Question: You are considering 2 bonds that will be issued tomorrow. Both are rated triple B (BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10% coupon, neither can be called except for sinking fund purposes, and both are offered to you at their $1,000 par values. However, Bond SF has a sinking fund while Bond NSF does not. Under the sinking fund, the company must call and pay off 5% of the bonds at par each year. The yield curve at the time is upward sloping. The bond’s prices, being equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would generally be expected to have a higher yield than Bond NSF.
Answer Options:
a. True
b. False
Answer: b. False
Question: Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts price risk to companies, it offers no advantages to corporate issuers.
Answer Options:
a. True
b. False
Answer: b. False
Question: A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%.
Answer Options:
a. True
b. False
Answer: a. True
Question: You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.
Answer Options:
a. True
b. False
Answer: a. True
Question: If the required rate of return on a bond (rd) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)
Answer Options:
a. True
b. False
Answer: a. True
Question: The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant.
Answer Options:
a. True
b. False
Answer: a. True
Question: Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.
Answer Options:
a. True
b. False
Answer: a. True
Question: Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds.
Answer Options:
a. True
b. False
Answer: a. True
Question: A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond.
Answer Options:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
a. You hold two bonds, a 10-year, zero coupon, and a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from its current level, the zero coupon bond will experience the larger percentage decline.
b. The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates.
c. You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline.
d. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates.
e. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates.
Answer Options:
a. True
b. False
c. False
d. False
e. False
Answer: a. True
Question: Which of the following events would make it more likely that a company would call its outstanding callable bonds?
a. The company’s bonds are downgraded.
b. Market interest rates rise sharply.
Answer Options:
a. True
b. False
Answer: b. False
Question: Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows:
T-bond = 7.72%
AAA = 8.72%
BBB = 10.18%
The differences in rates among these issues were most probably caused primarily by:
a. Real risk-free rate differences.
b. Tax effects.
c. Default and liquidity risk differences.
d. Maturity risk differences.
e. Inflation differences.
Answer Options:
a. False
b. False
c. True
d. False
e. False
Answer: c. True
Question: Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?
a. Adding additional restrictive covenants that limit management’s actions.
b. Adding a call provision.
c. The rating agencies change the bond’s rating from Baa to Aaa.
d. Making the bond a first mortgage bond rather than a debenture.
e. Adding a sinking fund.
Answer Options:
a. False
b. True
c. False
d. False
e. False
Answer: b. True
Question: Which of the following statements is CORRECT?
a. Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued.
b. Most sinking funds require the issuer to provide funds to a trustee, who holds the money so that it will be available to pay off bondholders when the bonds mature.
c. A sinking fund provision makes a bond more risky to investors at the time of issuance.
d. Sinking fund provisions never require companies to retire their debt; they only establish “targets” for the company to reduce its debt over time.
e. If interest rates increase after a company has issued bonds with a sinking fund, the company will be less likely to buy bonds on the open market to meet its sinking fund obligation and more likely to call them in at the sinking fund call price.
Answer Options:
a. True
b. False
c. False
d. False
e. False
Answer: a. True