Answer Choices:
a. True
b. False
Answer: b. False
Question: Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor’s perspective than regular bonds. a. True b. False
Answer Choices:
a. True
b. False
Answer: b. False
Question: Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength. a. True b. False
Answer Choices:
a. True
b. False
Answer: a. True
Question: If the pure expectations theory holds, which of the following statements is CORRECT?
Answer Choices:
a. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
b. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
c. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.
d. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond.
Answer: c. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If a coupon bond is selling at a premium, then the bond’s current yield is zero.
b. If a coupon bond is selling at a discount, then the bond’s expected capital gains yield is negative.
c. If a bond is selling at a discount, the yield to call is a better measure of the expected return than the yield to maturity.
d. The current yield on Bond A exceeds the current yield on Bond B. Therefore, Bond A must have a higher yield to maturity than Bond B.
e. If a coupon bond is selling at par, its current yield equals its yield to maturity.
Answer: e. True
Question: Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.
Answer Choices:
a. True
b. False
Answer: a. True
Question: The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.
Answer Choices:
True
False
Answer: a. True
Question: The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT?
Answer Choices:
a. The yield on a 2-year T-bond must exceed that on a 5-year T-bond.
b. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
c. The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond.
d. The conditions in the problem cannot all be true—they are internally inconsistent.
e. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.
Answer: b. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
Question: Which of the following statements is CORRECT?
Answer Choices:
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: a. True
Question: Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, an 8% yield to maturity, and are noncallable. Which of the following statements is CORRECT?
Answer Choices:
a. Bond A has an 8% yield to maturity, and Bond B has a 7% yield to maturity.
b. Bond A sells at a premium, while Bond B sells at a discount.
c. Bond A has a 9% coupon, and Bond B has a 7% coupon. Both bonds have the same maturity, a face value of $1,000, an 8% yield to maturity, and are noncallable.
d. Bond A sells at a discount to par, while Bond B sells at a premium to par.
e. Bond A sells at par, and Bond B sells at a premium to par.
Answer: b. True
Question: Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond. a. True b. False
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices.
b. The total yield on a bond is derived from dividends plus changes in the price of the bond.
c. Bonds are generally regarded as being riskier than common stocks, and therefore bonds have higher required returns.
d. Bonds issued by larger companies always have lower yields to maturity (due to less risk) than bonds issued by smaller companies.
e. The market price of a bond will always approach its par value as its maturity date approaches, provided the bond’s required return remains constant.
Answer: e. True
Question: There is an inverse relationship between bonds’ quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower. a. True b. False
Answer Choices:
a. True
b. False
Answer: a. True
Question: Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that
Answer Choices:
a. Inflation is expected to decline in the future.
b. The economy is not in a recession.
c. Long-term bonds are a better buy than short-term bonds.
d. Maturity risk premiums could help to explain the yield curve’s upward slope.
e. Long-term interest rates are more volatile than short-term rates.
Answer: d. Maturity risk premiums could help to explain the yield curve’s upward slope.
Question: The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.
Answer Choices:
a. True
b. False
Answer: b. False
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 rates fall after its issue, a zero coupon bond could trade at a price above its maturity (or par) value.
c. If rates fall rapidly, a zero coupon bond’s expected appreciation could become negative.
d. If a firm moves from a position of strength toward financial distress, its bonds’ yield to maturity would probably decline.
e. If a bond is selling at a premium, this implies that its yield to maturity exceeds its coupon rate.
Answer: a. True
Question: Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
Answer Choices:
a. Bond 8’s current yield will increase each year.
b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
c. Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
d. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year.
e. Over the next year, Bond 8’s price is expected to decrease, Bond 10’s price is expected to stay the same, and Bond 12’s price is expected to increase.
Answer: d. True
Question: Managers should under no conditions take actions that increase their firm’s risk relative to the market, regardless of how much those actions would increase the firm’s expected rate of return.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.
b. If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.
c. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.
d. If the maturity risk premium (MRP) equals zero, the yield curve must be flat.
e. The yield curve can never be downward sloping.
Answer: a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.