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30)
Coupon 0%
Call Date: July 1, 2008
Call Price 103.74%
Maturity: July 1, 2015
A irm issues the convertible debt shown above. The price of stock in this company on July
1, 2008 is $27.24. What is the minimum conversion ratio that would make a bondholder
prefer to convert rather than accept the call price?
A) 33 shares per $1,000 principal amount
B) 36 shares per $1,000 principal amount
C) 38 shares per $1,000 principal amount
D) 42 shares per $1,000 principal amount
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
31) Which of the following statements is FALSE regarding a call provision?
A) The issuer can repurchase a fraction of the outstanding bonds in the market or it can
make a tender ofer for the entire issue.
B) A call provision allows the issuer to repurchase the bonds at a predetermined price.
C) The call price is generally set at or below, and expressed as a percentage of, the bond's
face value.
D) A call feature allows the issuer of the bond the right (but not the obligation) to retire all
outstanding bonds on (or after) a speciic date (the call date), for the call price.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
28
32) Which of the following statements is FALSE?
A) When bond yields have increased, by exercising the call on the callable bond and then
immediately reinancing, the issuer can lower its borrowing costs.
B) To understand how call provisions afect the price of a bond, we irst need to consider
when an issuer will exercise its right to call the bond.
C) If the call provision ofers a cheaper way to retire the bonds the issuer will forgo the
option of purchasing the bonds in the open market and call the bonds instead.
D) An issuer can always retire one of its bonds early by repurchasing the bond in the open
market.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
33) Which of the following statements is FALSE?
A) The holder of a callable bond faces reinvestment risk precisely when it hurts: when
market rates are lower than the coupon rate she is currently receiving.
B) When yields have risen, the issuer will not choose to exercise the call on the callable
bond.
C) The issuer will exercise the call option only when the prevailing market rate exceeds the
coupon rate of the bond.
D) A callable bond is relatively less attractive to the bondholder than the identical non-
callable bond.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
29
34) Which of the following statements is FALSE?
A) Before the call date, investors anticipate the optimal strategy that the issuer will follow,
and the bond price relects this strategy.
B) The yield to maturity of a callable bond is calculated as if the bond were called at the
earliest opportunity.
C) A callable bond will trade at a lower price (and therefore a higher yield) than an
otherwise equivalent non-callable bond.
D) The price of a callable bond can be low when yields are high, but does not rise above the
call value when the yield is low.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
35) Which of the following statements is FALSE?
A) The assumption that underlies the yield calculation of a callable bond—that it will not be
called—is not always realistic, so bond traders often quote the yield to call.
B) The yield to call (YTC) is the annual yield of a callable bond assuming that the bond is
called at the earliest opportunity.
C) We can think of the yield to maturity of a callable bond as the interest rate the
bondholder receives if the bond is not called and repaid in full.
D) Because the price of a callable bond is higher than the price of an otherwise identical
non-callable bond, the yield to maturity of a callable bond will be lower than the yield to
maturity for its non-callable counterpart.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
30
36) Which of the following statements regarding sinking fund provisions is FALSE?
A) With a sinking fund, if a bond is trading at below its face value, because the bonds are
repurchased at par, the decision as to which bonds to repurchase is made by lottery.
B) With a sinking fund, instead of repaying the entire principal balance on the maturity
date, the company makes regular payments into a sinking fund administered by a trustee
over the life of the bond.
C) Sinking fund provisions usually specify a minimum rate at which the issuer must
contribute to the fund.
D) Because the sinking fund allows the issuer to repurchase the bonds at par, the option to
accelerate the payments is another form of call provision.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
37) Which of the following statements is FALSE?
A) A convertible bond can be thought of as a regular bond plus a special type of call option
called a warrant.
B) On the maturity date of the bond, the strike price of the embedded warrant in a
convertible bond is equal to the face value of the bond divided by the conversion ratio—that
is, the conversion price.
C) Calling a convertible bond transfers the remaining time value of the conversion option
from shareholders to bondholders.
D) If the stock price is low so that the embedded warrant is deep out-of-the-money, the
conversion provision is not worth much and the bond's value is close to the value of a
straight bond—an otherwise identical bond without the conversion provision.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
31
38) A company issues a 10-year, callable bond at par with 8% annual coupon payments. The
bond can be called at par in one year after issue or any time after that on a coupon
payment date. The call price is $104 per $100 of face value. What is the yield to call if this
bond is called in one year?
A) 7%
B) 12%
C) 10%
D) 4%
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
39) A company issues a 20-year, callable bond at par with a(n) 9% annual coupon
payments. The bond can be called at par in three years or any time after that on a coupon
payment date. The call price is $110 per $100 of face value. What is the yield to call?
A) 7%
B) 15%
C) 9%
D) 12%
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
40) When a callable bond sells at a premium, the likelihood of a call is ________ and the
yield to worst is the yield to ________.
A) high, call
B) low, call
C) low, maturity
D) high, maturity.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
32
41) When a callable bond sells at a discount, the bond's coupon rate is ________ than market
yields and the yield to worst is the yield to ________.
A) higher, call
B) lower, maturity
C) lower, call
D) high, maturity
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
42) A convertible bond has a face value of $1,000 and a conversion ratio of 50. This bond
will sell at a premium when which of the following occurs?
A) when market rates fall below the bond's coupon rate
B) when the irm's stock sells for more than $20 per share
C) when market rates rise above the bond's coupon rate
D) A and B
AACSB Objective: Analytic Skills
Author: WC
Question Status: Revised
43) Which of the following is a type of call provision?
A) sinking fund
B) balloon payment
C) conversion feature
D) indenture
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
33
44) A callable bond will typically have a ________ yield than an otherwise identical bond
without a call feature because ________.
A) lower, the irm loses lexibility with a callable bond
B) higher, the irm loses lexibility with a callable bond
C) lower, the option to call a bond is valuable
D) higher, the option to call a bond is valuable
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
45) What are callable bonds?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
46) What is yield to call?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
47) What is yield to maturity?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
48) What is yield to worst?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
34
