4) Which of the following statements is FALSE?
A) The bond’s expected return, which is equal to the firm’s debt cost of capital, is less than the
yield to maturity if there is a risk of default.
B) The two best-known bond-rating companies are Standard & Poor’s and Dow Jones.
C) Bonds in the bottom five categories are often call speculative bonds, junk bonds, or high-yield
bonds.
D) Bond ratings encourage widespread investor participation and relatively liquid markets.
5) Which of the following statements is FALSE?
A) Bond ratings encourage widespread investor participation and relatively liquid markets.
B) Bonds in the top four categories are often referred to as investment grade bonds.
C) A bond’s rating depends on the risk of bankruptcy as well as the bondholder’s ability to lay
claim to the firm’s assets in the event of a bankruptcy.
D) Debt issues with a low-priority claim in bankruptcy will have a better rating than issues from
the same company that have a higher priority in bankruptcy.
6) Which of the following statements is FALSE?
A) Investors pay less for bonds with credit risk than they would for an otherwise identical
default-free bond.
B) Credit spreads fluctuate as perceptions regarding the probability of default change.
C) Credit spreads are high for bonds with high ratings.
D) We refer to the difference between the yields of the corporate bonds and the Treasury yields
as the default spread or credit spread.
7) Taggart Transcontinental has issued at par a zero-coupon bond with a ten-year maturity.
Investors believe there is a 10% chance that Taggart Transcontinental will default on these
bonds. If they do default, investors expect to receive only 50 cents per dollar they are owned. If
investors require an 8% return on their investment in these bonds, then the yield to maturity on
these bonds will be closest to (assume annual compounding):
A) 6.0%
B) 6.5%
C) 7.0%
D) 8.0%
Use the following information to answer the question(s) below.
Security
Term
(years)
Yield
(%)
Treasury
20
5.5%
AAA Corporate
20
7.0%
BBB Corporate
20
8.0%
B Corporate
20
9.6%
8) The credit spread on AAA-rated corporate bonds is:
A) 1.0%
B) 1.5%
C) 2.6%
D) 4.1%
9) The credit spread on B-rated corporate bonds is:
A) 1.0%
B) 1.5%
C) 2.6%
D) 4.1%
10) Wyatt Oil is contemplating issuing a 20-year bond with semiannual coupons, a coupon rate
of 7%, and a face value of $1000. Wyatt Oil believes it can get a BBB rating from Standard and
Poor’s for this bond issue. If Wyatt Oil is successful in getting a BBB rating, then the issue price
for these bonds would be closest to:
A) $800
B) $891
C) $901
D) $1,000
11) Wyatt oil is contemplating issuing a 20-year bond with semiannual coupons, a coupon rate of
8%, and a face value of $1000. Wyatt Oil believes it can get a AAA rating from Standard and
Poor’s for this bond issue. If Wyatt Oil is successful in getting a AAA rating, then the issue price
for these bonds would be closest to:
A) $891
B) $901
C) $1,000
D) $1,107
Use the table for the question(s) below.
Consider the following yields to maturity on various one-year zero-coupon securities:
Security
Yield (%)
Treasury
4.6
AAA corporate
4.8
BBB corporate
5.6
B Corporate
6.2
12) The price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate
bond with a BBB rating is closest to:
A) 95.60
B) 94.16
C) 95.42
D) 94.70
13) The price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate
bond with a AAA rating is closest to:
A) 94.70
B) 95.60
C) 94.16
D) 95.42
14) The credit spread of the BBB corporate bond is closest to:
A) 1.0%
B) 5.6%
C) 1.6%
D) 0.8%
15) The credit spread of the B corporate bond is closest to:
A) 1.6%
B) 0.8%
C) 1.0%
D) 1.4%
Use the information for the question(s) below.
Luther Industries needs to raise $25 million to fund a new office complex. The company plans
on issuing ten-year bonds with a face value of $1000 and a coupon rate of 7.0% (annual
payments). The following table summarizes the YTM for similar ten-year corporate bonds of
various credit ratings:
Rating
AAA
A
BBB
BB
YTM
6.70%
7.00%
7.40%
8.00%
16) Assuming that Luther’s bonds receive a AAA rating, the price of the bonds will be closest to:
A) $1021
B) $1014
C) $1000
D) $937
17) Assuming that Luther’s bonds receive a AAA rating, the number of bonds that Luther must
issue to raise the needed $25 million is closest to:
A) 24,655
B) 25,000
C) 24,477
D) 26,681
18) What rating must Luther receive on these bonds if they want the bonds to be issued at par?
A) A
B) B
C) BBB
D) AA
19) Suppose that when these bonds were issued, Luther received a price of $972.42 for each
bond. What is the likely rating that Luther’s bonds received?
A) AA
B) BBB
C) B
D) A
20) Explain why the expected return of a corporate bind does not equal its yield to maturity?
6.5 Sovereign Bonds
1) Sovereign debt is:
A) debt issued by national governments.
B) debt denominated in sovereigns.
C) always riskless.
D) debt issued by Greece.
2) According to Figure 6.5, the percent of countries in default or restructuring debt:
A) hit an all-time high in 2000-2005.
B) peaked during World War II.
C) is high whenever Greece defaults.
D) is never more than 1/3.
3) A key difference between sovereign default and corporate bonds is:
A) unlike a corporation, a country facing difficulty meeting its financial obligations is can not
default.
B) unlike corporate debt, sovereign debt prices are not inverse to yields.
C) unlike a corporation, any country can turn to the EMU to pay off its debts.
D) unlike a corporation, a country facing difficulty meeting its financial obligations typically has
the option to print more currency.
4) An exception to the key difference between sovereign default and corporate bonds is:
A) member states of the U.S.
B) member states of the EMU.
C) member states of the African Union.
D) member states of the NAFTA.
6.6 Appendix: Forward Interest Rates
1) Forward interest rates:
A) accurately predict future spots rates because of the law of one price.
B) tend not to be good predictors of future spot rates.
C) tend to be biased downward as predictors of future spot rates when the yield curve is upward
sloping.
D) tend to be biased upward as predictors of future spot rates when the yield curve is downward
sloping.
2) Which of the following statements is FALSE?
A) The forward rate for year 1 is the rate on an investment that starts today and is repaid in one
year; it is equivalent to an investment in a one-year zero-coupon bond.
B) The forward rate is only a good predictor of spot interest rates in the future when investors are
risk adverse.
C) We can use the law of one price to calculate the forward rate from the zero-coupon yield
curve.
D) An interest rate forward contract is a contract today that fixes the interest rate for a loan or
investment in the future.
3) Which of the following statements is FALSE?
A) In general, the expected future spot interest rate will reflect investor’s preferences toward the
risk of future interest rate fluctuations.
B) If investors did not care about risk, then they would be indifferent between investing in a two-
year bond and investing in a one-year bond and rolling over the money in one-year.
C) When we refer to the one-year forward rate for year 5, we mean the rate available today on a
one-year investment that begins four years from today and is repaid five years from today.
D) In general, we can compute the forward rate for year n by comparing an investment in an n–
year, zero-coupon bond to an investment in an (n + 1) year, zero-coupon bond, with the interest
rate earned in the nth year being guaranteed through an interest rate forward contract.
4) Which of the following statements is FALSE?
A) Forward rates tend not to be good predictors of future spot rates.
B) Given the risk associated with interest rate changes, corporate managers require tools to help
manage this risk.
C) One of the most important tools to manage the risk of interest rate changes are interest rate
forward contracts.
D) A spot rate is an interest rate that we can guarantee today for a loan or investment that will
occur in the future.
5) Which of the following equations is INCORRECT?
A) Expected future spot interest rate = forward interest rate + risk premium
B) (1 + f1) × (1 + f2) × (1 + f3) × … × (1 + fn) = (1 + YTMn)n
C) fn = – 1
D) (1 + YTMn)n = (1 + YTMn – 1)n – 1(1 + fn)
Use the table for the question(s) below.
Consider the following zero-coupon yields on default free securities:
Maturity (years)
1
3
4
5
Zero-Coupon YTM
5.80%
5.20%
5.00%
4.80%
6) The forward rate for year 2 (the forward rate quoted today for an investment that begins in one
year and matures in two years) is closest to:
A) 5.80%
B) 5.50%
C) 5.20%
D) 5.65%
7) The forward rate for year 3 (the forward rate quoted today for an investment that begins in two
years and matures in three years) is closest to:
A) 4.5%
B) 5.0%
C) 5.2%
D) 4.6%
8) The forward rate for year 4 (the forward rate quoted today for an investment that begins in
three years and matures in four years) is closest to:
A) 4.5%
B) 4.6%
C) 4.4%
D) 5.0%
9) The forward rate for year 5 (the forward rate quoted today for an investment that begins in
four years and matures in five years) is closest to:
A) 4.0%
B) 3.8%
C) 4.8%
D) 4.2%