CHAPTER 7
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CHAPTER 7

Course: MBA 816, Spring 2009

School: Fort Hays

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CHAPTER 7 Interest Rates and Bond Valuation I. DEFINITIONS COUPON a 1. The stated interest payment, in dollars, made on a bond each period is called the bonds: coupon. face value. maturity. yield to maturity. coupon rate. a. b. c. d. e. FACE VALUE b 2. The principal amount of a bond that is repaid at the end of the loan term is called the bonds: coupon. face value. maturity. yield to maturity. coupon rate....

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7 Interest CHAPTER Rates and Bond Valuation I. DEFINITIONS COUPON a 1. The stated interest payment, in dollars, made on a bond each period is called the bonds: coupon. face value. maturity. yield to maturity. coupon rate. a. b. c. d. e. FACE VALUE b 2. The principal amount of a bond that is repaid at the end of the loan term is called the bonds: coupon. face value. maturity. yield to maturity. coupon rate. a. b. c. d. e. MATURITY c 3. The specified date on which the principal amount of a bond is repaid is called the bonds: coupon. face value. maturity. yield to maturity. coupon rate. a. b. c. d. e. YIELD TO MATURITY d 4. a. b. c. d. e. The rate of return required by investors in the market for owning a bond is called the: coupon. face value. maturity. yield to maturity. coupon rate. COUPON RATE e 5. a. b. c. d. e. The annual coupon of a bond divided by its face value is called the bonds: coupon. face value. maturity. yield to maturity. coupon rate. PAR BONDS a 6. A bond with a face value of $1,000 that sells for $1,000 in the market is called a _____ bond. par value discount premium zero coupon floating rate a. b. c. d. e. DISCOUNT BONDS b 7. A bond with a face value of $1,000 that sells for less than $1,000 in the market is called a _____ bond. par discount premium zero coupon floating rate a. b. c. d. e. PREMIUM BONDS c 8. A bond with a face value of $1,000 that sells for more than $1,000 in the market is called a _____ bond. par a. b. c. d. e. discount premium zero coupon floating rate UNFUNDED DEBT d 9. a. b. c. d. e. The unfunded debt of a firm is generally understood to mean the firms: preferred stock. debts that mature in more than one year. debentures. debts that mature in less than one year. secured debt. INDENTURE a 10. The written, legally binding agreement between the corporate borrower and the lender detailing the terms of a bond issue is called the: a. b. c. d. e. indenture. covenant. terms of trade. form 5140. call provision. REGISTERED BONDS b 11. The form of bond issue in which the registrar of the company records ownership of each bond, with relevant payments made directly to the owner of record, is called the _____ form. a. b. c. d. e. new-issue registered bearer debenture collateral BEARER BONDS c 12. The form of bond issue in which the bond is issued without record of the owners name, with relevant payments made directly to whoever physically holds the bond, is called the _____ form. a. b. c. d. e. new-issue registered bearer debenture collateral DEBENTURES e 13. The unsecured debts of a firm with maturities greater than 10 years are most literally called: a. b. c. unfunded liabilities. sinking funds. bonds. d. e. notes. debentures. NOTES d 14. The unsecured debts of a firm with maturities less than 10 years are most literally called: a. b. c. d. e. unfunded liabilities. sinking funds. bonds. notes. debentures. SENIORITY e 15. In the event of default, _____ debt holders must give preference to more _____ debt holders in the priority of repayment distributions. a. b. c. d. e. short-term; long-term long-term; short-term senior; junior senior; subordinated subordinated; senior SINKING FUND a 16. An account managed by the bond trustee for early bond redemption payments is called a: a. b. c. d. e. sinking fund. collateral payment account. deed in trust account. call provision. par value fund. CALL PROVISION b 17. An agreement giving the bond issuer the option to repurchase the bond at a specified price prior to maturity is the _____ provision. a. b. c. d. e. sinking fund call seniority collateral trustee CALL PREMIUM c 18. The amount by which the call price exceeds the bonds par value is the: a. b. c. d. e. coupon rate. redemption value. call premium. original-issue discount. call rate. DEFERRED CALL PROVISION d 19. A deferred call provision refers to the: a. b. c. d. e. open market price of a callable bond on a certain date. seniority of callable bonds to noncallable bonds in the event of corporate default. prohibition of a company from ever redeeming callable bonds. prohibition of a company from redeeming callable bonds prior to a certain date. amount by which the call price for a callable bond exceeds its par value. PROTECTIVE COVENANT e 20. Parts of the indenture limiting certain actions that might be taken during the term of the loan to protect the interests of the lender are called: a. b. c. d. e. trustee relationships. sinking funds provisions. bond ratings. deferred call provisions. protective covenants. TREASURY BONDS a 21. The long-term bonds issued by the United States government are called _____ bonds. a. b. c. Treasury municipal floating-rate d. e. junk zero coupon MUNICIPAL BONDS b 22. The long-term bonds issued by state and local governments in the United States are called _____ bonds. a. b. c. d. e. Treasury municipal floating-rate junk zero coupon ZERO COUPON BONDS e 23. A bond that makes no coupon payments and is initially priced at a deep discount is called a _____ bond. a. b. c. d. e. Treasury municipal floating-rate junk zero coupon FLOATING-RATE BONDS c 24. A bond that pays a variable amount of coupon interest over time is called a _____ bond. a. Treasury b. c. d. e. municipal floating-rate junk zero coupon CONVERTIBLE BONDS d 25. A bond which, at the election of the holder, can be swapped for a fixed number of shares of common stock at any time prior to the bonds maturity is called a _____ bond. a. b. c. d. e. zero coupon callable putable convertible warrant PRICE TRANSPARENCY a 26. A financial market is _____ if it is possible to easily observe its prices and trading volume. a. b. c. d. e. transparent open ordered in equilibrium chaotic CURRENT YIELD b 27. The annual coupon payment of a bond divided by its market price is called the: a. b. c. d. e. coupon rate. current yield. yield to maturity. bid-ask spread. capital gains yield. BID PRICES c 28. The price a dealer is willing to pay for a security held by an investor is called the: a. b. c. d. e. equilibrium price. ask price. bid price. bid-ask spread. auction price. ASK PRICES d 29. The price a dealer is willing to accept for selling a security to an investor is called the: a. b. c. d. equilibrium price. auction price. bid price. ask price. e. bid-ask spread. NOMINAL RATES e 30. Interest rates or rates of return on investments that have not been adjusted for the effects of inflation are called _____ rates. a. b. c. d. e. coupon stripped effective real nominal REAL RATES a 31. Interest rates or rates of return on investments that have been adjusted for the effects of inflation are called _____ rates. a. b. c. d. e. real nominal effective stripped coupon FISHER EFFECT b 32. The relationship between nominal rates, real rates, and inflation is known as the: a. Miller and Modigliani theorem. b. c. d. e. Fisher effect. Gordon growth model. term structure of interest rates. interest rate risk premium. TERM STRUCTURE OF INTEREST RATES c 33. The relationship between nominal interest rates on default-free, pure discount securities and the time to maturity is called the: a. b. c. d. e. liquidity effect. Fisher effect. term structure of interest rates. inflation premium. interest rate risk premium. INFLATION PREMIUM d 34. The _____ premium is that portion of a nominal interest rate or bond yield that represents compensation for expected future overall price appreciation. a. b. c. d. e. default risk taxability liquidity inflation interest rate risk DEFAULT RISK PREMIUM a 35. The _____ premium is that portion of a nominal interest rate or bond yield that represents compensation for the possibility of nonpayment by the bond issuer. a. b. c. d. e. default risk taxability liquidity inflation interest rate risk II. CONCEPTS BOND FEATURES d 36. A bond with a 7 percent coupon that pays interest semi-annually and is priced at par will have a market price of _____ and interest payments in the amount of _____ each. a. b. c. d. e. $1,007; $70 $1,070; $35 $1,070; $70 $1,000; $35 $1,000; $70 BOND PRICES AND YIELDS e 37. All else constant, a bond will sell at _____ when the yield to maturity is _____ the coupon rate. a. a premium; higher than b. c. d. e. a premium; equal to at par; higher than at par; less than a discount; higher than BOND PRICES AND YIELDS d 38. All else constant, a coupon bond that is selling at a premium, must have: a. b. c. d. e. a coupon rate that is equal to the yield to maturity. a market price that is less than par value. semi-annual interest payments. a yield to maturity that is less than the coupon rate. a coupon rate that is less than the yield to maturity. BOND PRICES c 39. The market price of a bond is equal to the present value of the: a. b. c. d. e. face value minus the present value of the annuity payments. annuity payments plus the future value of the face amount. face value plus the present value of the annuity payments. face value plus the future value of the annuity payments. annuity payments minus the face value of the bond. BOND PRICES a 40. As the yield to maturity increases, the: a. b. c. d. e. amount the investor is willing to pay to buy a bond decreases. longer the time to maturity. lower the coupon rate desired by that investor. higher the price the investor offers to buy a bond. lower the rate of return desired by the investor. SEMIANNNUAL BONDS e 41. American Fortunes is preparing a bond offering with an 8 percent coupon rate. The bonds will be repaid in 10 years. The company plans to issue the bonds at par value and pay interest semiannually. Given this, which of the following statements are correct? I. The initial selling price of each bond will be $1,000. II. After the bonds have been outstanding for 1 year, you should use 9 as the number of compounding periods when calculating the market value of the bond. III. Each interest payment per bond will be $40. IV. The yield to maturity when the bonds are first issued is 8 percent. a. b. c. d. e. I and II only II and III only II, III, and IV only I, II, and III only I, III, and IV only SEMIANNUAL BONDS AND EFFECTIVE ANNUAL RATE d 42. The newly issued bonds of the Wynslow Corp. offer a 6 percent coupon with semiannual interest payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be: a. b. c. d. e. equal to 3 percent. greater than 3 percent but less than 4 percent. equal to 6 percent. greater than 6 percent but less than 7 percent. equal to 12 percent. INTEREST RATE RISK d 43. Which one of the following statements is correct concerning interest rate risk as it relates to bonds, all else equal? a. b. c. d. The shorter the time to maturity, the greater the interest rate risk. The higher the coupon rate, the greater the interest rate risk. For a bond selling at par value, there is no interest rate risk. The greater the number of semiannual interest payments, the greater the interest rate risk. The lower the amount of each interest payment, the lower the interest rate risk. e. INTEREST RATE RISK e 44. Which one of the following bonds has the greatest interest rate risk? a. b. c. d. 5-year; 9 percent coupon 5-year; 7 percent coupon 7-year; 7 percent coupon 9-year; 9 percent coupon e. 9-year; 7 percent coupon INTEREST RATE RISK b 45. Interest rate risk _____ as the time to maturity increases. a. b. c. d. e. increases at an increasing rate increases at a decreasing rate increases at a constant rate decreases at an increasing rate decreases at a decreasing rate INTEREST RATE RISK c 46. You own a bond that has a 7 percent coupon and matures in 12 years. You purchased this bond at par value when it was originally issued. If the current market rate for this type and quality of bond is 7.5 percent, then you would expect: a. b. c. d. e. the bond issuer to increase the amount of each interest payment on these bonds. the yield to maturity to remain constant due to the fixed coupon rate. to realize a capital loss if you sold the bond at the market price today. todays market price to exceed the face value of the bond. the current yield today to be less than 7 percent. INTEREST RATE RISK c 47. You expect interest rates to decline and wish to capitalize on the anticipated changes in bond prices. To realize your maximum gain, all else constant, you should purchase _____ bonds. a. b. c. d. e. short-term; low coupon short-term; high coupon long-term; zero coupon long-term; low coupon long-term; high coupon YIELD TO MATURITY AND CURRENT YIELD e 48. All else constant, as the market price of a bond increases the current yield _____ and the yield to maturity _____ a. b. c. d. e. increases; increases. increases; decreases. remains constant; increases. decreases; increases. decreases; decreases. BOND FEATURES d 49. Which of the following statements concerning bond features is (are) correct? I. Bondholders generally have voting power in a corporation. II. Bond interest is tax-deductible as a business expense. III. The repayment of the bond principle is tax-deductible. IV. Failure to pay either the interest payments or the bond principle as agreed can cause a firm to go into bankruptcy. a. b. c. d. e. II only I and II only III and IV only II and IV only II, III, and IV only BOND INDENTURE d 50. Which of the following items are generally included in a bond indenture? I. call provisions II. security description III. current yield IV. protective covenants a. b. c. d. e. I and II only II and IV only II, III, and IV only I, II, and IV only I, II, III, and IV BOND CLASSIFICATIONS e 51. Which one of the following statements is correct concerning bond classifications? a. A debenture is a long-term bond secured by the fixed assets of a firm. b. c. d. A mortgage security is a bond issued solely by a home builder. A note is a bond which has an original maturity date longer than 10 years. A subordinated bond receives preferential treatment over all other bonds in a bankruptcy. e. A callable bond can be repurchased by the issuer prior to the initial maturity date. CALLABLE BONDS b 52. Callable bonds generally: a. b. c. d. e. allow the bondholder to decide when the bond is to be called. are associated with sinking funds. permit the issuer to repurchase the bonds at a discount. are called within the first couple of years after issuance. are required to have a deferred call provision if they have a make-whole call provision. PROTECTIVE COVENANTS c 53. Which of the following is a (are) positive covenant(s) that might be found in a bond indenture? I. The company shall maintain a current ratio of 1.5 or better. The company must limit the amount of dividends it pays according to the stated II. formula. III. The company cannot lease any major assets without approval by the lender. IV. The company must maintain the loan collateral in good working order. a. I only b. c. d. e. I and II only I and IV only II and IV only I, II, and IV only PROTECTIVE COVENANTS e 54. Protective covenants: a. are primarily designed to protect the issuing corporation from unreasonable demands of bondholders. b. c. d. e. are consistent for all bonds issued by a corporation within the United States. are limited to stating actions which a firm must take. only apply to bonds that have a deferred call provision. are primarily designed to protect bondholders from future actions of the bond issuer. BOND RATINGS b 55. Which one of the following statements concerning bond ratings is correct? a. b. c. Standard and Poors and Value Line are the primary bond rating agencies. Bond ratings are solely an assessment of the creditworthiness of the bond issuer. Investment grade bonds include only those bonds receiving one of the highest three bond ratings. d. e. Bond ratings evaluate the expected price volatility of a bond issue. All bonds receive the same rating classification from all rating agencies. BOND RATINGS d 56. A fallen angel is a bond that: a. b. c. lowered its annual interest payment. has moved from being a long-term obligation to being a short-term obligation. has moved from having a yield to maturity in excess of the coupon rate to having a yield to maturity that is less than the coupon rate. d. e. has moved from being an investment-grade bond to being a junk bond. is rated as Ba by one rating agency and rated as BB by another rating agency. TREASURY BONDS a 57. Bonds issued by the U.S. government: I. are considered to be free of default risk. II. are considered to be free of interest rate risk. III. provide totally tax-free income. IV. pay interest that is exempt from federal income taxes. a. b. c. d. e. I only I and III only I and IV only II and III only II and IV only TREASURY BONDS d 58. Treasury bonds are: a. b. c. d. e. those bonds issued by any governmental agency in the U.S. issued only on the first day of each fiscal year by the U.S. Department of Treasury. preferred by high-income individuals because they offer the best tax benefits. generally issued as coupon bonds. totally risk-free. MUNICIPAL BONDS a 59. Municipal bonds: a. b. c. d. e. offer income tax advantages to individuals. generally pay a higher rate of return than corporate bonds. are those bonds issued only by local municipalities, such as a city or a borough. are rarely callable. pay interest that is always exempt from both federal and state income taxes. TAXABLE VERSUS MUNICIPAL BONDS d 60. The break-even tax rate between a taxable corporate bond yielding 7 percent and a comparable nontaxable municipal bond yielding 5 percent can be expressed as: a. b. c. d. .07 (1 - t*) = .05. .05 (1 - t*) = .07. .07 + (1 - t*) = .05. .07 (1 - t*) = .05. e. .05 (1 - t*) = .07. ZERO COUPON BONDS e 61. A zero coupon bond: a. b. is sold at a large premium. has a price equal to the future value of the face amount given a specified rate of return. c. d. e. can only be issued by the U.S. Treasury. has less interest rate risk than a comparable coupon bond. has implicit interest which is calculated by amortizing the loan. ZERO COUPON BONDS b 62. The total interest paid on a zero-coupon bond is equal to: a. b. c. d. e. zero. the face value minus the issue price. the face value minus the market price on the maturity date. $1,000 minus the face value. $1,000 minus the par value. FLOATING-RATE BONDS d 63. The collar of a floating-rate bond refers to the minimum and maximum: a. b. call periods. maturity dates. c. d. e. market prices. coupon rates. yields to maturity. FLOATING-RATE BONDS d 64. Which of the following are common characteristics of floating-rate bonds? I. adjustable coupon rates II. adjustable maturity dates III. put provision IV. coupon cap a. b. c. d. e. I and II only II and III only I, II, and IV only I, III, and IV only I, II, III, and IV FLOATING RATE BONDS c 65. A corporation is more prone to issue floating-rate bonds when they expect future interest rates to _____ over the life of the bond. a. b. c. remain constant increase briefly and then decline slightly continually decline d. briefly e. decline and then increase significantly continually increase CATASTROPHE BONDS e 66. Cat bonds are primarily designed to help: a. b. c. d. e. cities recover from economic recessions. corporations recover from overseas competition. the federal government cope with huge deficits. animal food producers raise capital to compete internationally. insurance companies recover from natural disasters. TYPES OF BONDS AND INVESTOR PREFERENCES c 67. Investors generally tend to buy: a. b. c. d. e. Treasury bonds for their high yields. municipal bonds for their high yields. convertible bonds for their potential price appreciation. corporate bonds for their liquidity. Treasury bonds for their preferential tax treatment. TYPES OF BONDS b 68. A convertible bond is a bond that can be: a. b. exchanged for cash at prescribed points in time. exchanged for a stated number of shares of common stock of the bond issuer. c. in modified from a fixed coupon bond into a floating coupon bond at prescribed points time. d. e. submitted to the issuer for redemption at the discretion of the bondholder. submitted for payment any time the economy converts into a recessionary period. PUT PROVISION c 69. A put provision in a bond indenture allows: a. a bond issuer to recall the bond after a specified period of time at a price that exceeds the face amount. b. a bondholder to force the issuer to increase the coupon rate if inflation increases by more than a specified amount. the bondholder to force the issuer to buy back the bond at a specified price prior to maturity. d. e. the issuer to convert a coupon bond into a zero coupon bond at their discretion. the issuer to suspend interest payments for any year in which the interest expense exceeds the net income of the firm. c. BOND TRADING b 70. If you want to sell a bond issued by a smaller corporation, you: a. b. c. can always do so quite easily by trading it on the New York Stock Exchange. may encounter difficulties in executing the trade. can usually do so quite efficiently due to the high liquidity of the bond market. d. e. can do so quite quickly due to the high volume of trading in the bond markets. will most likely trade in an auction market, such as the New York Stock Exchange. BASIS POINT a 71. One basis point is equal to: a. b. c. d. e. .01 percent. .10 percent. 1.0 percent. 10 percent. 100 percent. CORPORATE BOND QUOTE c 72. The EST SPREAD shown in The Wall Street Journal listing of corporate bonds represents the estimated: a. b. c. d. e. yield to maturity. difference between the current yield and the yield to maturity. difference between the bonds yield and the yield of a particular Treasury issue. range of yields to maturity provided by the bond over its life to date. difference between the yield to call and the yield to maturity. TREASURY BOND QUOTE e 73. A Treasury bond that is quoted at 100:07 is selling: a. at 7 percent over the face amount. b. c. d. e. at a 7 percent discount. at a 7 percent premium. at par and pays a 7 percent coupon. for about $2.19 over face value. TREASURY BONDS b 74. As of 2004, the longest maturity Treasury security currently being issued is the: a. b. c. d. e. 5-year note. 10-year note. 15-year bond. 20-year bond. 30-year bond. BID VERSUS ASKED PRICES a 75. A Treasury bond has an asked quote of 100:12 and a bid quote of 100:11. One bond: a. b. c. d. e. can be purchased at a price of $1,003.75. can be sold at a price of $1,003.75. has a spread of 10 basis points. has a yield to maturity that lies between 11 and 12 percent. can be sold to a dealer at a price of $1,001.10. CLEAN VERSUS DIRTY PRICES c 76. Today, August 13, you want to buy a bond with a quoted price of 101.5. The bond pays interest on February 1 and August 1. The price you will pay to purchase this bond is equal to the: a. b. c. d. e. clean price. muddy price. dirty price. par value price. bid price. REAL RATE OF RETURN d as 77. The increase you realize in buying power as a result of owning a bond is referred to the _____ rate of return. a. b. c. d. e. inflated realized nominal real risk-free FISHER EFFECT e 78. The Fisher formula is expressed as: a. b. c. 1 + r = (1 + R) (1 + h). 1 + r = (1 + R) (1 + h). 1 + h = (1 + r) (1 + R). d. e. 1 + R = (1 + r) (1 + h). 1 + R = (1 + r) (1 + h). FISHER EFFECT d 79. The Fisher Effect primarily emphasizes the effects of _____ risk on an investors rate of return. a. b. c. d. e. default market interest rate inflation maturity TERM STRUCTURE OF INTEREST RATES a 80. The term structure of interest rates reflects the: a. b. c. d. e. pure time value of money for various lengths of time. actual risk premium being paid for corporate bonds of varying maturities. pure inflation adjustment applied to bonds of various maturities. interest rate risk premium applicable to bonds of varying maturities. nominal interest rates applicable to coupon bonds of varying maturities. TERM STRUCTURE OF INTEREST RATES d 81. Which of the following statements are correct concerning the term structure of interest rates? I. The outlook for future inflation influences the shape of the term structure of interest rates. II. The term structure of interest rates includes only the real rate of return and the inflation premium. III. The interest rate risk premium is included in the term structure of interest rates. IV. The term structure of interest rates can be downsloping. a. b. c. d. e. I and II only II and IV only III and IV only I, III, and IV only I, II, and IV only CORPORATE VERSUS TREASURY BONDS c 82. Two of the primary differences between a corporate bond and a Treasury bond with identical maturity dates are related to: a. b. c. d. e. interest rate risk and time value of money. time value of money and inflation. taxes and potential default. taxes and inflation. inflation and interest rate risk. III. PROBLEMS YIELD TO MATURITY c 83. The bonds issued by Jensen & Son bear a 6 percent coupon, payable semiannually. The bond matures in 8 years and has a $1,000 face value. Currently, the bond sells at par. What is the yield to maturity? a. b. c. d. e. 5.87 percent 5.97 percent 6.00 percent 6.09 percent 6.17 percent YIELD TO MATURITY a 84. A General Co. bond has an 8 percent coupon and pays interest annually. The face value is $1,000 and the current market price is $1,020.50. The bond matures in 20 years. What is the yield to maturity? a. b. c. d. e. 7.79 percent 7.82 percent 8.00 percent 8.04 percent 8.12 percent YIELD TO MATURITY d 85. Winston Enterprises has a 15-year bond issue outstanding that pays a 9 percent coupon. The bond is currently priced at $894.60 and has a par value of $1,000. Interest is paid semiannually. What is the yield to maturity? a. b. c. d. e. 8.67 percent 10.13 percent 10.16 percent 10.40 percent 10.45 percent PRICE OF COUPON BOND a 86. Wine and Roses, Inc. offers a 7 percent coupon bond with semiannual payments and a yield to maturity of 7.73 percent. The bonds mature in 9 years. What is the market price of a $1,000 face value bond? a. b. c. d. e. $953.28 $953.88 $1,108.16 $1,401.26 $1,401.86 PRICE OF COUPON BOND c 87. Party Time, Inc. has a 6 percent coupon bond that matures in 11 years. The bond pays interest semiannually. What is the market price of a $1,000 face value bond if the yield to maturity is 12.9 percent? a. b. $434.59 $580.86 c. d. e. $600.34 $605.92 $947.87 PRICE OF COUPON BOND d 88. Gugenheim, Inc. offers a 7 percent coupon bond with annual payments. The yield to maturity is 5.85 percent and the maturity date is 9 years. What is the market price of a $1,000 face value bond? a. b. c. d. e. $742.66 $868.67 $869.67 $1,078.73 $1,079.59 TIME TO MATURITY OF COUPON BOND a 89. The Lo Sun Corporation offers a 6 percent bond with a current market price of $875.05. The yield to maturity is 7.34 percent. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond matures? a. b. c. d. e. 16 years 18 years 24 years 30 years 36 years TIME TO MATURITY OF COUPON BOND b 90. High Noon Sun, Inc. has a 5 percent, semiannual coupon bond with a current market price of $988.52. The bond has a par value of $1,000 and a yield to maturity of 5.29 percent. How many years is it until this bond matures? a. b. c. d. e. 4.0 years 4.5 years 6.5 years 8.0 years 9.0 years PRICE OF ZERO COUPON a 91. Your firm offers a 10-year, zero coupon bond. The yield to maturity is 8.8 percent. What is the current market price of a $1,000 face value bond? a. b. c. d. e. $430.24 $473.26 $835.56 $919.12 $1,088.00 PRICE OF ZERO COUPON BOND b 92. Teds Co. offers a zero coupon bond with an 11.3 percent yield to maturity. The bond matures in 16 years. What is the current price of a $1,000 face value bond? a. b. c. d. e. $178.78 $180.33 $188.36 $190.09 $192.18 TIME TO MATURITY OF ZERO COUPON BOND c 93. The zero coupon bonds of Markco, Inc. have a market price of $394.47, a face value of $1,000, and a yield to maturity of 6.87 percent. How many years is it until this bond matures? a. b. c. d. e. 7 years 10 years 14 years 18 years 21 years INTEREST RATE RISK b of 94. A 12-year, 5 percent coupon bond pays interest annually. The bond has a face value $1,000. What is the change in the price of this bond if the market yield rises to 6 percent from the current yield of 4.5 percent? a. b. c. 11.11 percent decrease 12.38 percent decrease 12.38 percent increase d. e. 14.13 percent decrease 14.13 percent increase INTEREST RATE RISK d 95. Jackson Central has a 6-year, 8 percent annual coupon bond with a $1,000 par value. Earls Enterprises has a 12-year, 8 percent annual coupon bond with a $1,000 par value. Both bonds currently have a yield to maturity of 6 percent. Which of the following statements are correct if the market yield increases to 7 percent? a. b. c. d. e. Both bonds would decrease in value by 4.61 percent. The Earls bond will increase in value by $88.25. The Jackson bond will increase in value by 4.61 percent. The Earls bond will decrease in value by 7.56 percent. The Earls bond will decrease in value by $50.68. CURRENT YIELD a 96. DAngelos bonds have a face value of $1,000 and a current market price of $1010. The bonds have a 7 percent coupon rate. What is the current yield on these bonds? a. b. c. d. e. 6.93 percent 6.97 percent 7.00 percent 7.03 percent 7.07 percent CURRENT YIELD d 97. Mitzis, II. Bonds offer a 6 percent coupon at a current market price of $989. The bonds have a face value of $1,000 and a call price of $1,020. What is the current yield on these bonds? a. b. c. d. e. 5.88 percent 5.97 percent 6.00 percent 6.07 percent 6.12 percent CALL PREMIUM c 98. The bonds offered by Leos Pumps are callable in 3 years at a quoted price of 101. What is the amount of the call premium on a $1,000 par value bond? a. b. c. d. e. $3.33 $5.00 $10.00 $13.33 $100.00 CORPORATE BOND QUOTE c a 99. A corporate bond is quoted at a current price of 102.767. What is the market price of bond with a $1,000 face value? a. b. c. $1,000.28 $1,002.77 $1,027.67 d. e. $1,102.77 $1,276.70 ZERO COUPON BOND QUOTE c 100. A $1,000 face value zero coupon bond is quoted at a price of 43.30. What is the amount you would pay to purchase this bond? a. b. c. d. e. $43.30 $430.30 $433.00 $956.70 $1,043.30 TREASURY BOND QUOTE b 101. A Treasury bond is quoted at a price of 106:13. What is the market price of this bond if the face value is $1,000? a. b. c. d. e. $106.13 $1,064.06 $1,106.13 $1,106.41 $1,106.64 TREASURY BOND QUOTE AND COUPON RATE c 102. A Treasury bond is quoted at a price of 101:00 with a current yield of 5.94 percent. What is the coupon rate? a. b. c. d. e. 5.88 percent 5.94 percent 6.00 percent 6.06 percent 6.88 percent CORPORATE QUOTE AND CURRENT YIELD e 103. A corporate bond is quoted at a price of 98.625 with a 7.875 coupon. The bond pays interest semiannually. What is the current yield on one of these bonds? a. b. c. d. e. 7.50 percent 7.76 percent 7.88 percent 7.97 percent 7.98 percent TREASURY QUOTE AND CURRENT YIELD a 104.A Treasury bond is quoted at a price of 103:23 with a 4.625 coupon. The bond pays interest semiannually. What is the current yield on one of these bonds? a. b. c. d. e. 4.46 percent 4.54 percent 4.63 percent 4.68 percent 4.74 percent BID-ASK SPREAD c 105. A Treasury bond is quoted as 101:18 asked and 101:16 bid. What is the bid-ask spread in dollars on a $1,000 face value bond? a. b. c. d. e. $.02 $.20 $.625 $2.00 $6.25 EFFECTIVE ANNUAL RATES AND INTEREST PAYMENTS a 106. The semiannual, ten-year bonds of Adep, Inc. are selling at par and have an effective annual yield of 4.295 percent. What is the amount of each interest payment on a $1,000 Adep bond? a. b. c. d. e. $21.25 $21.48 $21.50 $42.50 $42.95 FISHER EFFECT c 107. A bond that pays interest annually yields a 7.25 percent rate of return. The inflation rate for the same period is 3.5 percent. What is the real rate of return on this bond? a. 3.50 percent b. c. d. e. 3.57 percent 3.62 percent 3.72 percent 3.75 percent FISHER EFFECT b 108. The bonds of Franks Welding, Inc. pay an 8 percent coupon, have a 7.98 percent yield to maturity and have a face value of $1,000. The current rate of inflation is 2.5 percent. What is the real rate of return on these bonds? a. b. c. d. e. 5.32 percent 5.35 percent 5.37 percent 5.42 percent 5.48 percent FISHER EFFECT d 109. The outstanding bonds of Roy Thomas, Inc. provide a real rate of return of 3.6 percent. The current rate of inflation is 2.5 percent. What is the nominal rate of return on these bonds? a. b. c. d. e. 6.10 percent 6.13 percent 6.16 percent 6.19 percent 6.22 percent FISHER EFFECT a 110. The nominal rate of return on the bonds of Stus Boats is 8.75 percent. The real rate of return is 3.4 percent. What is the rate of inflation? a. b. c. d. e. 5.17 percent 5.28 percent 5.35 percent 5.43 percent 5.49 percent ZERO COUPON BOND AND IMPLICIT INTEREST c 111. A zero coupon bond with a face value of $1,000 is issued with an initial price of $463.34. The bond matures in 25 years. What is the implicit interest, in dollars, for the first year of the bonds life? a. b. c. d. e. $9.08 $12.56 $14.48 $21.47 $31.25 ZERO COUPON BOND PRICING c 112. The MerryWeather Firm wants to raise $10 million to expand their business. To accomplish this, they plan to sell 30-year, $1,000 face value zero-coupon bonds. The bonds will be priced to yield 6 percent. What is the minimum number of bonds they must sell to raise the $10 million they need? a. b. c. d. e. 47,411 52,667 57,435 60,000 117,435 IV. ESSAYS TREASURY YIELD CURVE 113. Draw a graph of a typical Treasury yield curve and discuss why it usually takes that shape. The student should draw a graph similar to the Treasury yield curve found in the text. Factors impacting the shape of the yield curve are the risk free rate, the inflation premium and the interest rate risk premium. BOND YIELD PREMIUMS 114. Explain why some bond investors are subject to liquidity risk, default risk, and/or taxability risk. How do each of these risks affect the yield of a bond? Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at their actual value. Default risk is the likelihood the corporation will default on its bond obligations. Taxability risk reflects the fact that some bonds are taxed disadvantageously compared to others. If any of these risks exist, investors will require compensation by demanding a high yield. CROSSOVER BONDS 115. Explain what a crossover bond is and the risks and expected rewards for investors when they purchase such bonds. A crossover bond is one that is rated investment grade by one rating agency and below investment grade by another. Since the ratings agencies disagree, investors must essentially take a position as to which one is correct. Given the added likelihood of default, investors should expect to earn a risk premium over investment grade bonds when purchasing crossovers. INTEREST RATE RISK 116. Define what is meant by interest rate risk. Assume you are the manager of a $100 million portfolio of corporate bonds and you believe interest rates will fall. What adjustments should you make to your portfolio based on your beliefs? Interest rate risk is the risk that arises for bond owners from fluctuating interest rates. All else the same, if interest rates are expected to fall you should purchase long-term bonds and/or low coupon bonds, and sell shorter-term, higher-coupon bonds. INTEREST RATE RISK AND THE ISSUER 117. Why do corporations issue 100-year bonds, knowing that interest rate risk is highest for very long-term bonds? How does the interest rate risk affect the issuer? Essentially, the issuer takes the opposite side of the interest rate risk position. By issuing long-term bonds, the corporation is essentially betting that rates wont fall significantly. If they do, the corporation will incur a loss due to borrowing at rates higher than the going market rates. On the other hand, if rates rise, the corporation benefits by having locked in its borrowing rate for up to 100 years. In addition, these bonds are a source of long-term financing where the cost, i.e. the interest, is tax deductible. If the firm should issue stocks, the cost, i.e. the dividends, are not tax deductible. This is why the IRS frowns on 100 year bonds. YIELD CURVE 118. In the early 1980s, the Treasury yield curve had a severe downward slope with shortterm yields near 20% and long-term yields below 15%. Explain how such a pattern might occur. The downward slope occurs because the expected inflation premium is declining. The decline in the inflation premium is significant enough to overcome the interest rate risk premium. BOND RATINGS 119. Interest rate risk is often explained by using the concept of a teeter-totter. Explain interest rate risk and how it is related to the movements of a teeter-totter. Interest rates sit on one end of the teeter-totter while bond prices sit on the other end. As interest rates move up, bond prices move down as seen by the movements of a teetertotter. Movement in the opposite direction also applies. In addition, short-term bonds are located a short distance from the fulcrum while longterm bonds are situated towards the end of the teeter-totter illustrating that long-term bonds move further in reaction to a change in interest rates than do short-term bonds. BOND VALUATION 120. The discussion of asset pricing in the text suggests that an investor will be indifferent between two bonds which have equal yields to maturity as long as they have equivalent default risk. Can you think of any real-world factors which might make a given investor prefer one of these bonds over the other? Note that the question only implies the bonds have the same yields and bond ratings. There are the additional issues of taxability, liquidity and interest rate risk. Students should be able to recap the discussion on the determinants of bond yields found in section 7.7 of the text.

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Fort Hays - MBA - 816
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Fort Hays - MBA - 816
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University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
University of Texas - M - 91795
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Michigan State University - PHY - 184
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