978-0134083285 Chapter 7 Part 2

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5) Liquidation value is of primary importance to investors because it represents the true amount of cash

that an investor is likely to receive.

Keywords: Liquidation Value

Learning Obj.: L.O. 7.3

AACSB: Reflective Thinking

6) If a bond has a market value that is higher than its par value, then the required return on the bond

must be less than the bond’s coupon rate.

Keywords: Market Value, Par Value, Required Return, Coupon Rate

Learning Obj.: L.O. 7.3

AACSB: Reflective Thinking

7) Harold considers investing in an LM Corp. bond and decides not to purchase the bond. Which of the

following statements is MOST correct?

A) The intrinsic value of the bond for the investor is less than the market value of the bond.

B) The liquidation value of the bond is greater than the market value of the bond.

C) The intrinsic value of the bond for the investor is less than the par value of the bond.

D) The intrinsic value of the bond for the investor is greater than the book value of the bond.

Keywords: Intrinsic Value, Market Value, Book Value, Par Value

Learning Obj.: L.O. 7.3

AACSB: Reflective Thinking

8) In an efficient securities market, the market value of a security is equal to

A) its liquidation value.

B) its book value.

C) its intrinsic value.

D) par value.

Keywords: Efficient Markets, Liquidation Value, Book Value, Intrinsic Value

Learning Obj.: L.O. 7.3

AACSB: Reflective Thinking

9) If markets were entirely efficient (perfect), which of the following would we conclude?

A) There would be no inflation.

B) Book value would be the same as market value.

C) No firms would ever default on their bonds.

D) Market value and intrinsic value would be the same.

Keywords: Efficient Markets, Market Value, Intrinsic Value

Learning Obj.: L.O. 7.3

AACSB: Analytical Thinking

10) Market efficiency implies which of the following?

A) book value = intrinsic value

B) market value = intrinsic value

C) book value = market value

D) liquidation value = book value

Keywords: Efficient Markets, Market Value, Intrinsic Value

Learning Obj.: L.O. 7.3

AACSB: Analytical Thinking

11) When the intrinsic value of an asset exceeds the market value,

A) the asset is undervalued to the investor.

B) the asset is overvalued to the investor.

C) liquidation value must be higher than book value.

D) Market value and intrinsic value are always the same; therefore, this could not happen.

Keywords: Intrinsic Value, Market Value

Learning Obj.: L.O. 7.3

AACSB: Analytical Thinking

12) The present value of the expected future cash flows of an asset represents the asset’s

A) liquidation value.

B) book value.

C) intrinsic value.

D) par value.

Keywords: Intrinsic Value

Learning Obj.: L.O. 7.3

AACSB: Reflective Thinking

13) Which type of value is shown on the firm’s balance sheet?

A) book value

B) liquidation value

C) market value

D) intrinsic value

Keywords: Book Value, Balance Sheet

Learning Obj.: L.O. 7.3

AACSB: Reflective Thinking

14) Explain the different types of value.

Keywords: Intrinsic Value, Market Value

Learning Obj.: L.O. 7.3

AACSB: Reflective Thinking

Learning Objective 7.4

1) In an efficient market, two investors may agree on the amount and timing of a bond’s expected cash

flows and also on the bond’s risk level, as measured by its debt rating, and still determine two different

values for the bond.

Keywords: Determinants of Value, Bonds

Learning Obj.: L.O. 7.4

AACSB: Reflective Thinking

2) Which of the following affect an asset‘s value to an investor?

I. Amount of an asset‘s expected cash flow

II. The riskiness of the cash flows

III. Timing of an asset‘s cash flows

IV. Investor‘s required rate of return

A) I, II, III

B) I, III, IV

C) I, II, IV

D) I, II, III, IV

Keywords: Cash Flow, Risk, Required Return

Learning Obj.: L.O. 7.4

AACSB: Reflective Thinking

3) Finance theory suggests that the current market value of a bond is based upon which of the following?

A) the future value of interest paid on a bond

B) the sum total of principal and interest paid on a bond

C) the sum of the present value of the bond’s interest payments and the present value of the principal

D) the present value of a bond’s par value plus the future value of the bond’s present value

Keywords: Market Value, Present Value

Learning Obj.: L.O. 7.4

AACSB: Reflective Thinking

4) What are the three important elements of asset valuation?

Keywords: Intrinsic Value

Learning Obj.: L.O. 7.4

AACSB: Reflective Thinking

Learning Objective 7.5

1) As interest rates, and consequently investors’ required rates of return, change over time the ________ of

outstanding bonds will change as a result.

A) maturity date

B) coupon interest payment

C) par value

D) price

Keywords: Bond Valuation, Interest Rates

Learning Obj.: L.O. 7.5

AACSB: Analytical Thinking

2) In the present value bond valuation model, risk is generally incorporated into the

A) maturity amount.

B) timing of cash flows (assuming more risky cash flows are received early).

C) discount rate or required return.

D) cash flows (making some smaller if they are more risky).

Keywords: Bond Valuation, Required Return

Learning Obj.: L.O. 7.5

AACSB: Analytical Thinking

3) Fred and Ethel are both considering buying a corporate bond with a coupon rate of 8%, a face value of

$1,000, and a maturity date of January 1, 2025. Which of the following statements is MOST correct?

A) Because both Fred and Ethel will receive the same cash flows if they each buy a bond, they both must

assign the same value to the bond.

B) If Fred decides to buy the bond, then Ethel will also decide to buy the bond, if markets are efficient.

C) Fred and Ethel will only buy the bonds if the bonds are rated BBB or above.

D) Fred may determine a different value for a bond than Ethel because each investor may have a different

level of risk aversion, and hence a different required return.

Keywords: Required Return, Bond Valuation

Learning Obj.: L.O. 7.5

AACSB: Reflective Thinking

Learning Objective 7.6

1) The value of a bond is the present value of both the future interest to be received and the price of the

bond.

Keywords: Bond Valuation, Present Value, Coupon Rate

Learning Obj.: L.O. 7.6

AACSB: Reflective Thinking

2) A bond with a par value of $1,000 is listed in the Wall Street Journal at a price of 100.50. This bond is

selling for $1,005.

Keywords: Bond Quotation, Par Value

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

3) The Wall Street Journal bond quotes indicate that the net close for a bond with a $1,000 par value is

. The closing price for that bond was $100.75.

Keywords: Bond Quotations

Learning Obj.: L.O. 7.6

AACSB: Reflective Thinking

4) The value of a bond is inversely related to changes in the investor‘s present required rate of return.

Keywords: Bond Valuation, Required Return

Learning Obj.: L.O. 7.6

AACSB: Reflective Thinking

5) In Excel, the variable pv stands for a bond‘s par value.

Keywords: Excel, Par Value

Learning Obj.: L.O. 7.6

AACSB: Information Technology

6) When using the pv (present value) function in Excel to calculate bond values, the bond’s coupon rate is

entered as the Rate variable.

Keywords: Excel, Required Return

Learning Obj.: L.O. 7.6

AACSB: Information Technology

7) Charlie Corporation has two bonds outstanding. Both bonds mature in 10 years, have a face value of

$1,000, and have a yield to maturity of 8%. One bond is a zero coupon bond and the other bond has a

coupon rate of 8%. Which of the following statements is true?

A) Both bonds must sell for the same price if markets are in equilibrium.

B) The zero coupon bond must have a higher price because of its greater capital gain potential.

C) The zero coupon bond must sell for a lower price than the bond with an 8% coupon rate.

D) All rational investors will prefer the 8% bond because it pays more interest.

Keywords: Zero Coupon Bond, Coupon Rate, Bond Valuation

Learning Obj.: L.O. 7.6

AACSB: Reflective Thinking

8) Both Investor A and Investor B are considering the purchase of Corporation FJR bonds. The bonds are

selling at a price of $1,100 each. Investor A decides to buy the bonds and Investor B does not buy the

bonds.

A) Investor A must have a required return lower than the required return for Investor B.

B) The yield to maturity for Investor A must be higher than the yield to maturity for Investor B.

C) The yield to maturity for Investor A must be less than the yield to maturity for Investor B.

D) The yield to maturity for this bond must be higher than the coupon rate.

Keywords: Required Return, Bond Valuation

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

9) A bond issued by Liberty, Inc. 10 years ago has a coupon rate of 8% and a face value of $1,000. The

bond will mature in 15 years. What is the value to an investor with a required return of 12.5%?

A) $800

B) $750.86

C) $658.94

D) $701.52

Keywords: Bond Valuation, Required Return, Coupon Rate

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

10) Which of the following will cause the value of a bond to increase, other things held the same?

A) Investors’ required rate of return increases.

B) The company‘s debt rating drops from AAA to BBB.

C) Interest rates decrease.

D) The bond is callable.

Keywords: Bond Valuation, Required Return, Bond Ratings, Callable Bonds

Learning Obj.: L.O. 7.6

AACSB: Reflective Thinking

11) The interest on corporate bonds is typically paid

A) semiannually.

B) annually.

C) quarterly.

D) monthly.

Keywords: Semiannual Interest

Learning Obj.: L.O. 7.6

AACSB: Reflective Thinking

12) Nunavet Ocean Cruises sold an issue of 12-year $1,000 par bonds to build new ships. The bonds pay

4.85% interest, semiannually. Today‘s required rate of return is 9.7%. How much should these bonds sell

for today? Round off to the nearest $1.

A) $771.86

B) $732.93

C) $660.45

D) $598.33

Keywords: Intrinsic Value, Semiannual Interest

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

13) Bryant Inc. just issued $1,000 par 30-year bonds. The bonds sold for $1,107.20 and pay interest

semiannually. Investors require a rate of 7.75% on the bonds. What is the bonds’ coupon rate?

A) 9.333%

B) 7.750%

C) 4.125%

D) 8.675%

Keywords: Coupon Rate, Semiannual Interest, Intrinsic Value

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

14) Valley Manufacturing Inc. just issued $1,000 par 20-year bonds. The bonds sold for $758.18 and pay

interest semiannually. Investors require a rate of 9% on the bonds. What is the bonds‘ coupon rate?

A) 6%

B) 7%

C) 8%

D) 9%

Keywords: Coupon Rate, Semiannual Interest, Intrinsic Value

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

15) PR Corporation just issued $1,000 par 20-year bonds. The bonds sold for $936 and pay interest

semiannually. Investors require a rate of 7.00% on the bonds. What is the amount of the semiannual

interest payment on the bonds?

A) $64.50

B) $55.00

C) $32.00

D) $21.75

Keywords: Semiannual Interest, Required Return

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

16) A Johnson corporation bond is currently selling for $850. The bond matures in 20 years, has a face

value of $1,000, and a yield to maturity of 14.30%. The bond’s coupon rate is

A) 10%.

B) 11%.

C) 12%.

D) 13%.

Keywords: Coupon Rate, Bond Valuation

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

17) LRQ Inc. issued bonds on July 1, 2006. The bonds had a coupon rate of 5.5%, with interest paid

semiannually. The face value of the bonds is $1,000 and the bonds mature on July 1, 2021. What is the

intrinsic value of an LRQ Corporation bond on July 1, 2012 to an investor with a required return of 7%?

A) $901.08

B) $902.27

C) $1,000.00

D) $1,104.28

Keywords: Intrinsic Value, Semiannual Interest, Required Return, Coupon Rate

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

18) Andre owns a corporate bond with a coupon rate of 8% that matures in 10 years. Ruth owns a

corporate bond with a coupon rate of 12% that matures in 25 years. If interest rates go down, then

A) the value of Andre’s bond will decrease and the value of Ruth‘s bond will increase.

B) the value of both bonds will increase.

C) the value of Ruth‘s bond will decrease more than the value of Andre’s bond due to the longer time to

maturity.

D) the value of both bonds will remain the same because they were both purchased in an earlier time

period before the interest rate changed.

Keywords: Intrinsic Value, Time to Maturity

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

19) Assume that Bunch Inc. has an issue of 18-year $1,000 par value bonds that pay 7% interest, annually.

Further assume that today‘s required rate of return on these bonds is 5%. How much would these bonds

sell for today? Round off to the nearest $1.

A) $1,233.79

B) $1,201.32

C) $1,134.88

D) $1,032.56

Keywords: Intrinsic Value, Required Return

Learning Obj.: L.O. 7.6

AACSB: Reflective Thinking

20) What is the value of a bond that has a par value of $1,000, a coupon of $120 (annually), and matures in

10 years? Assume a required rate of return of 7.02%.

A) $1,198.45

B) $1,200.78

C) $1,284.38

D) $1,349.45

Keywords: Intrinsic Value, Bond Valuation

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

21) What is the value of a bond that matures in 17 years, makes an annual coupon payment of $50, and

has a par value of $1,000? Assume a required rate of return of 5.90%.

A) $823.48

B) $856.98

C) $895.23

D) $905.02

Keywords: Intrinsic Value, Bond Valuation

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

22) What is the value of a bond that matures in 5 years, has an annual coupon payment of $110, and a par

value of $2,000? Assume a required rate of return of 8.69%.

A) $938.50

B) $1,876.99

C) $1,891.36

D) $1,749.83

Keywords: Intrinsic Value, Bond Valuation

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking

23) Alice Kitchen‘s, Inc. bonds have a 10% coupon rate with semiannual coupon payments. They have

years to maturity and a par value of $1,000. Compute the value of Alice’s bonds if investors’

required rate of return is 8%.

A) $1,156.22

B) $1,239.33

C) $1,137.10

D) $1,084.44

Keywords: Intrinsic Value, Semiannual Interest

Learning Obj.: L.O. 7.6

AACSB: Analytical Thinking