Answer Choices:
a. True
b. False
Answer: b. False
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: Which of the following statements is CORRECT?
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 Choices:
a. False
b. False
c. False
d. False
e. True
Answer: e. 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: Which of the following statements is CORRECT?
a. If a bond is selling at a discount, the yield to call is a better measure of return than is the yield to maturity.
b. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.
c. On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest.
Answer Choices:
a. True
b. False
c. False
Answer: a. 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:
a. True
b. False
Answer: a. 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.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
A. Assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. The premium bond must have a lower current yield and a higher capital gains yield than the par bond.
B. A bond’s current yield must always be either equal to its yield to maturity or between its yield to maturity and its coupon rate.
C. If a bond sells at par, then its current yield will be less than its yield to maturity.
D. If a bond sells for less than par, then its yield to maturity is less than its coupon rate.
Answer: A. Assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. The premium bond must have a lower current yield and a higher capital gains yield than the par bond.
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.
Answer Choices:
a. True
b. False
Answer: b. False
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?
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 Choices:
a. False
b. False
c. False
d. True
e. False
Answer: d. True
Question: Which of the following statements is CORRECT?
a. A zero coupon bond’s current yield is equal to its yield to maturity.
b. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par.
c. All else equal, if a bond’s yield to maturity increases, its price will fall.
d. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.
e. All else equal, if a bond’s yield to maturity increases, its current yield will fall.
Answer Choices:
a. False
b. False
c. True
d. False
e. False
Answer: c. True
Question: Which of the following statements is CORRECT?
a. If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate decrease 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 Choices:
a. False
b. False
c. False
d. False
e. True
Answer: e. True
Question: Which of the following statements is CORRECT?
Answer Choices:
A. Once a 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 being 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. 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.
Question: Which of the following statements is CORRECT?
a. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
b. Liquidity premiums are generally higher on Treasury than corporate bonds.
c. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
d. Default risk premiums are generally lower on corporate than on Treasury bonds.
e. Reinvestment risk is lower, other things held constant, on long-term than on short-term bonds.
Answer Choices:
a. False
b. False
c. False
d. False
e. True
Answer: e. True
Question: As a general rule, a company’s debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.
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. The price of a discount bond will increase over time, assuming that the bond’s yield to maturity remains constant.
Question: Which of the following statements is CORRECT?
Answer Choices:
A. A bond is likely to be called if its coupon rate is below its YTM.
B. A bond is likely to be called if its market price is below its par value.
C. Even if a bond’s YTC exceeds its YTM, an investor with an investment horizon longer than the bond’s maturity would be worse off if the bond were called.
D. A bond is likely to be called if its market price is equal to its par value.
E. A bond is likely to be called if it sells at a discount below par.
Answer: C. Even if a bond’s YTC exceeds its YTM, an investor with an investment horizon longer than the bond’s maturity would be worse off if the bond were called.
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: Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.
Answer Choices:
a. True
b. False
Answer: a. True
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.
Answer Choices:
a. True
b. False
Answer: a. True
Question: You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?
a. The price of Bond B will decrease over time, but the price of Bond A will increase over time.
b. The prices of both bonds will remain unchanged.
c. The price of Bond A will decrease over time, but the price of Bond B will increase over time.
d. The prices of both bonds will increase by 7% per year.
e. The prices of both bonds will increase over time, but the price of Bond A will increase at a faster rate.
Answer Choices:
a. False
b. False
c. True
d. False
e. False
Answer: c. True
Question: A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?
a. The bond’s current yield is less than 8%.
b. If the yield to maturity remains at 8%, then the bond’s price will decline over the next year.
c. The bond’s coupon rate is less than 8%.
d. If the yield to maturity increases, then the bond’s price will increase.
e. If the yield to maturity remains at 8%, then the bond’s price will remain constant over the next year.
Answer Choices:
a. False
b. True
c. False
d. False
e. False
Answer: b. True