a. 10-year, zero coupon bonds have more reinvestment risk than 10-year, 10% coupon bonds.
b. A 10-year, 10% coupon bond has less reinvestment risk than a 10-year, 5% coupon bond (assuming all else equal).
c. The total (rate of) return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year, divided by the bond’s price at the beginning of the year.
d. The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10% bond.
e. A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%.
Answer Choices:
a. False
b. False
c. True
d. False
e. False
Answer: c. True
Question: A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation.
Answer Choices:
a. True
b. False
Answer: a. 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 Choices:
a. False
b. True
c. False
d. False
e. False
Answer: b. True
Question: Which of the following statements is CORRECT?
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 Choices:
a. True
b. False
c. False
d. False
e. False
Answer: a. True
Question: If a firm raises capital by selling new bonds, it could be called the “issuing firm,” and the coupon rate is generally set equal to the required rate on bonds of equal risk.
Answer Choices:
a. True
b. False
Answer: b. False
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:
a. True
b. False
Answer: a. True
Question: Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?
a. 10-year, zero coupon bond.
b. 20-year, 10% coupon bond.
c. 20-year, 5% coupon bond.
d. 1-year, 10% coupon bond.
Answer Choices:
a. False
b. False
c. False
d. False
e. True
Answer: e. True
Question: Which of the following statements is CORRECT?
a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.
b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.
c. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.
d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.
e. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.
Answer Choices:
a. True
b. False
c. True
d. False
e. False
Answer: a. True
Question: Which of the following statements is CORRECT?
a. If a bond is selling at a discount to par, its current yield will be greater than its yield to maturity.
b. All else equal, bonds with longer maturities have less price risk than bonds with shorter maturities.
c. If a bond is selling at its par value, its current yield equals its capital gains yield.
d. If a bond is selling at a premium, its current yield will be less than its capital gains yield.
e. All else equal, bonds with larger coupons have less price risk than bonds with smaller coupons.
Answer Choices:
a. False
b. False
c. False
d. False
e. True
Answer: e. True
Question: Which of the following statements is CORRECT?
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 Choices:
a. False
b. False
c. False
d. False
e. True
Answer: e. True
Question: Which of the following bonds has the greatest price risk?
a. A 10-year $100 annuity.
b. A 10-year, $1,000 face value, zero coupon bond.
c. A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
d. All 10-year bonds have the same price risk since they have the same maturity.
e. A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.
Answer Choices:
a. False
b. True
c. False
d. False
e. False
Answer: b. True
Question: A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?
a. The prices of both bonds will decrease by the same amount.
b. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.
c. Both bonds would decline in price, but the 8-year bond would have the greater percentage decline in price.
d. A market yield increase is the same as a yield to maturity increase.
e. The prices of both bonds would increase by the same amount.
Answer Choices:
a. False
b. True
c. False
d. False
e. False
Answer: b. True
Question: Which of the following statements is CORRECT?
a. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value.
b. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.
c. Other things held constant, including the coupon rate, a corporation would rather issue noncallable bonds than callable bonds.
d. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond because it would have a shorter expected life.
e. Bonds are exposed to both reinvestment risk and price risk. Longer-term low-coupon bonds, relative to shorter-term high-coupon bonds, are generally more exposed to reinvestment risk than price risk.
Answer Choices:
a. True
b. True
c. True
d. False
e. False
Answer: b. 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 Choices:
a. True
b. False
Answer: b. False