c.
Junk bonds typically provide a lower yield to maturity than investment-grade bonds.
d.
A debenture is a secured bond that is backed by some or all of the firm’s fixed assets.
e.
Junior debt is debt that has been more recently issued, and in bankruptcy it is paid off after
senior debt because the senior debt was issued first.
68. Which of the following statements is CORRECT?
a.
Other things held constant, a callable bond should have a lower yield to maturity than a
noncallable bond.
b.
Once a firm declares bankruptcy, it must then be liquidated by the trustee, who uses the
proceeds to pay bondholders, unpaid wages, taxes, and lawyer fees.
c.
Income bonds must pay interest only if the company earns the interest. Thus, these
securities cannot bankrupt a company prior to their maturity, and this makes them safer to
the issuing corporation than “regular” bonds.
d.
A firm with a sinking fund that gave it the choice of calling the required bonds at par or
buying the bonds in the open market would generally choose the open market purchase if
the coupon rate exceeded the going interest rate.
e.
One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax
savings from the debt until the bonds mature.
69. Which of the following statements is CORRECT?
a.
All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required
return for bonds of similar risk is 8%.
b.
The price of a discount bond will increase over time, assuming that the bond’s yield to
maturity remains constant.
c.
For a given firm, its debentures are likely to have a lower yield to maturity than its
mortgage bonds.
d.
When large firms are in financial distress, they are almost always liquidated, whereas
smaller firms are generally reorganized.
e.
The total return on a bond during a given year consists only of the coupon interest
payments received.
70. Which of the following statements is NOT CORRECT?
a.
The expected return on a corporate bond must be less than its promised return if the
probability of default is greater than zero.
b.
All else equal, senior debt has less default risk than subordinated debt.
c.
A company’s bond rating is affected by its financial ratios and provisions in its indenture.
d.
Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy
must be liquidated, and the sale proceeds must be used to pay off its debt according to the
seniority of the debt as spelled out in the Act.
e.
All else equal, secured debt is less risky than unsecured debt.
71. Which of the following statements is CORRECT?
a.
A bond is likely to be called if its market price is below its par value.
b.
Even if a bond’s YTC exceeds its YTM, an investor with an investment horizon longer
than the bond’s maturity would be worse off if the bond were called.
c.
A bond is likely to be called if its market price is equal to its par value.
d.
A bond is likely to be called if it sells at a discount below par.
e.
A bond is likely to be called if its coupon rate is below its YTM.
72. Which of the following statements is CORRECT?
a.
A bond’s current yield must always be either equal to its yield to maturity or between its
yield to maturity and its coupon rate.
b.
If a bond sells at par, then its current yield will be less than its yield to maturity.
c.
If a bond sells for less than par, then its yield to maturity is less than its coupon rate.
d.
A discount bond’s price declines each year until it matures, when its value equals its par
value.
e.
Assume that two bonds have equal maturities and are of equal risk, but one bond sells at
par while the other sells at a premium above par. The premium bond must have a lower
current yield and a higher capital gains yield than the par bond.
73. Assume that a 10-year Treasury bond has a 12% annual coupon, while a 15-year T-bond has an 8%
annual coupon. Assume also that the yield curve is flat, and all Treasury securities have a 10% yield to
maturity. Which of the following statements is CORRECT?
a.
If interest rates decline, the prices of both bonds will increase, but the 10-year bond would
have a larger percentage increase in price.
b.
The 10-year bond would sell at a discount, while the 15-year bond would sell at a
premium.
c.
The 10-year bond would sell at a premium, while the 15-year bond would sell at par.
d.
If the yield to maturity on both bonds remains at 10% over the next year, the price of the
10-year bond would increase, but the price of the 15-year bond would fall.
e.
If interest rates decline, the prices of both bonds will increase, but the 15-year bond would
have a larger percentage increase in price.
74. Listed below are some provisions that are often contained in bond indentures. Which of these
provisions, viewed alone, would tend to reduce the yield to maturity that investors would otherwise
require on a newly issued bond?
1.
Fixed assets are used as security for a bond.
2.
A given bond is subordinated to other classes of debt.
3.
The bond can be converted into the firm’s common stock.
4.
The bond has a sinking fund.
5.
The bond has a call provision.
6.
The indenture contains covenants that prevent the use of additional debt.
a.
1, 4, 6
b.
1, 2, 3, 4, 6
c.
1, 2, 3, 4, 5, 6
d.
1, 3, 4, 5, 6
e.
1, 3, 4, 6
75. Suppose International Digital Technologies decides to raise a total of $200 million, with $100 million
as long-term debt and $100 million as common equity. The debt can be mortgage bonds or debentures,
but by an iron-clad provision in its charter, the company can never raise any additional debt beyond
the original $100 million. Given these conditions, which of the following statements is CORRECT?
a.
If the debt were raised by issuing $50 million of debentures and $50 million of first
mortgage bonds, we could be certain that the firm’s total interest expense would be lower
than if the debt were raised by issuing $100 million of debentures.
b.
In this situation, we cannot tell for sure how, or whether, the firm’s total interest expense
on the $100 million of debt would be affected by the mix of debentures versus first
mortgage bonds. The interest rate on each of the two types of bonds would increase as the
percentage of mortgage bonds used was increased, but the result might well be such that
the firm’s total interest charges would not be affected materially by the mix between the
two.
c.
The higher the percentage of debentures, the greater the risk borne by each debenture, and
thus the higher the required rate of return on the debentures.
d.
If the debt were raised by issuing $50 million of debentures and $50 million of first
mortgage bonds, we could be certain that the firm’s total interest expense would be lower
than if the debt were raised by issuing $100 million of first mortgage bonds.
e.
The higher the percentage of debt represented by mortgage bonds, the riskier both types of
bonds will be and, consequently, the higher the firm’s total dollar interest charges will be.
76. Which of the following statements is CORRECT?
a.
If their maturities and other characteristics were the same, a 5% coupon bond would have
more interest rate price risk than a 10% coupon bond.
b.
A 10-year coupon bond would have more reinvestment rate risk than a 5-year coupon
bond, but all 10-year coupon bonds have the same amount of reinvestment rate risk.
c.
A 10-year coupon bond would have more interest rate price risk than a 5-year coupon
bond, but all 10-year coupon bonds have the same amount of interest rate price risk.
d.
If their maturities and other characteristics were the same, a 5% coupon bond would have
less interest rate price risk than a 10% coupon bond.
e.
A zero coupon bond of any maturity will have more interest rate price risk than any
coupon bond, even a perpetuity.
77. Which of the following statements is CORRECT?
a.
All else equal, an increase in interest rates will have a greater effect on the prices of short–
term than long-term bonds.
b.
All else equal, an increase in interest rates will have a greater effect on higher-coupon
bonds than it will have on lower-coupon bonds.
c.
If a bond’s yield to maturity exceeds its coupon rate, the bond’s price must be less than its
maturity value.
d.
If a bond’s yield to maturity exceeds its coupon rate, the bond’s current yield must be less
than its coupon rate.
e.
If two bonds have the same maturity, the same yield to maturity, and the same level of
risk, the bonds should sell for the same price regardless of the bond’s coupon rates.
78. Assuming all else is constant, which of the following statements is CORRECT?
a.
For any given maturity, a 1.0 percentage point decrease in the market interest rate would
cause a smaller dollar capital gain than the capital loss stemming from a 1.0 percentage
point increase in the interest rate.
b.
From a corporate borrower’s point of view, interest paid on bonds is not tax-deductible.
c.
Price sensitivity as measured by the percentage change in price due to a given change in
the required rate of return decreases as a bond’s maturity increases.
d.
For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (rd)
causes a larger dollar capital loss than the capital gain stemming from a 1.0 percentage
point decrease in the interest rate.
e.
A 20-year zero coupon bond has more reinvestment rate risk than a 20-year coupon bond.
79. Kessen Inc.’s bonds mature in 7 years, have a par value of $1,000, and make an annual coupon
payment of $70. The market interest rate for the bonds is 8.5%. What is the bond’s price?
a.
$923.22
b.
$946.30
c.
$969.96
d.
$994.21
e.
$1,019.06
80. Noncallable bonds that mature in 10 years were recently issued by Sternglass Inc. They have a par
value of $1,000 and an annual coupon of 5.5%. If the current market interest rate is 7.0%, at what price
should the bonds sell?
a.
$829.21
b.
$850.47
c.
$872.28
d.
$894.65
e.
$917.01
81. Curtis Corporation’s noncallable bonds currently sell for $1,165. They have a 15-year maturity, an
annual coupon of $95, and a par value of $1,000. What is their yield to maturity?
a.
6.20%
b.
6.53%
c.
6.87%
d.
7.24%
e.
7.62%
82. Sommers Co.’s bonds currently sell for $1,080 and have a par value of $1,000. They pay a $100 annual
coupon and have a 15-year maturity, but they can be called in 5 years at $1,125. What is their yield to
maturity (YTM)?
a.
8.56%
b.
9.01%
c.
9.46%
d.
9.93%
e.
10.43%
83. Sentry Corp. bonds have an annual coupon payment of 7.25%. The bonds have a par value of $1,000, a
current price of $1,125, and they will mature in 13 years. What is the yield to maturity on these bonds?
a.
5.56%
b.
5.85%
c.
6.14%
d.
6.45%
e.
6.77%
84. Meacham Enterprises’ bonds currently sell for $1,280 and have a par value of $1,000. They pay a $135
annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,050. What is their
yield to call (YTC)?
a.
6.39%
b.
6.72%
c.
7.08%
d.
7.45%
e.
7.82%
85. Perry Inc.’s bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and
a par value of $1,000. What is their current yield?
a.
7.39%
b.
7.76%
c.
8.15%
d.
8.56%
e.
8.98%
86. Rogoff Co.’s 15-year bonds have an annual coupon rate of 9.5%. Each bond has face value of $1,000
and makes semiannual interest payments. If you require an 11.0% nominal yield to maturity on this
investment, what is the maximum price you should be willing to pay for the bond?
a.
$891.00
b.
$913.27
c.
$936.10
d.
$959.51
e.
$983.49
87. If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk
premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a
zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?
a.
1.90%
b.
2.09%
c.
2.30%
d.
2.53%
e.
2.78%
88. One year ago Lerner and Luckmann Co. issued 15-year, noncallable, 7.5% annual coupon bonds at
their par value of $1,000. Today, the market interest rate on these bonds is 5.5%. What is the current
price of the bonds, given that they now have 14 years to maturity?
a.
$1,077.01
b.
$1,104.62
c.
$1,132.95
d.
$1,162.00
e.
$1,191.79
89. Currently, Bruner Inc.’s bonds sell for $1,250. They pay a $120 annual coupon, have a 15-year
maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs
other than the call premium would be incurred to call and refund the bonds, and also assume that the
yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the
difference between this bond’s YTM and its YTC? (Subtract the YTC from the YTM.)
a.
2.11%
b.
2.32%
c.
2.55%
d.
2.80%
e.
3.09%
90. Gilligan Co.’s bonds currently sell for $1,150. They have a 6.75% annual coupon rate and a 15-year
maturity, and are callable in 6 years at $1,067.50. Assume that no costs other than the call premium
would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with
rates expected to remain at current levels on into the future. Under these conditions, what rate of return
should an investor expect to earn if he or she purchases these bonds, the YTC or the YTM?
a.
3.92%
b.
4.12%
c.
4.34%
d.
4.57%
e.
4.81%
91. Haswell Enterprises’ bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of
$1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond’s
price?
a.
1,063.09
b.
1,090.35
c.
1,118.31
d.
1,146.27
e.
1,174.93
92. CMS Corporation’s balance sheet as of today is as follows:
Long-term debt (bonds, at par)
$10,000,000
Preferred stock
2,000,000
Common stock ($10 par)
10,000,000
Retained earnings
4,000,000
Total debt and equity
$26,000,000
The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000. They mature
exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is
the current market value of the firm’s debt?
a.
$5,276,731
b.
$5,412,032
c.
$5,547,332
d.
$7,706,000
e.
$7,898,650
93. 5-year Treasury bonds yield 5.5%. The inflation premium (IP) is 1.9%, and the maturity risk premium
(MRP) on 5-year bonds is 0.4%. What is the real risk-free rate, r*?
a.
2.59%
b.
2.88%
c.
3.20%
d.
3.52%
e.
3.87%
Coupon rate
Par value
$1,000
Maturity (Yrs)
Periods/Yr.
YTM
N
I/YR
PMT
$20.00
Book value on balance sheet
Par value
Number of bonds = Book value/Par value
10,000
Calculate the market value of bonds:
Mkt value = PV Number of bonds =
94. The Gergen Group’s 5-year bonds yield 6.85%, and 5-year T-bonds yield 4.75%. The real risk-free rate
is r* = 2.80%, the default risk premium for Gergen’s bonds is DRP = 0.85% versus zero for T-bonds,
the liquidity premium on Gergen’s bonds is LP = 1.25%, and the maturity risk premium for all bonds is
found with the formula MRP = (t − 1) 0.1%, where t = number of years to maturity. What is the
inflation premium (IP) on 5-year bonds?
a.
1.40%
b.
1.55%
c.
1.71%
d.
1.88%
e.
2.06%
95. Chandler Co.’s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r*
= 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Chandler’s
bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found
with the formula MRP = (t − 1) 0.1%, where t = number of years to maturity. What is the default risk
premium (DRP) on Chandler’s bonds?
a.
0.99%
b.
1.10%
c.
1.21%
d.
1.33%
e.
1.46%
96. Squire Inc.’s 5-year bonds yield 6.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* =
2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Squire’s
bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found
with the formula MRP = (t − 1) 0.1%, where t = number of years to maturity. What is the liquidity
premium (LP) on Squire’s bonds?
a.
0.49%
b.
0.55%
c.
0.61%
d.
0.68%
e.
0.75%
97. Field Industries’ outstanding bonds have a 25-year maturity and $1,000 par value. Their nominal yield
to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $850. What is the
bond’s nominal (annual) coupon interest rate?
a.
6.27%
b.
6.60%
c.
6.95%
d.
7.32%
e.
7.70%
98. Jerome Corporation’s bonds have 15 years to maturity, an 8.75% coupon paid semiannually, and a
$1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a
price of $1,050. What is the bond’s nominal yield to call?
a.
5.01%
b.
5.27%
c.
5.54%
d.
5.81%
e.
6.10%
99. A 25-year, $1,000 par value bond has an 8.5% annual coupon. The bond currently sells for $875. If the
yield to maturity remains at its current rate, what will the price be 5 years from now?
a.
$839.31
b.
$860.83
c.
$882.90
d.
$904.97
e.
$927.60
100. McCurdy Co.’s Class Q bonds have a 12-year maturity, $1,000 par value, and a 5.75% coupon paid
semiannually (2.875% each 6 months), and those bonds sell at their par value. McCurdy’s Class P
bonds have the same risk, maturity, and par value, but the P bonds pay a 5.75% annual coupon.
Neither bond is callable. At what price should the annual payment bond sell?
a.
$943.98
b.
$968.18
c.
$993.01
d.
$1,017.83
e.
$1,043.28
101. Reinegar Corporation is planning two new issues of 25-year bonds. Bond Par will be sold at its $1,000
par value, and it will have a 10% semiannual coupon. Bond OID will be an Original Issue Discount
bond, and it will also have a 25-year maturity and a $1,000 par value, but its semiannual coupon will
be only 6.25%. If both bonds are to provide investors with the same effective yield, how many of the
OID bonds must Reinegar issue to raise $3,000,000? Disregard flotation costs, and round your final
answer up to a whole number of bonds.
a.
4,228
b.
4,337
c.
4,448
d.
4,562
e.
4,676