Chapter 07 – Interest Rates and Bond Valuation
7-1
Chapter 07
Interest Rates and Bond Valuation
Multiple Choice Questions
1. Mary just purchased a bond which pays $60 a year in interest. What is this $60 called?
A. coupon
B. face value
C. discount
D. call premium
E. yield
2. Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal
payment at maturity. What is the $1,000 called?
A. coupon
B. face value
C. discount
D. yield
E. dirty price
3. A bond’s coupon rate is equal to the annual interest divided by which one of the following?
A. call price
B. current price
C. face value
D. clean price
E. dirty price
4. The specified date on which the principal amount of a bond is payable is referred to as
which one of the following?
A. coupon date
B. yield date
C. maturity
D. dirty date
E. clean date
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5. Currently, the bond market requires a return of 11.6 percent on the 10-year bonds issued by
Winston Industries. The 11.6 percent is referred to as which one of the following?
A. coupon rate
B. face rate
C. call rate
D. yield to maturity
E. interest rate
6. The current yield is defined as the annual interest on a bond divided by which one of the
following?
A. coupon
B. face value
C. market price
D. call price
E. dirty price
7. An indenture is:
A. another name for a bond’s coupon.
B. the written record of all the holders of a bond issue.
C. a bond that is past its maturity date but has yet to be repaid.
D. a bond that is secured by the inventory held by the bond’s issuer.
E. the legal agreement between the bond issuer and the bondholders.
8. Atlas Entertainment has 15-year bonds outstanding. The interest payments on these bonds
are sent directly to each of the individual bondholders. These direct payments are a clear
indication that the bonds can accurately be defined as being issued:
A. at par.
B. in registered form.
C. in street form.
D. as debentures.
E. as callable.
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9. A bond that is payable to whomever has physical possession of the bond is said to be in:
A. new-issue condition.
B. registered form.
C. bearer form.
D. debenture status.
E. collateral status.
10. The Leeward Company just issued 15-year, 8 percent, unsecured bonds at par. These
bonds fit the definition of which one of the following terms?
A. note
B. discounted
C. zero-coupon
D. callable
E. debenture
11. Which of the following defines a note?
I. secured
II. unsecured
III. maturity less than 10 years
IV. maturity in excess of 10 years
A. III only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only
12. A sinking fund is managed by a trustee for which one of the following purposes?
A. paying interest payments
B. early bond redemption
C. converting bonds into equity securities
D. paying preferred dividends
E. reducing coupon rates
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13. A bond that can be paid off early at the issuer’s discretion is referred to as being which one
of the following?
A. zero coupon
B. callable
C. senior
D. collateralized
E. unsecured
14. A $1,000 face value bond can be redeemed early at the issuer’s discretion for $1,030, plus
any accrued interest. The additional $30 is called which one of the following?
A. dirty price
B. redemption value
C. call premium
D. original-issue discount
E. redemption discount
15. A deferred call provision is which one of the following?
A. requirement that a bond issuer pay the current market price, plus accrued interest, should
the firm decide to call a bond
B. ability of a bond issuer to delay repaying a bond until after the maturity date should the
issuer so opt
C. prohibition placed on an issuer which prevents that issuer from ever redeeming bonds prior
to maturity
D. prohibition which prevents bond issuers from redeeming callable bonds prior to a specified
date
E. requirement that a bond issuer pay a call premium which is equal to or greater than one
year’s coupon should that issuer decide to call a bond
16. A call-protected bond is a bond that:
A. is guaranteed to be called.
B. can never be called.
C. is currently being called.
D. is callable at any time.
E. cannot be called during a certain period of time.
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17. The items included in an indenture that limit certain actions of the issuer in order to
protect bondholder’s interests are referred to as the:
A. trustee relationships.
B. bylaws.
C. legal bounds.
D. “plain vanilla” conditions.
E. protective covenants.
18. A bond that has only one payment, which occurs at maturity, defines which one of the
following?
A. debenture
B. callable
C. floating-rate
D. junk
E. zero coupon
19. Which one of the following is the price a dealer will pay to purchase a bond?
A. call price
B. asked price
C. bid price
D. bid-ask spread
E. par value
20. You want to buy a bond from a dealer. Which one of the following prices will you pay?
A. call price
B. auction price
C. bid price
D. asked price
E. bid-ask spread
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21. The difference between the price that a dealer is willing to pay and the price at which he
or she will sell is called the:
A. equilibrium.
B. premium.
C. discount.
D. call price.
E. spread.
22. A bond is quoted at a price of $989. This price is referred to as which one of the
following?
A. call price
B. face value
C. clean price
D. dirty price
E. wholesale price
23. Pete paid $1,032 as his total cost of purchasing a bond. This price is referred to as the:
A. quoted price.
B. spread price.
C. clean price.
D. dirty price.
E. call price.
24. Real rates are defined as nominal rates that have been adjusted for which of the
following?
A. inflation
B. default risk
C. accrued interest
D. interest rate risk
E. both inflation and interest rate risk
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25. Interest rates that include an inflation premium are referred to as:
A. annual percentage rates.
B. stripped rates.
C. effective annual rates.
D. real rates.
E. nominal rates.
26. The Fisher effect is defined as the relationship between which of the following variables?
A. default risk premium, inflation risk premium, and real rates
B. nominal rates, real rates, and interest rate risk premium
C. interest rate risk premium, real rates, and default risk premium
D. real rates, inflation rates, and nominal rates
E. real rates, interest rate risk premium, and nominal rates
27. The pure time value of money is known as the:
A. liquidity effect.
B. Fisher effect.
C. term structure of interest rates.
D. inflation factor.
E. interest rate factor.
28. Which one of the following premiums is compensation for expected future inflation?
A. default risk
B. taxability
C. liquidity
D. inflation
E. interest rate risk
29. The interest rate risk premium is the:
A. additional compensation paid to investors to offset rising prices.
B. compensation investors demand for accepting interest rate risk.
C. difference between the yield to maturity and the current yield.
D. difference between the market interest rate and the coupon rate.
E. difference between the coupon rate and the current yield.
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30. A Treasury yield curve plots Treasury interest rates relative to which one of the
following?
A. market rates
B. comparable corporate bond rates
C. the risk-free rate
D. inflation
E. maturity
31. Which one of the following risk premiums compensates for the possibility of nonpayment
by the bond issuer?
A. default risk
B. taxability
C. liquidity
D. inflation
E. interest rate risk
32. The taxability risk premium compensates bond holders for which one of the following?
A. yield decreases in response to market changes
B. lack of coupon payments
C. possibility of default
D. a bond’s unfavorable tax status
E. decrease in a municipality’s credit rating
33. The liquidity premium is compensation to investors for:
A. purchasing a bond in the secondary market.
B. the lack of an active market wherein a bond can be sold for its actual value.
C. acquiring a bond with an unfavorable tax status.
D. redeeming a bond prior to maturity.
E. purchasing a bond that has defaulted on its coupon payments.
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34. An 8 percent corporate bond that pays interest semi-annually was issued last year. Which
two of the following most likely apply to this bond today if the current yield-to-maturity is 7
percent?
I. a structure as an interest-only loan
II. a current yield that equals the coupon rate
III. a yield-to-maturity equal to the coupon rate
IV. a market price that differs from the face value
A. I and III only
B. I and IV only
C. II and III only
D. II and IV only
E. III and IV only
35. A bond has a market price that exceeds its face value. Which of the following features
currently apply to this bond?
I. discounted price
II. premium price
III. yield-to-maturity that exceeds the coupon rate
IV. yield-to-maturity that is less than the coupon rate
A. III only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only
36. All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to
maturity.
A. a premium; less than
B. a premium; equal to
C. a discount; less than
D. a discount; higher than
E. par; less than
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37. The Walthers Company has a semi-annual coupon bond outstanding. An increase in the
market rate of interest will have which one of the following effects on this bond?
A. increase the coupon rate
B. decrease the coupon rate
C. increase the market price
D. decrease the market price
E. increase the time period
38. Which of the following are characteristics of a premium bond?
I. coupon rate < yield-to-maturity
II. coupon rate > yield-to-maturity
III. coupon rate < current yield
IV. coupon rate > current yield
A. I only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only
39. Which of the following relationships apply to a par value bond?
I. coupon rate < yield-to-maturity
II. current yield = yield-to-maturity
III. market price = call price
IV. market price = face value
A. I and II only
B. I and III only
C. II and IV only
D. I, II, and III only
E. II, III, and IV only
40. Which one of the following relationships is stated correctly?
A. The coupon rate exceeds the current yield when a bond sells at a discount.
B. The call price must equal the par value.
C. An increase in market rates increases the market price of a bond.
D. Decreasing the time to maturity increases the price of a discount bond, all else constant.
E. Increasing the coupon rate decreases the current yield, all else constant.
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41. Green Roof Inns is preparing a bond offering with a 6 percent, semiannual coupon and a
face value of $1,000. The bonds will be repaid in 10 years and will be sold at par. Given this,
which one of the following statements is correct?
A. The bonds will become discount bonds if the market rate of interest declines.
B. The bonds will pay 10 interest payments of $60 each.
C. The bonds will sell at a premium if the market rate is 5.5 percent.
D. The bonds will initially sell for $1,030 each.
E. The final payment will be in the amount of $1,060.
42. A newly issued bond has a 7 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. 3.5 percent.
B. greater than 3.5 percent but less than 7 percent.
C. 7 percent.
D. greater than 7 percent.
E. Answer cannot be determined from the information provided.
43. Which of the following increase the price sensitivity of a bond to changes in interest rates?
I. increase in time to maturity
II. decrease in time to maturity
III. increase in coupon rate
IV. decrease in coupon rate
A. II only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only
44. Which one of the following bonds is the least sensitive to interest rate risk?
A. 3-year; 4 percent coupon
B. 3-year; 6 percent coupon
C. 5-year; 6 percent coupon
D. 7-year; 6 percent coupon
E. 7-year; 4 percent coupon
Chapter 07 – Interest Rates and Bond Valuation
45. As a bond’s time to maturity increases, the bond’s sensitivity to interest rate risk:
A. increases at an increasing rate.
B. increases at a decreasing rate.
C. increases at a constant rate.
D. decreases at an increasing rate.
E. decreases at a decreasing rate.
46. You own a bond that has a 6 percent annual coupon and matures 5 years from now. You
purchased this 10-year bond at par value when it was originally issued. Which one of the
following statements applies to this bond if the relevant market interest rate is now 5.8
percent?
A. The current yield-to-maturity is greater than 6 percent.
B. The current yield is 6 percent.
C. The next interest payment will be $30.
D. The bond is currently valued at one-half of its issue price.
E. You will realize a capital gain on the bond if you sell it today.
