chapter 6

Question 1

Usually applied to debt instruments such as bank loans or bonds; the compensation paid by the borrower of funds to the lender; from the borrower’s point of view, the cost of borrowing funds.

Answer 1

interest rate

Question 2

Usually applied to equity instruments such as common stock; the cost of funds obtained by selling an ownership interest.

Answer 2

required return

Question 3

A rising trend in the prices of most goods and services.

Answer 3

inflation

Question 4

A general tendency for investors to prefer short-term (that is, more liquid) securities.

Answer 4

liquidity preference

Question 5

The rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where suppliers and demanders of funds have no liquidity preferences and there is no risk.

Answer 5

real rate of interest

Question 6

The actual rate of interest charged by the supplier of funds and paid by the demander.

Answer 6

nominal rate of interest

Question 7

A general trend of falling prices.

Answer 7

deflation

Question 8

The relationship between the maturity and rate of return for bonds with similar levels of ris

Answer 8

term structure of interest rates

Question 9

A graphic depiction of the term structure of interest rates

Answer 9

yield curve

Question 10

Compound annual rate of return earned on a debt security purchased on a given day and held to maturity.

Answer 10

yield to maturity (YTM)

Question 11

A
downward-sloping
yield curve indicates that short-term interest rates are generally higher than long-term interest rates.

Answer 11

inverted yield curve

Question 12

An
upward-sloping
yield curve indicates that long-term interest rates are generally higher than short-term interest rates.

Answer 12

normal yield curve

Question 13

A yield curve that indicates that interest rates do not vary much at different maturities.

Answer 13

flat yield curve A yield curve that indicates

Question 14

The theory that the yield curve reflects investor expectations about future interest rates; an expectation of rising interest rates results in an upwardsloping yield curve, and an expectation of declining rates results in a downward-sloping yield curve.

Answer 14

expectations theory

Question 15

Theory suggesting that longterm rates are generally higher than short-term rates (hence, the yield curve is upward sloping) because investors perceive short-term investments to be more liquid and less risky than long-term investments. Borrowers must offer higher rates on long-term bonds to entice investors away from their preferred short-term securities.

Answer 15

liquidity preference theory

Question 16

Theory suggesting that the market for loans is segmented on the basis of maturity and that the supply of and demand for loans within each segment determine its prevailing interest rate; the slope of the yield curve is determined by the general relationship between the prevailing rates in each market segment.

Answer 16

market segmentation theory

Question 17

A long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms.

Answer 17

corporate bond

Question 18

The percentage of a bond’s par value that will be paid annually, typically in two equal semiannual payments, as interest.

Answer 18

coupon interest rate

Question 19

A legal document that specifies both the rights of the bondholders and the duties of the issuing corporation.

Answer 19

bond indenture

Question 20

Provisions in a bond indenture specifying certain recordkeeping and general business practices that the bond issuer must follow; normally, they do not place a burden on a financially sound business.

Answer 20

standard debt provisions

Question 21

Provisions in a bond indenture that place operating and financial constraints on the borrower.

Answer 21

restrictive covenants

Question 22

In a bond indenture, the stipulation that subsequent creditors agree to wait until all claims of the senior debt are satisfied.

Answer 22

subordination

Question 23

A restrictive provision often included in a bond indenture, providing for the systematic retirement of bonds prior to their maturity.

Answer 23

sinking-fund requirement

Question 24

A paid individual, corporation, or commercial bank trust department that acts as the third party to a bond indenture and can take specified actions on behalf of the bondholders if the terms of the indenture are violated.

Answer 24

trustee

Question 25

A feature of convertible bonds that allows bondholders to change each bond into a stated number of shares of common stock.

Answer 25

conversion feature

Question 26

A feature included in nearly all corporate bond issues that gives the issuer the opportunity to repurchase bonds at a stated call price prior to

Answer 26

call feature

Question 27

The stated price at which a bond may be repurchased, by use of a call feature, prior to maturity.

Answer 27

call price

Question 28

The amount by which a bond’s call price exceeds its par value

Answer 28

call premium

Question 29

Instruments that give their holders the right to purchase a certain number of shares of the issuer’s common stock at a specified price over a certain period of time.

Answer 29

stock purchase warrant

Question 30

A measure of a bond’s cash return for the year; calculated by dividing the bond’s annual interest payment by its current price.

Answer 30

current yield

Question 31

Debenture
Subordinated Debenture
Income bond

Answer 31

Unsecured bonds

Question 32

Mortgage bonds .
Collateral trust bond
Equipment trust certificate

Answer 32

Secured Bonds

Question 33

A bond issued by an international borrower and sold to investors in countries with currencies other than the currency in which the bond is denominated.

Answer 33

Eurobond

Question 34

A bond that is issued by a foreign corporation or government and is denominated in the investor’s home currency and sold in the investor’s home market.

Answer 34

foreign bond

Question 35

The process that links risk and return to determine the worth of an asset.

Answer 35

valuation

Question 36

The amount by which a bond sells at a value that is less than its par value.

Answer 36

discount

Question 37

The amount by which a bond sells at a value that is greater than its par value

Answer 37

premium

Question 38

The chance that interest rates will change and thereby change the required return and bond value. Rising rates, which result in decreasing bond values, are of greatest concer

Answer 38

interest rate risk