Answer Choices:
a. The coupon rate should be exactly equal to 6%.
b. The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%.
c. The rate should be slightly greater than 6%.
d. The rate should be over 7%.
e. The rate should be over 8%.
Answer: b. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The yield curve for both Treasury and corporate bonds should be flat.
b. The yield curve for Treasury securities would be flat, but the yield curve for corporate securities might be downward sloping.
c. The yield curve for Treasury securities cannot be downward sloping.
d. The maturity risk premium would be zero.
e. If 2-year bonds yield more than 1-year bonds, an investor with a 2-year time horizon would almost certainly end up with more money if he or she bought 2-year bonds.
Answer: e. If 2-year bonds yield more than 1-year bonds, an investor with a 2-year time horizon would almost certainly end up with more money if he or she bought 2-year bonds.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold.
b. Long-term bonds have less price risk but more reinvestment risk than short-term bonds.
c. If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less price risk.
Answer: a. True
Question: The real risk-free rate of interest is expected to remain constant at 3% for the foreseeable future. However, inflation is expected to increase steadily over the next 30 years, so the Treasury yield curve has an upward slope. Assume that the pure expectations theory holds. You are also considering two corporate bonds, one with a 5-year maturity and one with a 10-year maturity. Both have the same default and liquidity risks. Given these assumptions, which of the statements is CORRECT?
Answer Choices:
a. Since the pure expectations theory holds, the 10-year corporate bond must have the same yield as the 5-year corporate bond.
b. Since the pure expectations theory holds, all 5-year Treasury bonds must have higher yields than all 10-year Treasury bonds.
c. Since the pure expectations theory holds, all 10-year corporate bonds must have the same yield as 10-year Treasury bonds.
d. The 10-year Treasury bond must have a higher yield than the 5-year corporate bond.
e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.
Answer: e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If a coupon bond is selling at par, its current yield equals its yield to maturity.
b. If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.
c. If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.
d. If a bond’s yield to maturity exceeds its annual coupon, then the bond will trade at a premium.
e. If a coupon bond is selling at a premium, its current yield equals its yield to maturity.
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 Choices:
a. True
b. False
Answer: a. True
Question: Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. All else equal, senior debt generally has a lower yield to maturity than subordinated debt.
b. An indenture is a bond that is less risky than a mortgage bond.
c. The expected return on a corporate bond will generally exceed the bond’s yield to maturity.
d. If a bond’s coupon rate exceeds its yield to maturity, then its expected return to investors will also exceed its yield to maturity.
e. Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated.
Answer: a. True
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 Choices:
a. True
b. False
Answer: b. False
Question: A call provision gives bondholders the right to demand, or “call for,” repayment of a bond. Typically, companies call bonds if interest rates rise and do not call them if interest rates decline.
Answer Choices:
True
False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the use of debt until the bonds mature.
b. Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.
c. Once a firm declares bankruptcy, it must be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and legal fees.
d. Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than “regular” bonds.
e. A firm with a sinking fund that gives it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.
Answer: d. True
Question: The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present.
Answer Choices:
True
False
Answer: a. True
Question: Is 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 Choices:
a. True
b. False
Answer: b. False
Question: A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?
Answer Choices:
a. The bond sells at a price below par.
b. The bond has a current yield greater than 8%.
c. The bond sells at a discount.
d. The bond’s required rate of return is less than 7.5%.
e. If the yield to maturity remains constant, the price of the bond will decline over time.
Answer: e. True
Question: The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.
Answer Choices:
a. True
b. False
Answer: b. False
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 Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The total return on a bond during a given year is based only on the coupon interest payments received.
b. All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required return for bonds of similar risk is 8%.
c. The price of a discount bond will increase over time, assuming that the bond’s yield to maturity remains constant.
Answer: c. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. All else equal, secured debt is more risky than unsecured debt.
b. The expected return on a corporate bond must be greater than its promised return if the probability of default is greater than zero.
c. All else equal, senior debt has more default risk than subordinated debt.
d. A company’s bond rating is affected by its financial ratios but not by provisions in its indenture.
e. Under Chapter 7 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off claims against it according to the priority of the claims as spelled out in the Act.
Answer: e. True
Question: Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?
Answer Choices:
a. An 8-year bond with a 9% coupon.
b. A 1-year bond with a 15% coupon.
c. A 3-year bond with a 10% coupon.
d. A 10-year zero coupon bond.
e. A 10-year bond with a 10% coupon.
Answer: d. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The yield on a 3-year Treasury bond cannot exceed the yield on a 2-year Treasury bond.
b. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
c. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
d. The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5-year AAA-rated corporate bond.
e. The following represents a “possibly reasonable” formula for the maturity risk premium on bonds: MRP = –0.1%(t), where t is the years to maturity.
Answer: b. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Downward-sloping yield curves are inconsistent with the expectations theory.
b. The actual shape of the yield curve depends only on expectations about future inflation.
c. If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.
d. If the yield curve is upward sloping, the maturity risk premium must be positive and the inflation rate must be zero.
e. Yield curves must be either upward or downward sloping—they cannot first rise and then decline.
Answer: c. If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.
Question: A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?
Answer Choices:
a. If market interest rates decline, the price of the bond will also decline.
b. The bond is currently selling at a price below its par value.
c. If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today.
d. The bond should currently be selling at its par value.
e. If market interest rates remain unchanged, the bond’s price one year from now will be higher than it is today.
Answer: c. True
Question: Assuming the pure expectations theory is correct, which of the following statements is CORRECT?
Answer Choices:
a. If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.
b. If both 2-year and 3-year Treasury rates are 7%, then 5-year rates must also be 7%.
c. If 1-year rates are 6% and 2-year rates are 7%, then the market expects 1-year rates to be 6.5% in one year.
d. Reinvestment rate risk is higher on long-term bonds, and interest rate (price) risk is higher on short-term bonds.
e. Interest rate (price) risk and reinvestment rate risk are relevant to investors in corporate bonds, but these concepts do not apply to Treasury bonds.
Answer: a. If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.
Question: Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond’s face value.
Answer Choices:
True
False
Answer: a. True
Question: A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT?
Answer Choices:
a. The bond’s expected capital gains yield is zero.
b. The bond’s yield to maturity is above 9%.
c. The bond’s current yield is above 9%.
d. If the bond’s yield to maturity declines, the bond will sell at a discount.
e. The bond’s current yield is less than its expected capital gains yield.
Answer: a. True