chapter 6

Question 1

a bond’s coupon payment is

Answer 1

a fixed amount of interest that is paid annually/semiannually by the issuer to its bondholders

Question 2

the bonds of a firm in financial distress may have a market value that is ______ than the face value at maturity

Answer 2

less

Question 3

when interest rates in the market rise, we can expect the price of bonds to

Answer 3

decrease

Question 4

what is not required to calculate the value of a bond

Answer 4

original issue price of bond

Question 5

ABC issued 1 million 6 percent annual coupon bonds that mature in 10 years. the face value is $1,000 per bond. what are the expected cash flows from one of these bonds?

Answer 5

$60 in interest at the end of each year for 10 years and a $1000 repayment of principal at the end of 10 years

Question 6

a bond’s face value is

Answer 6

the principal amount repaid at maturity

Question 7

if one bond matures in 10 years and the other in 5, which is more sensitive to interest rate risk

Answer 7

the 10-year bond. the longer the term, the greater the interest rate sensitivity

Question 8

when interest rates in the market fall, bond values will increase because

Answer 8

the PV of the bond’s remaining cash flows increases

Question 9

when using trial and error to compute the yield to maturity for a 6 percent coupon bond that trades at premium, the process can be shortened if the initial guess is _______

Answer 9

lower than 6% (YTM < coupon)

Question 10

what four variables are required to calculate the value of a bond

Answer 10

time remaining to maturity, yield to maturity, par value, coupon rate

Question 11

to find the total bond value, add the

Answer 11

present value of the amount paid at maturity to the annuity present value of the annual coupon payments

Question 12

current yield =

Answer 12

annual coupon payment / price

Question 13

the sensitivity of a bond’s price to interest rate changes is dependent on what two variables?

Answer 13

time to maturity and coupon rate

Question 14

the lower the coupon rate, the _______ the interest risk

Answer 14

greater

Question 15

if a bond is selling at a discount from its par value, the YTM must be ______ the coupon rate

Answer 15

greater than

Question 16

equity represents

Answer 16

ownership interest of a firm

Question 17

debenture

Answer 17

unsecured bond

Question 18

interest vs dividends taxes

Answer 18

interest - tax deductible
dividends - not tax deductible

Question 19

debt cannot be subordinated to

Answer 19

equity

Question 20

what is the purpose of a sinking fund

Answer 20

to create a fund to repay bonds when they fall due

Question 21

if a bond is issued with a ______ provision, it allows the issuer to repurchase all/part of the bond at defined prices and times

Answer 21

call

Question 22

bond ratings are based on the probability of

Answer 22

default risk

Question 23

default risk

Answer 23

the risk that the bond’s issuer may not be able to make all the required payments

Question 24

a bond with a BB rating has a ______ than a bond with a BBB rating

Answer 24

higher risk of default

Question 25

it is the duty of the bond ______ to manage sinking fund

Answer 25

trustee

Question 26

bonds that have dropped into junk territory are called

Answer 26

fallen angels

Question 27

bonds issued by state and local govs are called

Answer 27

municipal bonds

Question 28

what does a bond's rating reflect?

Answer 28

the ability of the firm to repay its debt and interest on time

Question 29

AAA rating =

Answer 29

strong position to meet debt obligations

Question 30

junk bonds are rated

Answer 30

below investment grade bonds

Question 31

a zero coupon bond

Answer 31

makes no interest payments

Question 32

what are features of municipal bonds

Answer 32

- issued by state and local govs - interest is exempt from federal taxes - in some cases, exempt from state taxes

Question 33

what are the cash flows involved in the purchase of a 5 year zero coupon bond that has a par value of $1000 and current price is $800?

Answer 33

pay 800 today, receive $1000 at the end of 5 years

Question 34

if bonds for AT&T are quoted at 115, they can be purchased

Answer 34

at 115 percent of par value plus accrued interest

Question 35

the relationship between nominal rates, real rates, and inflation is called

Answer 35

the fisher effect

Question 36

which 3 components determine the shape of the term structure of interest rates?

Answer 36

inflation premium, interest rate risk premium, real interest rate

Question 37

the bid-ask spread represents the

Answer 37

dealer's profit

Question 38

what three components influence the treasury yield curve

Answer 38

real rate of return, expected future inflation, interest rate risk premium

Question 39

which of the following may increase the yield on corporate bonds as compensation to investors but will not impact treasury bond yields

Answer 39

default risk premium, liquidity premium

Question 40

formula for relationship between nominal (R) and real (r) rate

Answer 40

(1 + R) = (1 + r) * (1 + h)

Question 41

inflation premium

Answer 41

additional return demanded by investors to compensate for expected inflation

Question 42

what does treasury yield curve show

Answer 42

yield for different maturities of treasury notes and bonds

Question 43

what is a bond

Answer 43

debt contract, interest-only loan

Question 44

ytm

Answer 44

the market required rate of return for bonds of similar risk and maturity - discount rate used to value a bond

Question 45

bond value formula

Answer 45

PV(annuity) + PV(lump sum)

Question 46

PV(annuity)

Answer 46

C * { 1 - [ 1 / (1 + YTM) ^ t ] / YTM }

Question 47

PV (lump sum)

Answer 47

F / (1 + YTM)^t

Question 48

attributes of debt

Answer 48

- not an ownership interest - no voting rights - interest is tax deductible - excess debt can lead to bankruptcy

Question 49

attributes of equity

Answer 49

- ownership interest - common stockholders vote to elect board of directors - dividends are not tax deductible - cannot go bankrupt

Question 50

treasury securities =

Answer 50

federal government debt

Question 51

floating rate bonds have

Answer 51

less of a price risk

Question 52

quoted bond price

Answer 52

"clean" price, net of accrued interest

Question 53

invoice price

Answer 53

"dirty" or "full" price, price actually paid, includes accrued interest

Question 54

accrued interest

Answer 54

interest earned since last coupon payment is owed to bond seller at time of sale

Question 55

accrued interest =

Answer 55

coupon amount * (# of days since last coupon payment/# of days between next and last coupon payment)