is equal to the coupon rate.
Explanation:
118) Provide an appropriate definition of a “nominal rate.”
Answer: The rate of return that has not been adjusted for inflation.
Explanation:
119) Explain how it is that the bond prices reported in The National Post are generated.
Answer: Bond prices are the result of the buying and selling of bonds by investors. As these parties interact, the bond price moves so that the seller can find a buyer and vice versa. What is needed to answer this question is a general understanding of the operation of financial markets.
118)
119)
Explanation:
120) Provide an appropriate definition of “default risk premium.”
Answer: The portion of a nominal interest rate or bond yield that represents
compensation for the possibility of default.
Explanation:
121) Provide an appropriate definition of “debenture.”
Answer: Unsecured debt, usually with a maturity of 10 years or more.
Explanation:
120)
121)
122) Provide an appropriate definition of “call protected.” 122)
Answer: Bond during period in which it cannot be redeemed by the issuer.
Explanation:
33
123) Provide an appropriate definition of “real rates.” 123)
Answer: Rate of return that has been adjusted for inflation.
Explanation:
124) Elaborate on what a BB credit rating signifies. 124)
Answer: BB signifies speculative, non-investment-grade credit quality. The capacity
for the payment of financial obligations is uncertain. Vulnerable to future
events.
Explanation:
125) Provide an appropriate definition of “call premium.” 125)
Answer: Amount by which the call price exceeds the par value of the bond.
Explanation:
126) Provide an appropriate definition of “bearer form.”
Answer: Bond issued without record of the owner’s name; payment is made to
whoever holds the bond.
Explanation:
127) Provide an appropriate definition of “sinking fund.”
Answer: Account managed by the bond trustee for early bond redemption.
Explanation:
126)
127)
128) Provide an appropriate definition of “deferred call.”
Answer: Call provision prohibiting the company from redeeming the bond before a
certain date.
Explanation:
129) In the early 1980s, the Treasury yield curve had a severe downward slope with short-term yields near 20% and long-term yields below 15%. Explain how such a pattern might occur.
Answer: The downward slope occurs because the expected inflation premium is declining. The decline in the inflation premium is significant enough to overcome the interest rate risk premium.
128)
129)
Explanation:
130) Provide an appropriate definition of “coupon.” 130)
Answer: The stated interest payment made on a bond.
Explanation:
131) Provide an appropriate definition of “protective covenant.” 131)
Answer: Limitation placed on certain transactions that can be taken during the term
of the loan, usually to protect the lender’s interest.
Explanation:
34
132) Identify and discuss the various components of a nominal interest rate. 132)
Answer: At a minimum, students should identify the real rate, the inflation premium, and the interest rate risk premium. The real rate tends to remain relatively constant. The inflation premium varies over time based on inflation expectations. The interest rate risk premium varies over time based on expected changes in the interest rates. Students might also mention a liquidity premium, a taxability premium, and a default risk premium.
Explanation:
133) What is the relationship between the current yield and YTM for premium bonds? 133) For discount bonds? For bonds selling at par value?
Answer: The current yield only refers to the yield of the bond at the current moment. It does not reflect the total return over the life of the bond. Current yield = annual coupon payment/price. Yield to maturity (YTM) is the interest rate required in the market on a bond, and this yield value is the discount rate used in the valuation formula for a bond. A premium bond sells above par value, and the current yield is always greater than YTM for a premium bond. A discount bond sells below par value, and the current yield is always lower than the YTM for a discount bond. For bonds selling at par, the current yield and YTM are equal.
Explanation:
134) The discussion of asset pricing in the text suggests that an investor will be 134)
indifferent between two bonds which have equal yields to maturity as long as they are of equivalent default risk. Can you think of any real-world factors which might make a given investor prefer one of these bonds over the other?
Answer: Note that the question only implies the bonds have the same yields and bond ratings. There are the additional issues of liquidity, and interest rate risk. To give a complete answer to this question, the A-student will be able to repeat the discussion of determinants of bond yields in Section 7. 7.
Explanation:
135) Provide an appropriate definition of “Canada plus call.”
Answer: Call provision that compensates bond investors for interest differential,
making it unattractive for an issuer to call a bond.
Explanation:
136) Elaborate on what an A credit rating signifies.
Answer: A signifies good credit quality. The capacity for the payment of financial obligations is substantial, but of lesser credit quality than AA. May be vulnerable to future events, but qualifying negative factors are considered
manageable.
Explanation:
135)
136)
35
137) One of the bond rating agencies ran into controversy when it began rating bonds 137)
of some companies without their approval. Many of the companies whose bonds were rated in this manner were upset by this. Why do you think a company would be unhappy to receive a “free” bond rating?
Answer: When ratings agencies rate bonds, they do so by relying on information provided by the company. Absent this information, the rating agency must rely on publicly available information, and may not have as clear a picture of the firm as it would if it received information directly from the company. Also, some firms argued that the rating agency was harsher with its ratings when the company was not compensating them for providing this service. As a result, some of the firms argued that they were essentially being blackmailed into buying a rating service in order to prevent poor ratings for their bonds. Also, for whatever reason, some firms may not wish to be rated by more than one agency and may purchase only one rating. If another rating agency steps in without being requested to do so, you could end up with crossover bonds.
Explanation:
138) Elaborate on what a D credit rating signifies. 138)
Answer: D signifies that the issuer has filed under any applicable bankruptcy, insolvency, or winding up statute or there is a failure to satisfy an obligation after the exhaustion of grace periods, a downgrade to D may occur. DBRS may also use SD (Selective Default) in cases where only some securities are impacted, such as the case of a “distressed exchange”. A financial obligation has not been met or it is clear that a financial obligation will not be met in the near future or a debt instrument has been subject to a distressed exchange. A downgrade to D may not immediately follow insolvency or restructuring filing as grace periods or extenuating circumstances may exist.
Explanation:
139) Provide an appropriate definition of “face value” or “par value.” 139)
Answer: The principal amount of a bond that is repaid at the end of the term.
Explanation:
140) Elaborate on what CCC/CC/C credit ratings signify. 140)
Answer: CCC/CC/C may signify very highly speculative credit quality. In danger of defaulting on financial obligations. There is little difference between these three categories, although CC and C ratings are normally applied to obligations that are seen as highly likely to default, or subordinated to obligations rated in the CCC to B range. Obligations in respect of which default has not technically taken place but is considered inevitable may be rated in the C category.
Explanation:
36
141) Provide an appropriate definition of “interest rate risk premium.” 141)
Answer: The compensation investors demand for bearing interest rate risk.
Explanation:
142) Provide four components likely to be included in bond indenture. Answer: Four likely components of an indenture include:
Maturity date
Sinking fund provision
Protective covenants
Security or collateral
Explanation:
143) Provide an appropriate definition of “Canada yield curve.”
Answer: A plot of the yields on Government of Canada notes and bonds relative to
maturity.
Explanation:
144) Provide an appropriate definition of “dirty price.”
Answer: The price of a bond including accrued interest, also known as the full or
invoice price. This is the price the buyer actually pays.
Explanation:
145) Define what is meant by interest rate risk. Assume you are the manager of a $100 million portfolio of corporate bonds and you believe interest rates will fall. What adjustments should you make to your portfolio based on your beliefs?
Answer: Interest rate risk is the risk that arises for bond owners from fluctuating interest rates. All else the same, if interest rates are expected to fall you should purchase long-term bonds and/or low coupon bonds, and sell
shorter-term, higher-coupon bonds.
Explanation:
146) Elaborate on what a BBB credit rating signifies.
Answer: BBB signifies adequate credit quality. The capacity for the payment of financial obligations is considered acceptable. May be vulnerable to future
events.
Explanation:
147) Provide an appropriate definition of “stripped bond” or “zero-coupon bond.” Answer: Bond that may be sold back to the issuer at a pre-specified price before
maturity.
Explanation:
142)
143)
144)
145)
146)
147)
37
148) Why do corporations issue 100-year bonds, knowing that interest rate risk is 148)
highest for very long-term bonds? How does the interest rate risk affect the
issuer?
Answer: Essentially, the issuer takes the opposite side of the interest rate risk
position. By issuing long-term bonds, the corporation is essentially betting
that rates won’t fall significantly. If they do, the corporation will incur a
loss due to borrowing at rates higher than the going market rates. On the
other hand, if rates rise, the corporation benefits by having locked in its
borrowing rate for up to 100 years.
Explanation:
149) Explain liquidity, default risk, and interest rate risk premiums. 149)
Answer: Liquidity problems exist in thinly traded bonds, default risk is the
likelihood the corporation will default on its bond obligations, and the
interest rate risk premium reflects the fact that bonds with differing coupon
rates and maturities are subject to differing levels of risk associated with
changes in interest rates. If any of these exist, investors will demand to be
compensated for the risk by demanding a yield premium to own the bonds.
Explanation:
150) Provide an appropriate definition of “call provision.” 150)
Answer: Agreement giving the corporation the option to repurchase the bond at a
specified price before maturity.
Explanation:
151) Using a teeter-totter as the basis for your analysis, explain the relationship 151)
between the market price of a bond and the market rate of interest. Include time
to maturity in your explanation.
Answer: The market price of a bond is one side of the teeter-totter and the market
rate of interest is the other side of the teeter-totter. As one side rises, the
other side falls. This depicts the inverse relationship between the price and
the rate. A short-term bond would be depicted as a point close to the
fulcrum point of the teeter-totter. An intermediate-term bond would be
depicted as a point part way between the fulcrum point and the end of one
side. A long-term bond would be depicted as a point on the very end of one
side of the teeter-totter. The further away from the fulcrum a point is, the
greater the degree of upward and downward movement. This illustrates that
long-term bonds fluctuate more in price than short-term bonds.
Explanation:
152) Provide an appropriate definition of “liquidity premium.” 152)
Answer: The portion of a nominal interest rate or bond yield that represents
compensation for lack of liquidity.
Explanation:
38
153) Assume the real rate of interest on 1-year, 10-year, and 30-year bonds is 3%. Also 153) assume the rate of inflation is expected to be 3% for the coming year.
Considering only an inflation premium, construct an example showing how an expected increase in the rate of inflation leads to an upward sloping term structure via the Fisher effect. Then, explain how the addition of interest rate risk will affect your results.
Answer: The student is expected to generate three nominal rates, each based on an increasing level of inflation, beginning with a one-year nominal rate of
6.09%. The result will be an upward sloping term structure of interest rates. Adding interest rate risk to the mix will increase the yields on the 10 and 30-year bonds, increasing the slope of the term structure.
Explanation:
154) What is the relationship between the price of a bond and it’s YTM?
Answer: The bond price is the present value of the cash flows from a bond. The
YTM is the interest rate used in valuing the cash flows from a bond.
Explanation:
155) Provide a graphical representation of a downward sloping term structure of interest rates.
154)
155)
Answer:
Explanation:
156) Provide an appropriate definition of a “note.” 156)
Answer: Unsecured debt, usually with a maturity under 10 years.
Explanation:
39
157) Investors who purchased bonds several years ago enjoyed double digit yields. 157)
These same investors today are complaining loudly about the current low single digit returns. Are investors that much worse off today? Explain what investors should be considering and how to determine whether they are better off or worse off today than they were several years ago.
Answer: Investors are comparing the nominal rates of return. The important thing to consider is the real rate of return, which considers the effects of inflation. If the real rate of return has held constant, then investors are neither better nor worse off than they were previously. If the real rate of return has increased, then investors are actually better off even though the nominal rate of return decreased significantly. Only if the real rate of return has decreased would investors be worse off. The Fisher formula should be mentioned as the method of determining the real rate of return.
Explanation:
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.
158) The shorter the term, the greater the interest rate risk.
Answer: True        False
Explanation:
159) The coupon rate will be less than the yield to maturity when a bond sells at a discount.
Answer:    True False
Explanation:
160) The yield to maturity will be greater than the coupon rate when a bond is selling at a premium.
Answer: True        False
Explanation:
161) Maintaining a current ratio of 1.5 or better while ensuring the loan collateral in good working order is an example of a positive covenant.
Answer:    True False
Explanation:
162) For two bonds identical but for coupon, the market price of the lower coupon bond will change more (in percentage terms) than that of the higher coupon bond for a given change in market interest rates.
Answer:    True False
Explanation:
163) Call provisions are included in the bond indenture.
Answer:    True False
Explanation:
158)
159)
160)
161)
162)
163)
40
164) Any regular coupon bond of any maturity will sell for its face value if the coupon rate is the same as the market rate of interest.
Answer:    True False
Explanation:
165) The repayment of the bond principle is tax-deductible.
Answer: True        False
Explanation:
166) All else the same, interest rate risk is highest for bonds with variable rate coupons.
Answer: True        False
Explanation:
167) Increasing the time to maturity and decreasing the coupon rate will increase the interest rate risk of a bond.
Answer:    True False
Explanation:
168) Debt can be subordinated to equity.
Answer: True        False
Explanation:
169) A sinking fund is used to pay off portions of debt each year.
Answer:    True False
Explanation:
170) All else equal, the market value of a corporate bond is always inversely related to its coupon rate.
Answer: True        False
Explanation:
171) The higher the coupon rate, the higher the interest rate risk.
Answer: True        False
Explanation:
172) Increasing the coupon rate and decreasing the time to maturity will increase the interest rate risk of a bond.
Answer: True        False
Explanation:
173) The outlook for future inflation influences the shape of the term structure of interest rates.
Answer:    True False
Explanation:
164)
165)
166)
167)
168)
169)
170)
171)
172)
173)
41
174) Adjustable maturity dates is a common characteristic of floating-rate bonds?
Answer: True        False
Explanation:
175) Prior to 1980, few firms raised funds directly by issuing junk bonds.
Answer:    True False
Explanation:
176) The interest rate risk premium is included in the term structure of interest rates.
Answer:    True False
Explanation:
177) The call premium increases as the time to maturity decreases.
Answer: True        False
Explanation:
178) The yield to maturity is generally included in a bond indenture.
Answer: True        False
Explanation:
179) An increase in the real rate of interest will cause the slope of the term structure of interest rates to increase.
Answer: True        False
Explanation:
180) Duration is a useful measure of interest rate risk because it incorporates a bond’s coupon rate.
Answer:    True False
Explanation:
181) All else the same, if interest rates fall, then bond prices will rise.
Answer:    True False
Explanation:
182) A high coupon bond is more interest rate sensitive than a low coupon bond.
Answer: True        False
Explanation:
183) Sinking fund provisions are included in the bond indenture.
Answer:    True False
Explanation:
184) The Dominion Bond Rating Service (DBRS) primarily considers interest rate risk rather than default risk when it rates debt.
Answer: True        False
Explanation:
174)
175)
176)
177)
178)
179)
180)
181)
182)
183)
184)
42
185) Maintaining a current ratio of 1.5 or better while ensuring the loan collateral in good working order is an example of a negative covenant.
Answer: True        False
Explanation:
186) A call provision, unlike a sinking fund, allows a company to retire its debt early for a specified price.
Answer: True        False
Explanation:
187) For a bond, total return = yield-to-maturity = market’s required return.
Answer:    True False
Explanation:
188) Duration is a useful measure of interest rate risk because it incorporates a bond’s default risk.
Answer: True        False
Explanation:
189) Your firm seeks to obtain a short-term loan from a local bank. The banker quotes you a rate of 9%. This is a real rate.
Answer: True        False
Explanation:
190) The term structure of interest rates can be down-sloping.
Answer:    True False
Explanation:
191) All else the same, if interest rates fall, the percentage price change for long-term bonds will be greater than for short-term bonds.
Answer:    True False
Explanation:
192) Bond prices are inversely related to market interest rates.
Answer:    True False
Explanation:
193) The term structure of interest rates compares the components of the Fisher formula.
Answer: True        False
Explanation:
194) Bond ratings issued by DBRS specifically account for default risk.
Answer:    True False
Explanation:
185)
186)
187)
188)
189)
190)
191)
192)
193)
194)
43
195) The call premium generally starts at 10% of par and decreases to zero with the passage of 195)
time.
Answer:TrueFalse
Explanation:
196) Failure to pay either the interest payments or the bond principle as agreed can cause a 196)
firm to go into bankruptcy.
Answer:TrueFalse
Explanation:
197) The term structure of interest rates includes only the real rate of return and the inflation 197)
premium.
Answer:TrueFalse
Explanation:
198) Assume you are considering two bonds identical in every way but for coupon frequency-bond A pays interest annually, and bond B pays interest semi-annually. Then, if they have the same price, the yield-to-maturity on bond A will always be greater than that on bond B.
Answer: True        False
Explanation:
199) All else the same, if interest rates fall, coupon payments on floating rate bonds will fall.
Answer:    True False
Explanation:
198)
199)
44
Answer Key
Testname: C7
1) D
2) C
3) B
4) C
5) D
6) C
7) C
8) D
9) B
10) D
11) B
12) E
13) B
14) C
15) D
16) B
17) B
18) C
19) A
20) B
21) A
22) E
23) D
24) C
25) B
26) A
27) B
28) B
29) A
30) D
31) C
32) C
33) A
34) B
35) D
36) B
37) A
38) E
39) A
40) B
41) A
42) D
43) C
44) E
45) B
46) C
47) C
48) A
49) E
50) E
45
Answer Key
Testname: C7
51) E
52) A
53) A
54) A
55) B
56) E
57) B
58) B
59) B
60) A
61) D
62) C
63) C
64) C
65) C
66) A
67) D
68) B
69) B
70) E
71) B
72) A
73) A
74) D
75) C
76) D
77) E
78) D
79) E
80) E
81) D
82) B
83) D
84) B
85) E
86) A
87) C
88) A
89) B
90) E
91) A
92) B
93) D
94) C
95) D
96) E
97) B
98) C
99) E
100) C
46
Answer Key
Testname: C7
101) Specified date at which the principal amount of a bond is paid.
102) The rate of interest paid to bondholders based on indenture.
103) The reason longer-term bonds have greater interest rate sensitivity is that a large portion of a bond’s value comes from the $1,000 face amount. The present value of this amount isn’t greatly affected by a small change in interest rates if it is to be received in one year. If it is to be received in 30 years, however, even a small change in the interest rate can have a significant effect once it is compounded for 30 years. The present value of the face amount becomes much more volatile with a longer-term bond as a result.
104) AAA signifies the highest credit quality. The capacity for the payment of financial obligations is exceptionally high and unlikely to be adversely affected by future events.
105) The portion of a nominal interest rate that represents compensation for expected future inflation.
106)
107) Registrar of company records ownership of each bond; payment is made directly to the owner of record.
108) Bond that may be sold back to the issuer at a pre-specified price before maturity.
109) The indenture is the written agreement between the corporation (the borrower) and its creditors.
110) The relationship between nominal returns, real returns, and inflation.
111) AA signifies superior credit quality. The capacity for the payment of financial obligations is considered high. Credit quality differs from AAA only to a small degree. Unlikely to be significantly vulnerable to future events.
112) The relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money.
113) B signifies highly speculative credit quality. There is a high level of uncertainty as to the capacity to meet financial obligations.
114) The price of a bond net of accrued interest; this is the price that is typically quoted.
115) Bond factors can also be affected by the following: Bond provisions
Default risk
Expected future inflation The lack of liquidity
116) The market interest rate that equates a bond’s present value of interest payments and principal repayment with its price.
47
Answer Key
Testname: C7
117) If the coupon rate is higher than the required return on a bond, the bond will sell at a premium, since it provides periodic income in the form of coupon payments in excess of that required by investors on other similar bonds. If the coupon rate is lower than the required return on a bond, the bond will sell at a discount since it provides insufficient coupon payments compared to that required by investors on other similar bonds. For premium bonds, the coupon rate exceeds the YTM; for discount bonds, the YTM exceeds the coupon rate; and for bonds selling at par, the YTM is equal to the coupon rate.
118) The rate of return that has not been adjusted for inflation.
119) Bond prices are the result of the buying and selling of bonds by investors. As these parties interact, the bond price moves so that the seller can find a buyer and vice versa. What is needed to answer this question is a general understanding of the operation of financial markets.
120) The portion of a nominal interest rate or bond yield that represents compensation for the possibility of default.
121) Unsecured debt, usually with a maturity of 10 years or more.
122) Bond during period in which it cannot be redeemed by the issuer.
123) Rate of return that has been adjusted for inflation.
124) BB signifies speculative, non-investment-grade credit quality. The capacity for the payment of financial obligations is uncertain. Vulnerable to future events.
125) Amount by which the call price exceeds the par value of the bond.
126) Bond issued without record of the owner’s name; payment is made to whoever holds the bond.
127) Account managed by the bond trustee for early bond redemption.
128) Call provision prohibiting the company from redeeming the bond before a certain date.
129) The downward slope occurs because the expected inflation premium is declining. The decline in the inflation premium is significant enough to overcome the interest rate risk premium.
130) The stated interest payment made on a bond.
131) Limitation placed on certain transactions that can be taken during the term of the loan, usually to protect the lender’s interest.
132) At a minimum, students should identify the real rate, the inflation premium, and the interest rate risk premium. The real rate tends to remain relatively constant. The inflation premium varies over time based on inflation expectations. The interest rate risk premium varies over time based on expected changes in the interest rates. Students might also mention a liquidity premium, a taxability premium, and a default risk premium.
133) The current yield only refers to the yield of the bond at the current moment. It does not reflect the total return over the life of the bond. Current yield = annual coupon payment/price. Yield to maturity (YTM) is the interest rate required in the market on a bond, and this yield value is the discount rate used in the valuation formula for a bond. A premium bond sells above par value, and the current yield is always greater than YTM for a premium bond. A discount bond sells below par value, and the current yield is always lower than the YTM for a discount bond. For bonds selling at par, the current yield and YTM are equal.
134) Note that the question only implies the bonds have the same yields and bond ratings. There are the additional issues of liquidity, and interest rate risk. To give a complete answer to this question, the A-student will be able to repeat the discussion of determinants of bond yields in Section 7. 7.
48
Answer Key
Testname: C7
135) Call provision that compensates bond investors for interest differential, making it unattractive for an issuer to call a bond.
136) A signifies good credit quality. The capacity for the payment of financial obligations is substantial, but of lesser credit quality than AA. May be vulnerable to future events, but qualifying negative factors are considered manageable.
137) When ratings agencies rate bonds, they do so by relying on information provided by the company. Absent this information, the rating agency must rely on publicly available information, and may not have as clear a picture of the firm as it would if it received information directly from the company. Also, some firms argued that the rating agency was harsher with its ratings when the company was not compensating them for providing this service. As a result, some of the firms argued that they were essentially being blackmailed into buying a rating service in order to prevent poor ratings for their bonds. Also, for whatever reason, some firms may not wish to be rated by more than one agency and may purchase only one rating. If another rating agency steps in without being requested to do so, you could end up with crossover bonds.
138) D signifies that the issuer has filed under any applicable bankruptcy, insolvency, or winding up statute or there is a failure to satisfy an obligation after the exhaustion of grace periods, a downgrade to D may occur. DBRS may also use SD (Selective Default) in cases where only some securities are impacted, such as the case of a “distressed exchange”. A financial obligation has not been met or it is clear that a financial obligation will not be met in the near future or a debt instrument has been subject to a distressed exchange. A downgrade to D may not immediately follow insolvency or restructuring filing as grace periods or extenuating circumstances may exist.
139) The principal amount of a bond that is repaid at the end of the term.
140) CCC/CC/C may signify very highly speculative credit quality. In danger of defaulting on financial obligations. There is little difference between these three categories, although CC and C ratings are normally applied to obligations that are seen as highly likely to default, or subordinated to obligations rated in the CCC to B range. Obligations in respect of which default has not technically taken place but is considered inevitable may be rated in the C category.
141) The compensation investors demand for bearing interest rate risk.
142) Four likely components of an indenture include:
Maturity date
Sinking fund provision Protective covenants Security or collateral
143) A plot of the yields on Government of Canada notes and bonds relative to maturity.
144) The price of a bond including accrued interest, also known as the full or invoice price. This is the price the buyer actually pays.
145) Interest rate risk is the risk that arises for bond owners from fluctuating interest rates. All else the same, if interest rates are expected to fall you should purchase long-term bonds and/or low coupon bonds, and sell shorter-term, higher-coupon bonds.
146) BBB signifies adequate credit quality. The capacity for the payment of financial obligations is considered acceptable. May be vulnerable to future events.
49
Answer Key
Testname: C7
147) Bond that may be sold back to the issuer at a pre-specified price before maturity.
148) Essentially, the issuer takes the opposite side of the interest rate risk position. By issuing long-term bonds, the corporation is essentially betting that rates won’t fall significantly. If they do, the corporation will incur a loss due to borrowing at rates higher than the going market rates. On the other hand, if rates rise, the corporation benefits by having locked in its borrowing rate for up to 100 years.
149) Liquidity problems exist in thinly traded bonds, default risk is the likelihood the corporation will default on its bond obligations, and the interest rate risk premium reflects the fact that bonds with differing coupon rates and maturities are subject to differing levels of risk associated with changes in interest rates. If any of these exist, investors will demand to be compensated for the risk by demanding a yield premium to own the bonds.
150) Agreement giving the corporation the option to repurchase the bond at a specified price before maturity.
151) The market price of a bond is one side of the teeter-totter and the market rate of interest is the other side of the teeter-totter. As one side rises, the other side falls. This depicts the inverse relationship between the price and the rate. A short-term bond would be depicted as a point close to the fulcrum point of the teeter-totter. An intermediate-term bond would be depicted as a point part way between the fulcrum point and the end of one side. A long-term bond would be depicted as a point on the very end of one side of the teeter-totter. The further away from the fulcrum a point is, the greater the degree of upward and downward movement. This illustrates that long-term bonds fluctuate more in price than short-term bonds.
152) The portion of a nominal interest rate or bond yield that represents compensation for lack of liquidity.
153) The student is expected to generate three nominal rates, each based on an increasing level of inflation, beginning with a one-year nominal rate of 6.09%. The result will be an upward sloping term structure of interest rates. Adding interest rate risk to the mix will increase the yields on the 10 and 30-year bonds, increasing the slope of the term structure.
154) The bond price is the present value of the cash flows from a bond. The YTM is the interest rate used in valuing the cash flows from a bond.
155)
156) Unsecured debt, usually with a maturity under 10 years.
50
Answer Key
Testname: C7
157) Investors are comparing the nominal rates of return. The important thing to consider is the real rate of return, which considers the effects of inflation. If the real rate of return has held constant, then investors are neither better nor worse off than they were previously. If the real rate of return has increased, then investors are actually better off even though the nominal rate of return decreased significantly. Only if the real rate of return has decreased would investors be worse off. The Fisher formula should be mentioned as the method of determining the real rate of return.
158) FALSE
159) TRUE
160) FALSE
161) TRUE
162) TRUE
163) TRUE
164) TRUE
165) FALSE
166) FALSE
167) TRUE
168) FALSE
169) TRUE
170) FALSE
171) FALSE
172) FALSE
173) TRUE
174) FALSE
175) TRUE
176) TRUE
177) FALSE
178) FALSE
179) FALSE
180) TRUE
181) TRUE
182) FALSE
183) TRUE
184) FALSE
185) FALSE
186) FALSE
187) TRUE
188) FALSE
189) FALSE
190) TRUE
191) TRUE
192) TRUE
193) FALSE
194) TRUE
195) FALSE
196) TRUE
197) FALSE
198) FALSE
199) TRUE
51

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