Chapter 07: Bonds and Their Valuation
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1. If a firm raises capital by selling new bonds, it could be called the “issuing firm,” and the coupon rate is generally set
equal to the required rate on bonds of equal risk.
a. True
b. False
2. A call provision gives bondholders the right to demand, or “call for,” repayment of a bond. Typically, companies call
bonds if interest rates rise and do not call them if interest rates decline.
a. True
b. False
3. Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis
prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1)
purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery
administered by the trustee, in which case the price paid is the bond’s face value.
a. True
b. False
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9. Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally
be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond.
a. True
b. False
10. As a general rule, a company’s debentures have higher required interest rates than its mortgage bonds because
mortgage bonds are backed by specific assets while debentures are unsecured.
a. True
b. False
11. Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers,
and to provide financing to companies of questionable financial strength.
a. True
b. False
Chapter 07: Bonds and Their Valuation
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a. True
b. False
15. Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-
rate debt shifts price risk to companies, it offers no advantages to corporate issuers.
a. True
b. False
16. A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and
is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if
interest rates are greater than 10%.
a. True
b. False
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19. The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds,
other things held constant.
a. True
b. False
20. Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such
covenants are spelled out in bond indentures.
a. True
b. False
21. Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second
mortgage bonds.
a. True
b. False
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a. The bond’s coupon rate exceeds its current yield.
b. The bond’s current yield exceeds its yield to maturity.
c. The bond’s yield to maturity is greater than its coupon rate.
d. The bond’s current yield is equal to its coupon rate.
e. If the yield to maturity stays constant until the bond matures, the bond’s price will remain at $850.
33. Which of the following statements is CORRECT?
a. If a bond is selling at a discount, the yield to call is a better measure of return than is the yield to maturity.
b. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not
purchase a bond with an expected capital loss.
c. On an expected yield basis, the expected current yield will always be positive because an investor would not
purchase a bond that is not expected to pay any cash coupon interest.
d. If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield
is zero.
e. The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to
maturity than Bond B.
34. Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond
8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at
par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
a. Bond 8’s current yield will increase each year.
Chapter 07: Bonds and Their Valuation
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b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected
to change, their prices should all remain at their current levels until maturity.
c. Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
d. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year.
e. Over the next year, Bond 8’s price is expected to decrease, Bond 10’s price is expected to stay the same, and
Bond 12’s price is expected to increase.
35. A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following
statements is CORRECT?
a. The bond’s current yield is less than 8%.
b. If the yield to maturity remains at 8%, then the bond’s price will decline over the next year.
c. The bond’s coupon rate is less than 8%.
d. If the yield to maturity increases, then the bond’s price will increase.
e. If the yield to maturity remains at 8%, then the bond’s price will remain constant over the next year.
Chapter 07: Bonds and Their Valuation
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c. A 10-year bond with an 8% coupon.
d. A 10-year bond with a 12% coupon.
e. A 10-year zero coupon bond.
43. Which of the following statements is CORRECT?
a. All else equal, high-coupon bonds have less reinvestment risk than low-coupon bonds.
b. All else equal, long-term bonds have less price risk than short-term bonds.
c. All else equal, low-coupon bonds have less price risk than high-coupon bonds.
d. All else equal, short-term bonds have less reinvestment risk than long-term bonds.
e. All else equal, long-term bonds have less reinvestment risk than short-term bonds.
44. Which of the following statements is CORRECT?
a. One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until
it matures or is sold.
b. Long-term bonds have less price risk but more reinvestment risk than short-term bonds.
c. If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less
price risk.
d. Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more price risk but less
reinvestment risk.
e. Long-term bonds have less price risk and also less reinvestment risk than short-term bonds.
