Answer Options:
a. True
b. False
Answer: a
Question: Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Options:
a. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond.
b. The real risk-free rate is higher for corporate than for Treasury bonds.
c. Most evidence suggests that the maturity risk premium is zero.
d. Liquidity premiums are higher for Treasury than for corporate bonds.
e. The pure expectations theory states that the maturity risk premium for Treasury bonds should be zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.
Answer: e
Question: Which of the following statements is CORRECT?
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: c
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 Options:
a. True
b. False
Answer: b
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 Options:
a. True
b. False
Answer: a
Question: Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)
Answer Options:
a. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
b. The effect of a change in the market risk premium depends on the slope of the yield curve.
c. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
d. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
e. The effect of a change in the market risk premium depends on the level of the risk-free rate.
Answer: d
Question: Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?
Answer Options:
a. In equilibrium, long-term rates must be equal to short-term rates.
b. An upward-sloping yield curve implies that future short-term rates are expected to decline.
c. The maturity risk premium is assumed to be zero.
d. Inflation is expected to be zero.
e. Consumer prices as measured by an index of inflation are expected to rise at a constant rate.
Answer: c
Question: If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?
Answer Options:
a. An upward-sloping Treasury yield curve means that the market expects interest rates to decline in the future.
b. A 5-year T-bond would always yield less than a 10-year T-bond.
c. The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat.
d. The yield curve for stocks must be above that for bonds, but both yield curves must have the same slope.
e. If the maturity risk premium is zero for Treasury bonds, then it must be negative for corporate bonds.
Answer: c
Question: In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t – 1)%, where t is the number of years until the bond matures. Given this information, which of the following statements is CORRECT?
a. The yield on 2-year Treasury securities must exceed the yield on 5-year Treasury securities.
b. The yield on 5-year Treasury securities must exceed the yield on 10-year Treasury securities.
c. The yield on 10-year Treasury securities must exceed the yield on 5-year Treasury securities.
d. The yield on 5-year Treasury securities must be less than the sum of the real risk-free rate plus the maturity risk premium.
e. The yield on 10-year Treasury securities must be less than the sum of the real risk-free rate plus the maturity risk premium.
Answer: c
Question: The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond’s remaining maturity.
Answer Options:
a. True
b. False
Answer: a
Question: The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called “interest rate risk,” or “price risk.”
True
False
Answer: True
Question: If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill.
True
False
Answer: False
Question: An upward-sloping yield curve is often called a “normal” yield curve, while a downward-sloping yield curve is called “abnormal.”
True
False
Answer: 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: c
Question: Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT?
Answer Options:
a. If the yield curve for Treasury securities is flat, Short’s bond must under all conditions have the same yield as Long’s bonds.
b. If the yield curve for Treasury securities is upward sloping, Long’s bonds must under all conditions have a higher yield than Short’s bonds.
c. If Long’s and Short’s bonds have the same default risk, their yields must under all conditions be equal.
Answer: b
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. A life 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: e
Question: Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.
a. True
b. False
Answer: a
Question: If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?
Answer Options:
a. An upward-sloping yield curve would imply that interest rates are expected to be lower in the future.
b. If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now.
c. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond.
d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
e. Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds.
Answer: d
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.
a. True
b. False
Answer: False
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?
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
Question: Which of the following statements is CORRECT?
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