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Chapter 7 Interest Rates and Bond Valuation

1. Assume you are considering two bonds identical in every way but for coupon frequency - bond A pays interest annually, and bond B pays interest semiannually. Then, if they have the same price, the yield-tomaturity on bond A will always be greater than that on bond B. Ans: False

Level: Basic

Subject: Bond Valuation

Type: Concepts

2. Any regular coupon bond of any maturity will sell for its face value if the coupon rate is the same as the market rate of interest. Ans: True

Level: Basic

Subject: Yield to Maturity

Type: Concepts

3. For a bond, total return = yield-to-maturity = market's required return. Ans: True

Level: Basic

Subject: Bond Yields

Type: Concepts

4. Debt can be subordinated to equity. Ans: False

Level: Basic

Subject: Subordinated Debt

Type: Concepts

5. A sinking fund is used to pay off portions of debt each year. Ans: True

Level: Basic

Subject: Sinking Fund

Type: Concepts

6. A call provision, unlike a sinking fund, allows a company to retire its debt early for a specified price. Ans: False

Level: Basic

Subject: Call Provision

Type: Concepts

7. The call premium generally starts at 10% of par and decreases to zero with the passage of time. Ans: False

Level: Basic

Subject: Call Premium

Type: Concepts

8. The Dominion Bond Rating Service (DBRS) primarily considers interest rate risk rather than default risk when they rate debt. Ans: False

Level: Basic

Subject: Bond Ratings

Type: Concepts

9. Bond ratings issued by DBRS specifically account for default risk. Ans: True

Level: Basic

Subject: Default Ratings

Type: Concepts

10. Prior to 1980, few firms raised funds directly by issuing junk bonds. Ans: True

Level: Basic

Subject: Junk Bonds

Type: Concepts

11. Your firm seeks to obtain a short-term loan from a local bank. The banker quotes you a rate of 9%. This is a real rate. Ans: False

Level: Basic

Subject: Nominal Returns

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited. Page 1

Chapter 7 Interest Rates and Bond Valuation

12. The stated interest payment, in dollars, made on a bond each period is called the bond's: A) Coupon. B) Face value. C) Maturity. D) Yield to maturity. E) Coupon rate. Ans: A

Level: Basic

Subject: Coupon

Type: Definitions

13. The principal amount of a bond that is repaid at the end of the loan term is called the bond's: A) Coupon. B) Face value. C) Maturity. D) Yield to maturity. E) Coupon rate. Ans: B

Level: Basic

Subject: Face Value

Type: Definitions

14. The annual coupon of a bond divided by its face value is called the bond's: A) Coupon. B) Face value. C) Maturity. D) Yield to maturity. E) Coupon rate. Ans: E

Level: Basic

Subject: Coupon Rate

Type: Definitions

15. The specified date on which the principal amount of a bond is repaid is called the bond's: A) Coupon. B) Face value. C) Maturity. D) Yield to maturity. E) Coupon rate. Ans: C

Level: Basic

Subject: Maturity

Type: Definitions

16. The rate of return required by investors in the market for owning a bond is called the: A) Coupon. B) Face value. C) Maturity. D) Yield to maturity. E) Coupon rate. Ans: D

Level: Basic

Subject: Yield to Maturity

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited. Page 2

Chapter 7 Interest Rates and Bond Valuation

17. A bond with face value $1,000 that sells for $1,000 in the market is called a ___________ bond. A) par B) discount C) premium D) zero coupon E) floating rate Ans: A

Level: Basic

Subject: Par Bonds

Type: Definitions

18. A bond with face value $1,000 that sells for less than $1,000 in the market is called a: A) Par bond. B) Discount bond. C) Premium bond. D) Zero coupon bond. E) Floating rate bond. Ans: B

Level: Basic

Subject: Discount Bonds

Type: Definitions

19. A bond with face value $1,000 that sells for more than $1,000 in the market is called a: A) Par bond. B) Discount bond. C) Premium bond. D) Zero coupon bond. E) Floating rate bond. Ans: C

Level: Basic

Subject: Premium Bonds

Type: Definitions

20. The written, legally binding agreement between the corporate borrower and the lender detailing the terms of a bond issue is called the: A) Indenture. B) Covenant. C) Terms of trade. D) Form 5140. E) Call provision. Ans: A

Level: Basic

Subject: Indenture

Type: Definitions

21. The written agreement between the corporation and its bond creditors is called a/an A) bond B) protective covenant C) indenture D) security agreement E) contract Ans: C

Level: Basic

Subject: Bond Indenture

Type: Definitions

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Chapter 7 Interest Rates and Bond Valuation

22. 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: A) New-issue form. B) Registered form. C) Bearer form. D) Debenture form. E) Collateral form. Ans: B

Level: Basic

Subject: Registered Bonds

Type: Definitions

23. The form of bond issue in which the bond is issued without record of the owner's name, with relevant payments made directly to whoever physically holds the bond, is called: A) New-issue form. B) Registered form. C) Bearer form. D) Debenture form. E) Collateral form. Ans: C

Level: Basic

Subject: Bearer Bonds

Type: Definitions

24. A/an _______ bond is issued without record of the purchaser's name. A) straight B) unfunded C) registered D) bearer E) income Ans: D

Level: Basic

Subject: Bearer Bonds

Type: Definitions

25. The unsecured debts of a firm with maturities greater than 10 years are most literally called: A) Unfunded liabilities. B) Sinking funds. C) Bonds. D) Notes. E) Debentures. Ans: E

Level: Basic

Subject: Debentures

Type: Definitions

26. A general claim on property that is not otherwise pledged is called a A) collateral bond B) debenture C) mortgage bond D) registered bond E) bearer bond Ans: B

Level: Basic

Subject: Debenture

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited. Page 4

Chapter 7 Interest Rates and Bond Valuation

27. A/an ________ is secured only by the reputation of the issuing firm. A) unfunded bond B) straight bond C) bearer bond D) registered bond E) debenture Ans: E

Level: Basic

Subject: Debentures

Type: Definitions

28. The unsecured debts of a firm with maturities less than 10 years are most literally called: A) Unfunded liabilities. B) Sinking funds. C) Bonds. D) Notes. E) Debentures. Ans: D

Level: Basic

Subject: Notes

Type: Definitions

29. In the event of default, _____________ debt holders must give preference to more __________ debt holders in the priority of repayment distributions. A) short-term; long-term B) long-term; short-term C) senior; junior D) senior; subordinated E) subordinated; senior Ans: E

Level: Basic

Subject: Seniority

Type: Definitions

30. An account managed by the bond trustee for early bond redemption payments is called a: A) Sinking fund. B) Collateral payment account. C) Deed in trust account. D) Call provision. E) Par value fund. Ans: A

Level: Basic

Subject: Sinking Fund

Type: Definitions

31. ________________ is an account into which periodic payments are made for the purpose of retiring a bond issue. A) An indenture B) A debenture C) A covenant D) A call option E) A sinking fund Ans: E

Level: Basic

Subject: Sinking Fund

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited. Page 5

Chapter 7 Interest Rates and Bond Valuation

32. An agreement giving the bond issuer the option to repurchase the bond at a specified price prior to maturity is the _______________ provision. A) sinking fund B) call C) seniority D) collateral E) trustee Ans: B

Level: Basic

Subject: Call Provision

Type: Definitions

33. The amount by which the call price exceeds the bond's par value is the: A) Coupon rate. B) Redemption value. C) Call premium. D) Original-issue discount. E) Call rate. Ans: C

Level: Basic

Subject: Call Premium

Type: Definitions

34. A deferred call provision refers to: A) The open market price of a callable bond on a certain date. B) The seniority of callable bonds to noncallable bonds in the event of corporate default. C) The prohibition of a company from ever redeeming callable bonds. D) The prohibition of a company from redeeming callable bonds prior to a certain date. E) The amount by which the call price for a callable bond exceeds its par value. Ans: D

Level: Basic

Subject: Deferred Call Provision

Type: Definitions

35. __________ included in the bond indenture to protect bondholders from certain actions by the company. A) Indentures are B) Debentures are C) Covenants are D) Articles of incorporation are E) A description of dedicated capital is Ans: C

Level: Basic

Subject: Covenants

Type: Definitions

36. Parts of the indenture limiting certain actions that might be taken during the term of the loan (usually to protect the interests of the lender) are called: A) Trustee relationships. B) Sinking funds provisions. C) Bond ratings. D) Deferred call provisions. E) Protective covenants. Ans: E

Level: Basic

Subject: Protective Covenant

Type: Definitions

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Chapter 7 Interest Rates and Bond Valuation

37. A stripped bond A) pays coupons at regular intervals until maturity B) typically sells at a premium from its face value C) increases in value when interest rates increase D) pays no coupons, thus it sells at a deep discount from face value E) decreases in value when interest rates decrease Ans: D

Level: Basic

Subject: Stripped Bonds

Type: Definitions

38. A bond that makes no coupon payments (and thus is initially priced at a deep discount to par value) is called a ________________ bond. A) Treasury B) municipal C) floating rate D) junk E) zero coupon Ans: E

Level: Basic

Subject: Zero Coupon Bonds

Type: Definitions

39. A bond that pays a variable amount of coupon interest over time is called a ____________ bond. A) Treasury B) municipal C) floating rate D) junk E) zero coupon Ans: C

Level: Basic

Subject: Floating Rate Bonds

Type: Definitions

40. 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 bond's maturity is called a _______________ bond. A) zero coupon B) callable C) putable D) convertible E) warrant Ans: D

Level: Basic

Subject: Convertible Bonds

Type: Definitions

41. You want to own equity in a Russian oil firm, but the firm does not have traded stock. If it had ___________ outstanding you could purchase them and then trade them in for shares of stock. A) convertible bonds B) put bonds C) debentures D) zero coupon bonds E) subordinated debentures Ans: A

Level: Basic

Subject: Convertible Bonds

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited. Page 7

Chapter 7 Interest Rates and Bond Valuation

42. A financial market is ____________- if it is possible to easily observe its prices and trading volume. A) transparent B) open C) ordered D) in equilibrium E) chaotic Ans: A

Level: Basic

Subject: Price Transparency

Type: Definitions

43. Interest rates or rates of return on investment that have not been adjusted for the effects of inflation are called: A) Coupon rates. B) Stripped rates. C) Effective rates. D) Real rates. E) Nominal rates. Ans: E

Level: Basic

Subject: Nominal Rates

Type: Definitions

44. Interest rates or rates of return on investment that have been adjusted for the effects of inflation are called: A) Real rates. B) Nominal rates. C) Effective rates. D) Stripped rates. E) Coupon rates. Ans: A

Level: Basic

Subject: Real Rates

Type: Definitions

45. The relationship between nominal rates, real rates, and inflation is known as the: A) Miller and Modigliani theorem. B) Fisher effect. C) Gordon growth model. D) Term structure of interest rates. E) Interest rate risk premium. Ans: B

Level: Basic

Subject: Fisher Effect

Type: Definitions

46. The relationship between nominal interest rates on default-free, pure discount securities and the time to maturity is called the: A) Liquidity effect. B) Fisher effect. C) Term structure of interest rates. D) Inflation premium. E) Interest rate risk premium. Ans: C

Level: Basic

Subject: Term Structure Of Interest Rates

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited. Page 8

Chapter 7 Interest Rates and Bond Valuation

47. The _____________ premium is that portion of a nominal interest rate or bond yield that represents compensation for expected future inflation. A) default risk B) taxability C) liquidity D) inflation E) interest rate risk Ans: D

Level: Basic

Subject: Inflation Premium

Type: Definitions

48. 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) default risk B) taxability C) liquidity D) inflation E) interest rate risk Ans: A

Level: Basic

Subject: Default Risk Premium

Type: Definitions

49. The face value of a bond: A) Is defined as the current market price. B) Includes the principal plus the total interest due. C) Is commonly defined as $10,000. D) Is the principal amount paid at maturity. E) Is defined as the principal amount minus the interest due at maturity. Ans: D

Level: Basic

Subject: Face Value

Type: Definitions

50. The rate that is computed by dividing the annual interest payment by the face value of a bond is called the: A) Discount rate. B) Yield-to-maturity. C) Coupon rate. D) Yield-to-call. E) Market rate. Ans: C

Level: Basic

Subject: Coupon Rate

Type: Definitions

51. The legal document that includes the basic terms and details of a bond is called the: A) Indenture agreement. B) Call provision. C) Debenture agreement. D) Registration form. E) Marketing form. Ans: A

Level: Basic

Subject: Indenture

Type: Definitions

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Chapter 7 Interest Rates and Bond Valuation

52. The rate of return earned by an investor who purchases a bond today and holds it for the remainder of the term is called the: A) Coupon rate. B) Compound rate. C) Yield-to-market. D) Yield-to-call. E) Yield-to-maturity. Ans: E

Level: Basic

Subject: Yield To Maturity

Type: Definitions

53. The call premium is: A) Equal to the par value but paid prior to maturity. B) Additional compensation paid to a bondholder in exchange for an early redemption. C) The `thou shalts' that must be met prior to the payment of the face value at maturity. D) The additional principal paid when a bond is granted an investment grade rating. E) The same as the face value but paid prior to maturity. Ans: B

Level: Basic

Subject: Call Premium

Type: Definitions

54. The limitations within a bond indenture agreement that prohibit certain actions by a firm are called: A) Sinking fund provisions. B) Negative covenants. C) Debenture provisions. D) Call provisions. E) Seniority requirements. Ans: B

Level: Basic

Subject: Negative Covenant

Type: Definitions

55. Junk bonds are: A) Bonds rated as BBB or lower by bond rating agencies. B) High quality, high interest bonds. C) Speculative in nature. D) Guaranteed by the government due to their quality. E) Issued as low coupon bonds. Ans: C

Level: Basic

Subject: Junk Bond

Type: Definitions

56. A bond that pays no separate interest payments is called a(n): A) Premium bond. B) Coupon bond. C) Junk bond. D) Zero coupon bond. E) Investment grade bond. Ans: D

Level: Basic

Subject: Zero Coupon Bond

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited. Page 10

Chapter 7 Interest Rates and Bond Valuation

57. A floating-rate bond by definition has a: A) Principal amount that varies with the inflation rate. B) Principal amount that varies with the time to maturity. C) Coupon payment that varies with an interest rate index. D) Coupon payment that varies with the time to maturity. E) Coupon payment that varies with the amount of debt outstanding. Ans: C

Level: Basic

Subject: Floating Rate Bond

Type: Definitions

58. The Fisher effect defines the relationship between: A) Nominal and real rates of return. B) The yield-to-maturity and the yield-to-call. C) Inflation and the yield-to-maturity. D) The market value and face value of a bond. E) A bond's rating and its real rate of return. Ans: A

Level: Basic

Subject: Fisher Effect

Type: Definitions

59. A corporation undertaking an expansion project issues 20 year bonds to finance the project. Which of the following is most likely true? A) The company does not need to make payments on the bonds unless it has positive earnings for the year. B) The company has borrowed money and must pay interest on the amount borrowed. C) The company did not have any outstanding bonds when it issued the new bonds. D) The bonds must have sold at a premium since expansion projects are generally risky. E) If the company could have issued preferred stock instead, they would have. Ans: B

Level: Basic

Subject: Issuing Debt

Type: Concepts

60. Which of the following would NOT be listed on the face of a bond? A) The coupon interest rate B) The maturity date C) The market price of the bond D) The coupon payment to be made E) The name of the issuer Ans: C

Level: Basic

Subject: Bond Face

Type: Concepts

61. All else the same, if inte...