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CFIN4
Chapter 6 – Bonds (Debt) – Characteristics and Valuation
1. Typically, debentures have higher interest rates than mortgage bonds primarily because the mortgage bonds are
backed by assets while debentures are unsecured.
a. True
b. False
2. A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are
exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and
reinvest it elsewhere at higher rates.
a. True
b. False
3. Issuing zero coupon bonds might appeal to a company that is considering investing in a long-term project that will
not generate positive cash flows for several years.
a. True
b. False
4. The motivation for floating rate bonds arose out of the costly experience of the early 1980s when inflation pushed
interest rates to very high levels causing sharp declines in the prices of long-term bonds.
a. True
b. False
CFIN4
Chapter 6 – Bonds (Debt) – Characteristics and Valuation
5. Because junk bonds are such high-risk instruments, the returns on such bonds aren't very high and the existence of
this market detracts from social welfare.
a. True
b. False
6. There is an inverse relationship between bond ratings and the required return on a bond. The required return is
lowest for AAA rated bonds, and required returns increase as the ratings get lower (worse).
a. True
b. False
7. LIBOR is an acronym for London Interbank Offer Rate, which is an average of interest rates offered by London
banks to U.S. corporations.
a. True
b. False
8. In general, long-term unsecured debt is less costly than long-term secured for a particular firm.
a. True
b. False
CFIN4
Chapter 6 – Bonds (Debt) – Characteristics and Valuation
9. Foreign debt is a debt instrument sold by a foreign borrower but denominated in the currency of the country in
which it is sold.
a. True
b. False
10. Foreign debt is debt sold in a country other than the one in whose currency the debt is denominated.
a. True
b. False
11. Eurobonds have a higher level of required disclosure than normally is found for bonds issued in domestic markets,
particularly the United States.
a. True
b. False
12. Eurobonds are typically issued as registered bonds rather than bearer bonds.
a. True
b. False
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
13. Eurocredits are bank loans that are denominated in the currency of a country other than where the lending bank is
located.
a. True
b. False
14. Although common stock represents a riskier investment to an individual than do bonds, in the sense of exposing the
firm to the risk of bankruptcy, bonds represent a riskier method of financing to a corporation than does common
stock.
a. True
b. False
15. Restrictive covenants are designed so as to protect both the bondholder and the issuer even though they may
constrain the actions of the firm's managers. Such covenants are contained in the bond's indenture.
a. True
b. False
16. One of the disadvantages to a firm in issuing zero coupon bonds is that the tax shield associated with the bonds'
appreciation cannot be claimed until the bond matures.
a. True
b. False
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
17. Floating rate debt is advantageous to investors because the interest rate moves up if market rates rise. Floating rate
debt shifts interest rate risk to companies and thus has no advantages for issuers.
a. True
b. False
18. If a firm raises capital by selling new bonds, the buyer is called the "issuing firm," and the coupon rate is generally
set equal to the required rate.
a. True
b. False
19. A 20-year original maturity bond with 1 year left to maturity has more interest rate price risk than a 10-year original
maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates.)
a. True
b. False
20. Regardless of the size of the coupon payment, the price of a bond moves in the opposite direction from interest rate
movements. For example, if interest rates rise, bond prices fall.
a. True
b. False
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
21. Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, be
subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.
a. True
b. False
22. A bond's value will increase as interest rates rise over time.
a. True
b. False
23. You have just noticed in the financial pages of the local newspaper that you can buy a bond ($1,000 par) for $800.
If the coupon rate is 10 percent, with annual interest payments, and there are 10 years to maturity, should you make
the purchase if your required return on investments of this type is 12 percent?
a. True
b. False
24. If two bonds have the same maturity and the same expected rate of return, but one has a higher coupon, the price
of the low coupon bond will be more affected by a given change in interest rates.
a. True
b. False
25. A bond with a $100 annual interest payment and $1,000 face value with five years to maturity (not expected to
default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates
were greater than 11%.
a. True
b. False
26. Call provisions on corporate bonds are generally included to protect the issuer against large declines in interest
rates. They affect the actual maturity of the bond but not its price.
a. True
b. False
27. Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10 percent currently have a
yield to maturity (YTM) equal to 8 percent. Based on this information, BB&C's bonds must currently be selling at
a premium in the financial markets.
a. True
b. False
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
28. If a bond is callable, and if interest rates in the economy decline, then the company can sell a new issue of low-
interest-rate bonds and use the proceeds to "call" the old bonds in and have effectively refinanced at a lower rate.
a. True
b. False
29. If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be selling at
a discount; i.e., the bond's market price should be less than its face (maturity) value.
a. True
b. False
30. If you buy a bond that is selling for less than its face, or maturity, value then the price (value) of the bond will
increase the maturity date nears if market interest rates do not change during the life of the bond.
a. True
b. False
31. The longer the maturity of a bond, the more its price will change in response to a given change in interest rates; this
is called interest rate price risk.
a. True
b. False
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
32. Bonds with long maturities expose the investor to high interest rate reinvestment risk, which is the risk that income
will differ from what is expected because the cash flows received from bonds will have to be reinvested at
different interest rates.
a. True
b. False
33. If we have two bonds with a simple interest rate yield of 9% where one bond is compounded quarterly and the
other bond is compounded monthly, the bond compounded quarterly will have a higher effective annual yield.
a. True
b. False
34. All else equal, a zero-coupon bond's price is more sensitive to changes interest rates than a bond with a 10% annual
coupon.
a. True
b. False
35. Which of the following are generally considered advantages of term loans over publicly issued bonds?
a. Lower flotation costs.
b. Speed, or how long it takes to bring the issue to market.
c. Flexibility, or the ability to adjust the bond's terms after it has been issued.
d. All of the above.
e. Only answers b and c above.
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
36. Other things held constant, if a bond indenture contains a call provision, the yield to maturity that would exist
without such a call provision will generally be the YTM with it.
a. Higher than
b. Lower than
c. The same as
d. Either higher or lower, depending on the level of call premium, than
e. Unrelated to
37. The terms and conditions to which a bond is subject are set forth in its
a. Debenture.
b. Underwriting agreement.
c. Indenture.
d. Restrictive covenants.
e. Call provision.
38. A contract negotiated directly with a bank in which the borrower agrees to make a series of interest and principal
payments on specific dates to the bank is called
a. preferred stock.
b. commercial paper.
c. convertible debt.
d. a term loan.
e. a bond issue.
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
39. A bond differs from term in loans in that
a. a bond issue is generally advertised.
b. a bond is sold to many investors.
c. a bond is offered to the public.
d. All of the above.
e. None of the above.
40. Which of the following types of debt are backed by some form of specific property?
a. Debenture.
b. Mortgage bond.
c. Subordinated debt.
d. All of the above.
e. None of the above.
41. A bond that has a claim on assets only after the senior debt has been paid off in the event of liquidation is called
what?
a. Debenture.
b. Income bond.
c. Indenture.
d. Subordinated debenture.
e. Mortgage bond.
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
42. Bonds that can be exchanged for shares of equity at the owner's discretion are called what?
a. Debenture.
b. Indenture.
c. Callable bond
d. Convertible bond.
e. Putable bond.
43. A bond that only pays interest if the firm has sufficient earnings to cover the interest payments is called what?
a. Callable bond.
b. Putable bond.
c. Convertible bond.
d. Income bond.
e. Indexed bond.
44. A bond that can be redeemed for cash at the bondholder's option is called what?
a. Convertible bond.
b. Putable bond.
c. Callable bond.
d. Debenture.
e. Income bond.
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
45. Which of the following events would make it less likely that a company would choose to call its outstanding callable
bonds?
a. Increase in interest rates.
b. Decrease in interest rates.
c. Increase in price of outstanding convertible bonds.
d. A decrease in call premium.
e. Answers b and c only.
46. A bond that pays no annual interest but is sold at a discount below its par value is called what?
a. Mortgage bond.
b. Callable bond.
c. Convertible bond.
d. Putable bond.
e. Zero coupon bond.
47. are high-risk, high-yield bonds used to finance mergers, leveraged buyouts, and troubled companies.
a. Callable bonds
b. Junk bonds
c. Convertible bonds
d. Floating rate bonds
e. Putable bonds
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
48. Which of the following ratings by Moody's represent bonds that are at least investment grade?
a. Caa
b. Baa
c. B
d. Ba
e. None of the above.
49. Which of the following ratings by Standard & Poor's represent speculative grade debt?
a. A
b. B
c. BB
d. BBB
e. None of the above.
50. Which of the following types of debt protect a bondholder against an increase in interest rates?
a. Floating rate debt.
b. Bonds that are redeemable ("putable") at par at the bondholders' option.
c. Bonds with call provisions.
d. All of the above.
e. Only answers a and b above.
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
51. Which of the following statements is correct?
a. A zero coupon bond provides no interest payments during the life of the bond, but it provides its owner with a
capital gain when the bond matures. In the United States, these bonds appeal to high-income investors
because the tax on capital gains income is deferred until the bond matures or is sold.
b. The "penalty" for having a low bond rating is more severe when the Security Market Line (SML) is relatively
steep than when it is not so steep.
c. A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the
yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an
otherwise identical noncallable bond.
d. A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells) at par, therefore
providing compensation to investors in the form of capital appreciation.
e. None of the above is a correct statement.
52. Which of the following statements is false?
a. Any bond sold outside the country of the borrower is called an international bond.
b. Foreign bonds and Eurobonds are two important types of international bonds.
c. Foreign bonds are bonds sold by a foreign borrower but denominated in the currency of the country in which
the issue is sold.
d. The term Eurobond specifically applies to any foreign bonds denominated in U.S. currency.
e. None of the above.
53. Which type of investor would be most likely to purchase zero coupon bonds?
a. Retired individuals seeking income for current consumption.
b. Individuals in high tax brackets.
c. Tax free investors such as pension funds.
d. Risk averse individuals anticipating increases in interest rates.
e. None of the above.
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
54. Which of the following securities is the riskiest to investors?
a. Floating rate notes.
b. Income bonds.
c. Treasury bills.
d. First mortgage bonds.
e. Common stock.
55. Listed below are some provisions that are often contained in bond indentures:
1. Fixed assets may be used as security.
2. The bond may be subordinated to other classes of debt.
3. The bond may be made convertible.
4. The bond may have a sinking fund.
5. The bond may have a call provision.
6. The bond may have restrictive covenants in its indenture.
Which of the above provisions, each viewed alone, would tend to reduce the yield to maturity investors would
otherwise require on a newly issued bond?
a. 1, 2, 3, 4, 5, 6
b. 1, 2, 3, 4, 6
c. 1, 3, 4, 5, 6
d. 1, 3, 4, 6
e. 1, 4, 6
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
56. Rollincoast Incorporated issued BBB bonds two years ago that provided a yield to maturity of 11.5 percent. Long-
term risk-free government bonds were yielding 8.7 percent at that time. The current risk premium on BBB bonds
versus government bonds is half what it was two years ago. If the risk-free long-term governments are currently
yielding 7.8 percent, then at what rate should Rollincoast expect to issue new bonds?
a. 7.8%
b. 8.7%
c. 9.2%
d. 10.2%
e. 12.9%
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
57. S. Claus & Company is planning a zero coupon bond issue. The bond has a par value of $1,000, matures in 2 years,
and will be sold at a price of $826.45. The firm's marginal tax rate is 40 percent. What is the annual after-tax cost
of debt to the company on this issue?
a. 4.0%
b. 6.0%
c. 8.0%
d. 10.0%
e. 12.0%
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Chapter 6 – Bonds (Debt) – Characteristics and Valuation
58. GP&L sold $1,000,000 of 12 percent, 30-year, semiannual payment bonds 15 years ago. The bonds are not callable,
but they do have a sinking fund which requires GP&L to redeem 5 percent of the original face value of the issue
each year ($50,000), beginning in Year 11. To date, 25 percent of the issue has been retired. The company can
either call bonds at par for sinking fund purposes or purchase bonds on the open market, spending sufficient money
to redeem 5 percent of the original face value each year. If the yield to maturity (15 years remaining) on the bonds
is currently 14 percent, what is the least amount of money GP&L must put up to satisfy the sinking fund provision?
a. $43,856
b. $50,000
c. $37,500
d. $43,796
e. $39,422
59. Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10.65 percent currently have
a yield to maturity (YTM) equal to 15.25 percent. Based on this information, BB&C's bonds must currently be
selling at in the financial markets.
a. par value
b. a discount
c. a premium
d. Not enough information is given to answer this question.
e. None of the above is a correct answer.
60. If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be
a. selling at a discount; i.e., the bond's market price should be less than its face (maturity) value.
b. selling at a premium; i.e., the bond's market price should be greater than its face value.
c. selling at par; i.e., the bond's market price should be the same as its face value.
d. purchased because it is a good deal.
61. A 12-year bond that has a 12 percent coupon rate is currently selling for $1,000, which equals the bond's face
value. If interest is paid semiannually, the bond's yield to maturity is
a. equal to 12 percent.
b. greater than 12 percent.
c. less than 12 percent.
d. More information is needed to answer this question.
e. None of the above is correct.
