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Chapter 7: Bonds Conceptual M/C Page 1
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is some overlap between the T/F and the multiple choice questions, as some T/F
statements are used in the MC questions. See the preface for information on the AACSB letter
indicators (F, M, etc.) on the subject lines.
Multiple Choice: True/False
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
4. A zero coupon bond is a bond that pays no interest and is offered (and
initially sells) at par. These bonds provide compensation to investors
in the form of capital appreciation.
a. True
b. False
CHAPTER 7
BONDS AND THEIR VALUATION
Page 2 Conceptual M/C Chapter 7: Bonds
5. The desire for floating-rate bonds, and consequently their increased
usage, arose out of the experience of the early 1980s, when inflation
pushed interest rates up to very high levels and thus caused sharp
declines in the prices of outstanding bonds.
a. True
b. False
6. The market value of any real or financial asset, including stocks,
bonds, or art work purchased in hope of selling it at a profit, may be
estimated by determining future cash flows and then discounting them
back to the present.
a. True
b. False
7. The price sensitivity of a bond to a given change in interest rates is
generally greater the longer the bond's remaining maturity.
a. True
b. False
8. A bond that had a 20-year original maturity with 1 year left to
maturity has more 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, and they cannot be called.)
a. True
b. False
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
Chapter 7: Bonds Conceptual M/C Page 3
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
12. There is an inverse relationship between bonds' quality ratings and
their required rates of return. Thus, the required return is lowest for
AAA-rated bonds, and required returns increase as the ratings get
lower.
a. True
b. False
13. Income bonds pay interest only if the issuing company actually earns
the indicated interest. Thus, these securities cannot bankrupt a
company, and this makes them safer from an investor's perspective than
regular bonds.
a. True
b. False
14. You are considering 2 bonds that will be issued tomorrow. Both are
rated triple B (BBB, the lowest investment-grade rating), both mature in
20 years, both have a 10% coupon, neither can be called except for
sinking fund purposes, and both are offered to you at their $1,000 par
values. However, Bond SF has a sinking fund while Bond NSF does not.
Under the sinking fund, the company must call and pay off 5% of the
bonds at par each year. The yield curve at the time is upward sloping.
The bond's prices, being equal, are probably not in equilibrium, as
Bond SF, which has the sinking fund, would generally be expected to
have a higher yield than Bond NSF.
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%.
Page 4 Conceptual M/C Chapter 7: Bonds
a. True
b. False
17. You have funds that you want to invest in bonds, and you just noticed
in the financial pages of the local newspaper that you can buy a $1,000
par value bond for $800. The coupon rate is 10% (with annual
payments), and there are 10 years before the bond will mature and pay
off its $1,000 par value. You should buy the bond if your required
return on bonds with this risk is 12%.
a. True
b. False
18. If the required rate of return on a bond (rd) is greater than its coupon
interest rate and will remain above that rate, then the market value of
the bond will always be below its par value until the bond matures, at
which time its market value will equal its par value. (Accrued
interest between interest payment dates should not be considered when
answering this question.)
a. True
b. False
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
22. 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.
Chapter 7: Bonds Conceptual M/C Page 5
a. True
b. False
Multiple Choice: Conceptual
Most of these questions can be answered by thinking about relationships and reasoning out
which answer is correct, but some require students to do a few calculations. Even if logical
answers can be determined, it may be useful to confirm them by working out some numbers.
Sometimes data are provided in the question, but sometimes students must make up their own
examples to take the numerical approach.
Most students will have to think carefully to answer the MEDIUM and HARD questions,
and that will take some time. Therefore, the more time they have to do the test or quiz, the better
their scores should be.
Some of the questions are focused on a particular section, but others have statements that
are covered in various sections. In the latter case, we indicate "Comprehensive" rather than
give a section number.
Finally, note that we provide answers only to selected questions. We see no need to
answer relatively easy, obvious questions, so we limit answers to questions where students might
have trouble understanding why their answer is wrong.
23. Which of the following statements is CORRECT?
a. You hold two bonds, a 10-year, zero coupon, issue and a 10-year bond
that pays a 6% annual coupon. The same market rate, 6%, applies to
both bonds. If the market rate rises from its current level, the
zero coupon bond will experience the larger percentage decline.
b. The time to maturity does not affect the change in the value of a
bond in response to a given change in interest rates.
c. You hold two bonds. One is a 10-year, zero coupon, bond and the
other is a 10-year bond that pays a 6% annual coupon. The same
market rate, 6%, applies to both bonds. If the market rate rises
from the current level, the zero coupon bond will experience the
smaller percentage decline.
d. The shorter the time to maturity, the greater the change in the value
of a bond in response to a given change in interest rates, other
things held constant.
e. The longer the time to maturity, the smaller the change in the value
of a bond in response to a given change in interest rates.
24. Which of the following events would make it more likely that a company
would call its outstanding callable bonds?
a. The company’s bonds are downgraded.
b. Market interest rates rise sharply.
c. Market interest rates decline sharply.
d. The company's financial situation deteriorates significantly.
e. Inflation increases significantly.
Page 6 Conceptual M/C Chapter 7: Bonds
25. Assume that interest rates on 20-year Treasury and corporate bonds with
different ratings, all of which are noncallable, are as follows:
T-bond = 7.72% A = 9.64%
AAA = 8.72% BBB = 10.18%
The differences in rates among these issues were most probably caused
primarily by:
a. Real risk-free rate differences.
b. Tax effects.
c. Default and liquidity risk differences.
d. Maturity risk differences.
e. Inflation differences.
26. Under normal conditions, which of the following would be most likely to
increase the coupon rate required for a bond to be issued at par?
a. Adding additional restrictive covenants that limit management's
actions.
b. Adding a call provision.
c. The rating agencies change the bond's rating from Baa to Aaa.
d. Making the bond a first mortgage bond rather than a debenture.
e. Adding a sinking fund.
27. Which of the following statements is CORRECT?
a. Sinking fund provisions sometimes turn out to adversely affect
bondholders, and this is most likely to occur if interest rates
decline after the bond was issued.
b. Most sinking funds require the issuer to provide funds to a trustee,
who holds the money so that it will be available to pay off
bondholders when the bonds mature.
c. A sinking fund provision makes a bond more risky to investors at the
time of issuance.
d. Sinking fund provisions never require companies to retire their debt;
they only establish “targets” for the company to reduce its debt
over time.
e. If interest rates increase after a company has issued bonds with a
sinking fund, the company will be less likely to buy bonds on the
open market to meet its sinking fund obligation and more likely to
call them in at the sinking fund call price.
Chapter 7: Bonds Conceptual M/C Page 7
28. Amram Inc. can issue a 20-year bond with a 6% annual coupon at par.
This bond is not convertible, not callable, and has no sinking fund.
Alternatively, Amram could issue a 20-year bond that is convertible
into common equity, may be called, and has a sinking fund. Which of
the following most accurately describes the coupon rate that Amram
would have to pay on the second bond, the convertible, callable bond
with the sinking fund, to have it sell initially at par?
a. The coupon rate should be exactly equal to 6%.
b. The coupon rate could be less than, equal to, or greater than 6%,
depending on the specific terms set, but in the real world the
convertible feature would probably cause the coupon rate to be less
than 6%.
c. The rate should be slightly greater than 6%.
d. The rate should be over 7%.
e. The rate should be over 8%.
29. Tucker Corporation is planning to issue new 20-year bonds. The current
plan is to make the bonds non-callable, but this may be changed. If
the bonds are made callable after 5 years at a 5% call premium, how
would this affect their required rate of return?
a. Because of the call premium, the required rate of return would
decline.
b. There is no reason to expect a change in the required rate of return.
c. The required rate of return would decline because the bond would then
be less risky to a bondholder.
d. The required rate of return would increase because the bond would
then be more risky to a bondholder.
e. It is impossible to say without more information.
30. A 10-year corporate bond has an annual coupon of 9%. The bond is
currently selling at par ($1,000). Which of the following statements
is CORRECT?
a. The bond’s expected capital gains yield is zero.
b. The bond’s yield to maturity is above 9%.
c. The bond’s current yield is above 9%.
d. If the bond’s yield to maturity declines, the bond will sell at a
discount.
e. The bond’s current yield is less than its expected capital gains
yield.
31. Which of the following statements is CORRECT?
a. A zero coupon bond's current yield is equal to its yield to maturity.
b. If a bond’s yield to maturity exceeds its coupon rate, the bond will
sell at par.
c. All else equal, if a bond’s yield to maturity increases, its price
will fall.
Page 8 Conceptual M/C Chapter 7: Bonds
d. If a bond’s yield to maturity exceeds its coupon rate, the bond will
sell at a premium over par.
e. All else equal, if a bond’s yield to maturity increases, its current
yield will fall.
32. A 15-year bond with a face value of $1,000 currently sells for $850.
Which of the following statements is CORRECT?
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.
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.
Chapter 7: Bonds Conceptual M/C Page 9
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.
36. A 12-year bond has an annual coupon of 9%. The coupon rate will remain
fixed until the bond matures. The bond has a yield to maturity of 7%.
Which of the following statements is CORRECT?
a. If market interest rates decline, the price of the bond will also
decline.
b. The bond is currently selling at a price below its par value.
c. If market interest rates remain unchanged, the bond’s price one year
from now will be lower than it is today.
d. The bond should currently be selling at its par value.
e. If market interest rates remain unchanged, the bond’s price one year
from now will be higher than it is today.
37. A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond
has a 10% coupon. Neither is callable, and both have the same yield to
maturity. If the yield to maturity of both bonds increases by the same
amount, which of the following statements would be CORRECT?
a. The prices of both bonds will decrease by the same amount.
b. Both bonds would decline in price, but the 10-year bond would have
the greater percentage decline in price.
c. The prices of both bonds would increase by the same amount.
d. One bond's price would increase, while the other bond’s price would
decrease.
e. The prices of the two bonds would remain constant.
38. You are considering two bonds. Bond A has a 9% annual coupon while
Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity,
and the YTM is expected to remain constant. Which of the following
statements is CORRECT?
a. The price of Bond B will decrease over time, but the price of Bond A
will increase over time.
b. The prices of both bonds will remain unchanged.
c. The price of Bond A will decrease over time, but the price of Bond B
will increase over time.
d. The prices of both bonds will increase by 7% per year.
e. The prices of both bonds will increase over time, but the price of
Bond A will increase at a faster rate.
Page 10 Conceptual M/C Chapter 7: Bonds
39. Which of the following bonds would have the greatest percentage
increase in value if all interest rates in the economy fall by 1%?
a. 10-year, zero coupon bond.
b. 20-year, 10% coupon bond.
c. 20-year, 5% coupon bond.
d. 1-year, 10% coupon bond.
e. 20-year, zero coupon bond.
40. Assume that all interest rates in the economy decline from 10% to 9%.
Which of the following bonds would have the largest percentage increase
in price?
a. An 8-year bond with a 9% coupon.
b. A 1-year bond with a 15% coupon.
c. A 3-year bond with a 10% coupon.
d. A 10-year zero coupon bond.
e. A 10-year bond with a 10% coupon.
41. Which of the following bonds has the greatest price risk?
a. A 10-year $100 annuity.
b. A 10-year, $1,000 face value, zero coupon bond.
c. A 10-year, $1,000 face value, 10% coupon bond with annual interest
payments.
d. All 10-year bonds have the same price risk since they have the same
maturity.
e. A 10-year, $1,000 face value, 10% coupon bond with semiannual
interest payments.
42. If its yield to maturity declined by 1%, which of the following bonds
would have the largest percentage increase in value?
a. A 1-year zero coupon bond.
b. A 1-year bond with an 8% coupon.
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.
Chapter 7: Bonds Conceptual M/C Page 11
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.
45. Which of the following statements is CORRECT?
a. If the maturity risk premium were zero and interest rates were
expected to decrease in the future, then the yield curve for U.S.
Treasury securities would, other things held constant, have an
upward slope.
b. Liquidity premiums are generally higher on Treasury than corporate
bonds.
c. The maturity premiums embedded in the interest rates on U.S. Treasury
securities are due primarily to the fact that the probability of
default is higher on long-term bonds than on short-term bonds.
d. Default risk premiums are generally lower on corporate than on
Treasury bonds.
e. Reinvestment risk is lower, other things held constant, on long-term
than on short-term bonds.
46. Which of the following statements is CORRECT?
a. All else equal, senior debt generally has a lower yield to maturity
than subordinated debt.
b. An indenture is a bond that is less risky than a mortgage bond.
c. The expected return on a corporate bond will generally exceed the
bond's yield to maturity.
d. If a bond’s coupon rate exceeds its yield to maturity, then its
expected return to investors will also exceed its yield to maturity.
e. Under our bankruptcy laws, any firm that is in financial distress
will be forced to declare bankruptcy and then be liquidated.
47. Which of the following statements is CORRECT?
a. If a coupon bond is selling at par, its current yield equals its
yield to maturity.
Page 12 Conceptual M/C Chapter 7: Bonds
b. If a coupon bond is selling at a discount, its price will continue
to decline until it reaches its par value at maturity.
c. If interest rates increase, the price of a 10-year coupon bond will
decline by a greater percentage than the price of a 10-year zero
coupon bond.
d. If a bond’s yield to maturity exceeds its annual coupon, then the
bond will trade at a premium.
e. If a coupon bond is selling at a premium, its current yield equals
its yield to maturity.
48. A 10-year bond with a 9% annual coupon has a yield to maturity of 8%.
Which of the following statements is CORRECT?
a. If the yield to maturity remains constant, the bond’s price one year
from now will be higher than its current price.
b. The bond is selling below its par value.
c. The bond is selling at a discount.
d. If the yield to maturity remains constant, the bond’s price one year
from now will be lower than its current price.
e. The bond’s current yield is greater than 9%.
49. A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity.
Which of the following statements is CORRECT?
a. The bond sells at a price below par.
b. The bond has a current yield greater than 8%.
c. The bond sells at a discount.
d. The bond’s required rate of return is less than 7.5%.
e. If the yield to maturity remains constant, the price of the bond will
decline over time.
50. An investor is considering buying one of two 10-year, $1,000 face
value, noncallable bonds: Bond A has a 7% annual coupon, while Bond B
has a 9% annual coupon. Both bonds have a yield to maturity of 8%, and
the YTM is expected to remain constant for the next 10 years. Which of
the following statements is CORRECT?
a. Bond B has a higher price than Bond A today, but one year from now
the bonds will have the same price.
b. One year from now, Bond A’s price will be higher than it is today.
c. Bond A’s current yield is greater than 8%.
d. Bond A has a higher price than Bond B today, but one year from now
the bonds will have the same price.
e. Both bonds have the same price today, and the price of each bond is
expected to remain constant until the bonds mature.
51. Which of the following statements is CORRECT?
a. If a bond is selling at a discount to par, its current yield will be
greater than its yield to maturity.
Chapter 7: Bonds Conceptual M/C Page 13
b. All else equal, bonds with longer maturities have less price risk
than bonds with shorter maturities.
c. If a bond is selling at its par value, its current yield equals its
capital gains yield.
d. If a bond is selling at a premium, its current yield will be less
than its capital gains yield.
e. All else equal, bonds with larger coupons have less price risk than
bonds with smaller coupons.
52. Which of the following statements is CORRECT?
a. If a 10-year, $1,000 par, zero coupon bond were issued at a price
that gave investors a 10% yield to maturity, and if interest rates
then dropped to the point where rd = YTM = 5%, the bond would sell at
a premium over its $1,000 par value.
b. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if
interest rates then dropped to the point where rd = YTM = 5%, we
could be sure that the bond would sell at a premium above its $1,000
par value.
c. Other things held constant, including the coupon rate, a corporation
would rather issue noncallable bonds than callable bonds.
d. Other things held constant, a callable bond would have a lower
required rate of return than a noncallable bond because it would
have a shorter expected life.
e. Bonds are exposed to both reinvestment risk and price risk. Longer-
term low-coupon bonds, relative to shorter-term high-coupon bonds,
are generally more exposed to reinvestment risk than price risk.
53. Which of the following statements is CORRECT?
a. If the Federal Reserve unexpectedly announces that it expects
inflation to increase, then we would probably observe an immediate
increase in bond prices.
b. The total yield on a bond is derived from dividends plus changes in
the price of the bond.
c. Bonds are generally regarded as being riskier than common stocks, and
therefore bonds have higher required returns.
d. Bonds issued by larger companies always have lower yields to maturity
(due to less risk) than bonds issued by smaller companies.
e. The market price of a bond will always approach its par value as its
maturity date approaches, provided the bond’s required return
remains constant.
54. Which of the following statements is CORRECT?
a. If a coupon bond is selling at par, its current yield equals its
yield to maturity.
b. If rates fall after its issue, a zero coupon bond could trade at a
price above its maturity (or par) value.
c. If rates fall rapidly, a zero coupon bond’s expected appreciation
could become negative.
Page 14 Conceptual M/C Chapter 7: Bonds
d. If a firm moves from a position of strength toward financial
distress, its bonds’ yield to maturity would probably decline.
e. If a bond is selling at a premium, this implies that its yield to
maturity exceeds its coupon rate.
55. Bond X has an 8% annual coupon, Bond Y has a 10% annual coupon, and
Bond Z has a 12% annual coupon. Each of the bonds is noncallable, has
a maturity of 10 years, and has a yield to maturity of 10%. Which of
the following statements is CORRECT?
a. If the bonds' market interest rate remains at 10%, Bond Z’s price
will be lower one year from now than it is today.
b. Bond X has the greatest reinvestment risk.
c. If market interest rates decline, the prices of all three bonds will
increase, but Z's price will have the largest percentage increase.
d. If market interest rates remain at 10%, Bond Z’s price will be 10%
higher one year from today.
e. If market interest rates increase, Bond X’s price will increase, Bond
Z’s price will decline, and Bond Y’s price will remain the same.
56. Bonds A, B, and C all have a maturity of 10 years and a yield to
maturity of 7%. Bond A’s price exceeds its par value, Bond B’s price
equals its par value, and Bond C’s price is less than its par value.
None of the bonds can be called. Which of the following statements is
CORRECT?
a. If the yield to maturity on each bond decreases to 6%, Bond A will
have the largest percentage increase in its price.
b. Bond A has the most price risk.
c. If the yield to maturity on the three bonds remains constant, the
prices of the three bonds will remain the same over the next year.
d. If the yield to maturity on each bond increases to 8%, the prices of
all three bonds will decline.
e. Bond C sells at a premium over its par value.
57. Which of the following statements is CORRECT?
a. 10-year, zero coupon bonds have more reinvestment risk than 10-year,
10% coupon bonds.
b. A 10-year, 10% coupon bond has less reinvestment risk than a 10-year,
5% coupon bond (assuming all else equal).
c. The total (rate of) return on a bond during a given year is the sum
of the coupon interest payments received during the year and the
change in the value of the bond from the beginning to the end of the
year, divided by the bond's price at the beginning of the year.
d. The price of a 20-year, 10% bond is less sensitive to changes in
interest rates than the price of a 5-year, 10% bond.
e. A $1,000 bond with $100 annual interest payments that has 5 years to
maturity and is not expected to default would sell at a discount if
interest rates were below 9% and at a premium if interest rates were
greater than 11%.
Chapter 7: Bonds Conceptual M/C Page 15
58. Which of the following statements is CORRECT?
a. The yield to maturity for a coupon bond that sells at a premium
consists entirely of a positive capital gains yield; it has a zero
current interest yield.
b. The market value of a bond will always approach its par value as its
maturity date approaches. This holds true even if the firm has
filed for bankruptcy.
c. Rising inflation makes the actual yield to maturity on a bond greater
than a quoted yield to maturity that is based on market prices.
d. The yield to maturity on a coupon bond that sells at its par value
consists entirely of a current interest yield; it has a zero
expected capital gains yield.
e. The expected capital gains yield on a bond will always be zero or
positive because no investor would purchase a bond with an expected
capital loss.
59. Which of the following statements is CORRECT?
a. If a coupon bond is selling at a premium, then the bond's current
yield is zero.
b. If a coupon bond is selling at a discount, then the bond's expected
capital gains yield is negative.
c. If a bond is selling at a discount, the yield to call is a better
measure of the expected return than the yield to maturity.
d. 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.
e. If a coupon bond is selling at par, its current yield equals its
yield to maturity.
60. Which of the following statements is CORRECT?
a. 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 their coupon rates.
b. All else equal, an increase in interest rates will have a greater
effect on the prices of short-term than long-term bonds.
c. 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.
d. If a bond’s yield to maturity exceeds its coupon rate, the bond’s
price must be less than its maturity value.
e. If a bond’s yield to maturity exceeds its coupon rate, the bond’s
current yield must be less than its coupon rate.
Page 16 Conceptual M/C Chapter 7: Bonds
61. Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon.
Both bonds have the same maturity, a face value of $1,000, an 8% yield
to maturity, and are noncallable. Which of the following statements is
CORRECT?
a. Bond A’s capital gains yield is greater than Bond B’s capital gains
yield.
b. Bond A trades at a discount, whereas Bond B trades at a premium.
c. If the yield to maturity for both bonds remains at 8%, Bond A’s
price one year from now will be higher than it is today, but Bond
B’s price one year from now will be lower than it is today.
d. If the yield to maturity for both bonds immediately decreases to 6%,
Bond A’s bond will have a larger percentage increase in value.
e. Bond A’s current yield is greater than that of Bond B.
(Comp.) Callable bonds C G Answer: a MEDIUM
62. Which of the following statements is CORRECT?
a. Two bonds have the same maturity and the same coupon rate. However,
one is callable and the other is not. The difference in prices
between the bonds will be greater if the current market interest
rate is below the coupon rate than if it is above the coupon rate.
b. A callable 10-year, 10% bond should sell at a higher price than an
otherwise similar noncallable bond.
c. Corporate treasurers dislike issuing callable bonds because these
bonds may require the company to raise additional funds earlier than
would be true if noncallable bonds with the same maturity were used.
d. Two bonds have the same maturity and the same coupon rate. However,
one is callable and the other is not. The difference in prices
between the bonds will be greater if the current market interest
rate is above the coupon rate than if it is below the coupon rate.
e. The actual life of a callable bond will always be equal to or less
than the actual life of a noncallable bond with the same maturity.
Therefore, if the yield curve is upward sloping, the required rate
of return will be lower on the callable bond.
63. Which of the following statements is CORRECT?
a. Senior debt is debt that has been more recently issued, and in
bankruptcy it is paid off after junior debt because the junior debt
was issued first.
b. A company's subordinated debt has less default risk than its senior
debt.
c. Convertible bonds generally have lower coupon rates than non-
convertible bonds of similar default risk because they offer the
possibility of capital gains.
d. Junk bonds typically provide a lower yield to maturity than
investment-grade bonds.
e. A debenture is a secured bond that is backed by some or all of the
firm’s fixed assets.
Chapter 7: Bonds Conceptual M/C Page 17
64. Which of the following statements is CORRECT?
a. One disadvantage of zero coupon bonds is that the issuing firm cannot
realize any tax savings from the use of debt until the bonds mature.
b. Other things held constant, a callable bond should have a lower yield
to maturity than a noncallable bond.
c. Once a firm declares bankruptcy, it must be liquidated by the
trustee, who uses the proceeds to pay bondholders, unpaid wages,
taxes, and legal fees.
d. 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.
e. A firm with a sinking fund that gives 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.
65. Which of the following statements is CORRECT?
a. The total return on a bond during a given year is based only on the
coupon interest payments received.
b. 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%.
c. The price of a discount bond will increase over time, assuming that
the bond’s yield to maturity remains constant.
d. For a given firm, its debentures are likely to have a lower yield to
maturity than its mortgage bonds.
e. When large firms are in financial distress, they are almost always
liquidated, whereas smaller firms are generally reorganized.
66. Which of the following statements is CORRECT?
a. All else equal, secured debt is more risky than unsecured debt.
b. The expected return on a corporate bond must be greater than its
promised return if the probability of default is greater than zero.
c. All else equal, senior debt has more default risk than subordinated
debt.
d. A company’s bond rating is affected by its financial ratios but not
by provisions in its indenture.
e. 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 claims against it according to the priority of
the claims as spelled out in the Act.
Page 18 Conceptual M/C Chapter 7: Bonds
67. Which of the following statements is CORRECT?
a. A bond is likely to be called if its coupon rate is below its YTM.
b. A bond is likely to be called if its market price is below its par
value.
c. 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.
d. A bond is likely to be called if its market price is equal to its par
value.
e. A bond is likely to be called if it sells at a discount below par.
68. Which of the following statements is CORRECT?
a. 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.
b. 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.
c. If a bond sells at par, then its current yield will be less than its
yield to maturity.
d. If a bond sells for less than par, then its yield to maturity is
less than its coupon rate.
e. A discount bond’s price declines each year until it matures, when its
value equals its par value.
69. Assume that a noncallable 10-year T-bond has a 12% annual coupon, while
a 15-year noncallable 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 would increase,
but the 15-year bond would have a larger percentage increase in
price.
b. If interest rates decline, the prices of both bonds would increase,
but the 10-year bond would have a larger percentage increase in
price.
c. The 10-year bond would sell at a discount, while the 15-year bond
would sell at a premium.
d. The 10-year bond would sell at a premium, while the 15-year bond
would sell at par.
e. 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.
