Chapter 8—BONDS AND OTHER SOURCES OF DEBT
MULTIPLE CHOICE
1. Zero coupon bonds are an example of
a.
original issue deep discount bonds
b.
extendible notes
c.
convertible bonds
d.
floating rate notes
2. If a firm could sell a mortgage bond at an 8% interest rate, it could sell an otherwise identical
debenture at
a.
a rate less than 8%
b.
8%
c.
a rate greater than 8%
d.
cannot be determined
3. The ____ the investor’s required rate of return on a bond, the ____ will be the value of the bond to the
investor.
a.
lower, higher
b.
higher, higher
c.
lower, lower
d.
higher, lower
4. The value of a perpetual bond is equal to the annual interest payment divided by the:
a.
risk-free rate
b.
required rate of return
c.
bank interest rate
d.
after-tax historical cost of capital
5. The yield-to–maturity of a bond with a finite maturity date is a function of all of the following
variables except:
a.
the current price
b.
the required rate of return on the bond
c.
the uniform annual interest payments
d.
the maturity value
6. Which of the following is not a characteristic of long- term debt?
a.
interest paid to bond holders is a tax-deductible expense to the firm
b.
firm is not legally required to pay interest to bond-holders
c.
usually has a specific maturity
d.
all of these are characteristics of long-term debt
7. The quality of a debenture depends on the
a.
general credit-worthiness of the issuing company
b.
value of the assets used as collateral
c.
the coupon rate of the debenture
d.
length of time to maturity
8. The indenture is a contract between the issuer and lenders that does all the following except:
a.
specifies the manner in which the principal must be repaid
b.
details the nature of the debt issue
c.
gives management’s expectations about return of the proceeds
d.
lists any restrictive covenants
9. The call feature of a long-term bond
a.
is an optional retirement provision
b.
states the call price
c.
allows the issuer to replace a high coupon bond with one with a lower coupon bond
d.
all these are correct answers.
10. A sinking fund allows the issuer to
a.
redeem an entire debt issue prior to maturity
b.
purchase a portion of the debt each year in the open market or call a portion of the debt for
mandatory redemption
c.
call the entire debt issue
d.
accumulate interest expenses into a sinking fund account
11. Normally the coupon rates on new bonds
a.
do not change over the life of the issue
b.
are set equal to the market rate plus an inflation premium
c.
float with changes in the prime rate
d.
are set just over the prevailing prime rate
12. Junk bonds are
a.
usually rated Ba or higher
b.
are issued by firms with a high debt ratio
c.
issued with coupon rates at least 8 percentage points or more above the highest quality
issues
d.
none of these are correct
13. The major advantages of long-term debt include all the following except:
a.
decrease in financial risk
b.
relatively low, explicit after-tax cost
c.
owners are able to maintain control
d.
increased earnings per share through using financial leverage
14. The value of a 15-year bond ____ for a given change in the required rate of return than the value of a
5-year bond.
a.
will change more
b.
will change less
c.
will not change
d.
cannot be determined from the information given
15. When the required rate of return is ____ the coupon rate, the bond will sell at a discount.
a.
less than
b.
greater than
c.
the same as
d.
equal to
16. The call feature is an advantage to the issuing firm
a.
if the bond has a floating rate
b.
if interest rates decline
c.
if the bond has a low par value
d.
if interest rates increase
17. There is a(n) ____ relationship between the value of a bond and its required rate of return.
a.
direct
b.
distant
c.
inverse
d.
turgid
18. The ____ represents the debtholders in dealings with the issuing company.
a.
trustee
b.
stakeholders
c.
broker
d.
investment banker
19. If an American Water Company bond has a coupon rate of 9.0 percent and is selling for $920, then the
yield to maturity must be:
a.
greater than 9%
b.
equal to 9%
c.
less than 9%
d.
cannot be determined
20. “Junk bond” is a term used to describe a bond that
a.
is in default
b.
is rated Ba or lower
c.
is currently paying interest
d.
has been downgraded by Moody’s
21. The basic relationship in bond valuation is for a given percentage point change in the required rate of
return, the ____ the time to maturity, the ____ the change in value.
a.
shorter, greater
b.
longer, smaller
c.
longer, greater
d.
shorter, smaller
22. ____ are not secured by specific assets.
a.
Equipment trust certificates
b.
Mortgage bonds
c.
Debentures
d.
Collateral trust bonds
23. A zero coupon bond is an example of ____.
a.
a fixed income security
b.
an original issue deep discount bond
c.
a tax-exempt bond
d.
both a fixed income security and an original issue deep discount bond
24. Junk bonds (i.e., bonds issued by companies with weak financial positions) rated ____ or lower by
Moody’s.
a.
Baa
b.
BBB
c.
Ba
d.
CCC
25. Which of the following features (if any) of preferred stock provides the investor with a measure of
protection against inflation?
a.
adjustable dividend rate
b.
cumulative feature
c.
call feature
d.
par value
26. The ____ of a debt issue is equal to the difference between the ____ and the ____.
a.
call price; market price; par value
b.
call price; market price; call premium
c.
call premium; call price; par value
d.
call premium; market price; par value
27. A zero coupon bond is a bond that
a.
originally sold at a discount
b.
will sell for a premium
c.
is a premium value bond
d.
has a high current yield
28. The term structure of interest rates is the pattern of interest rate yields for debt securities that are
similar in all respects except for differences in
a.
tax status
b.
liquidity
c.
risk of default
d.
maturity
29. The term structure of interest rates is the pattern of interest rate yields for securities that differ only in
a.
default risk
b.
liquidity premiums
c.
the yield to maturity
d.
the length of time to maturity
30. The maturity premium reflects a preference by many lenders for
a.
shorter maturities
b.
reducing yields
c.
high yield securities
d.
longer maturities
31. The default risk premium reflects the fact that
a.
the premium remains constant over time
b.
there is a positive relationship between risk and maturity
c.
there is a positive relationship between default risk and required returns
d.
the premium varies depending on the time to maturity
32. The following yields on 20 year bonds prevailed in January for the three securities shown:
Aa-rated corporate bond
9.98%
Baa-rated corporate bond
10.34%
B-rated corporate bond
11.12%
The difference in yields is due primarily to
a.
maturity risk premium
b.
default risk premium
c.
seniority risk premium
d.
financial risk premium
33. The ability of an investor to buy and sell a company’s securities quickly and without a significant loss
of value is known as the
a.
financial risk
b.
marketability risk
c.
business risk
d.
security risk
34. According to the ____, long-term interest rates are a function of expected short-term interest rates.
a.
Maturity theory
b.
Expectations theory
c.
Market segmentation theory
d.
Preferred habitat theory
35. The term structure of interest rates is related to the ____.
a.
default risk premium
b.
seniority risk premium
c.
marketability risk premium
d.
maturity risk premium
36. ____ refers to the ability of an investor to buy and sell a company’s securities quickly and without a
significant loss of value.
a.
Default risk
b.
Business and financial risk
c.
Maturity risk
d.
Marketability risk premium
37. The risk-free rate of return is composed of which of the following elements:
a.
risk premium and inflation
b.
cost of capital and risk premium
c.
real rate of return and risk premium
d.
real rate of return and inflation
38. The two elements that make up the risk-free rate of return are
a.
the supply of funds and the demand for funds
b.
the yield on 90-day Treasury bills plus an inflation premium
c.
the real rate of return plus an inflation premium
d.
the required return plus a risk premium
39. An AT&T 5 1/2s 97 bond with a current yield of 6.2% must be selling ____ its face value.
a.
above
b.
at
c.
below
d.
any of these could be correct
40. What is the yield to maturity for a Pep Boys zero coupon bond that matures in 14 years if the bond is
selling for $530.00?
a.
5.84%
b.
4.64%
c.
4.28%
d.
5.49%
41. If an Allied Chemical zero coupon bond due in 12 years is selling for $420.00, what is its yield to
maturity?
a.
7.50%
b.
4.64%
c.
6.51%
d.
2.85%
42. The State of Adaven issued $50 million of perpetual bonds in 1960. The bonds were issued in $100
denominations with an annual coupon interest rate of 5%. Determine the value of these bonds today to
an investor who requires a 10% return on his investment.
a.
$25
b.
$5
c.
$10
d.
$50
43. The State of Adaven issued $50 million of perpetual bonds in 1960. The bonds were issued in $100
denominations with an annual coupon interest rate of 5%. Determine the rate of return or yield on
these bonds if they are purchased at the current price of $40.
a.
12.5%
b.
8.0%
c.
5.0%
d.
1.25%
44. A General Electric 7 1/2s 96 bond closed at 98. What is the current yield?
a.
7.65%
b.
7.81%
c.
7.50%
d.
7.34%
45. J. C. Penney has an 11s 97 bond that closed at 102 3/8. What is the current yield on this bond?
a.
10.74%
b.
10.84%
c.
10.78%
d.
11.00%
46. A WPI 10s 08 bond closed at 89. What is the current yield on this bond?
a.
10.10%
b.
11.35%
c.
10.73%
d.
11.24%
47. Two-years ago, Trans-Atlantic Airlines sold a $250 million bond issue to finance the purchase of new
jet airliners. These bonds were issued in $1000 denominations with an original maturity of 12 years
and a coupon rate of 12%. Determine the value today of one of these bonds to an investor who requires
a 14% rate of return on these securities.
a.
$626
b.
$463
c.
$896
d.
$270
48. Two years ago, Trans-Atlantic Airlines sold $250 million worth of bonds at $1,000 each. The bonds
had a maturity of 12 years and a coupon rate of 12%. Today these bonds are selling for $910.
Determine the yield-to-maturity (to the nearest tenth of one percent).
a.
13.2%
b.
5.6%
c.
13.7%
d.
12.0%
49. What is the value of a $1000 par value Consul perpetual bond with a 6 percent coupon rate if the
required rate of return is 9 percent?
a.
$1,000
b.
$666.67
c.
$333.33
d.
$540.00
50. A refrigerator manufacturer, Zero King, issued a zero coupon bond with 10 years to maturity. What is
the yield-to–maturity of this bond if it is sold for $352?
a.
12.2%
b.
10%
c.
11%
d.
9%
51. Marko needs to raise capital through a zero-coupon bond debt offering. If the bonds will have 12 years
to maturity and the rate of return on a bond in Marko’s risk class is 11 percent, what will be the selling
price of the bond?
a.
$302.50
b.
$335.50
c.
$269.50
d.
$286.00
52. Five years ago, the City of Baltimore sold at par a $1,000 bond with a coupon rate of 8 percent and 20
years to maturity. If this bond pays interest semiannually, what is the value of this bond to an investor
who requires an 8 percent rate of return?
a.
$607.72
b.
$692.00
c.
$1,000
d.
cannot be determined from the information given
53. A Dow Chemical bond carries a 9 percent coupon, pays interest semiannually, and has 10 years to
maturity. What is the bond’s yield to maturity if the bond is selling for $937.75?
a.
8.0%
b.
10.0%
c.
9.0%
d.
8.4%
54. Determine the yield to maturity to the nearest tenth of 1 percent of a zero coupon bond with 8 years to
maturity that is currently selling for $404.
a.
11.3%
b.
12.3%
c.
11.7%
d.
12.0%
55. What is the value of an Orion bond that has a 10 percent coupon, pays interest semiannually, and has
10 years to maturity, if the required rate of return is 12 percent?
a.
$1,200
b.
$885.50
c.
$895.27
d.
$735.26
56. Determine the yield-to-call (to nearest 0.1 of a percent) of an LTV bond with a 14 percent coupon, that
pays interest semiannually. The bond can be called in 7 years, has a call premium of $140, and is
currently selling for $1154.
a.
12.0%
b.
16.2%
c.
12.7%
d.
5.7%
57. What is the value of a Northern Pacific bond with an 11 percent coupon, maturing in 15 years?
Assume the market rate for this bond is 14 percent and that the interest is paid semiannually.
a.
$1,000
b.
$790.74
c.
$813.50
d.
$915.10
58. What is the market value of a zero coupon bond with 5 years to maturity? The bond was originally
sold with a yield to maturity equal to 11 percent, but the market rate today is 9 percent.
a.
$593
b.
$650
c.
$621
d.
$495
59. What is the value of a PacTen bond with a 10 percent coupon that matures in 15 years? Assume the
current market rate for this bond is 16 percent and that interest is paid semiannually.
a.
$661.90
b.
$1,227.78
c.
$1,000
d.
$875.51
60. Determine the yield to maturity (to the nearest tenth of 1 percent) of an 8-year zero coupon bond
($1,000 par value) that is currently selling for $521.
a.
6.0%
b.
11.5%
c.
7.9%
d.
8.5%
61. ICX Company has an issue of perpetual bonds (par value to $1,000) that pays 5% annual interest.
Determine the yield (to the nearest tenth of 1 percent) if the bonds are currently selling for $625.
a.
5.0%
b.
8.0%
c.
3.1%
d.
6.25%
62. Mid-States Utility Company sold a 10-year note with a 7 7/8% coupon and a par value of $1,000. If
the note sold at a discount for $930, what was the implied yield-to–maturity to the nearest tenth of one
percent? Assume interest is paid semiannually.
a.
8.5%
b.
8.7%
c.
9.1%
d.
9.4%
63. Baywa has an outstanding bond that has a coupon rate of 8.3%. What is the market price of this bond
if it pays interest semi-annually, has 15 years to maturity, and the current required rate of return is 9%
on bonds of similar quality?
a.
$943
b.
$1059
c.
$954
d.
$1,000
64. Rascal Corporation bonds have a 10.60% coupon and a maturity value of $1,000. The bonds, which
pay interest semi-annually, will mature in 15 years, but the firm has the option to call the bond in 10
years at a premium of 106. You believe that Rascal will call the bonds in 10 years. If you require a pre-
tax return of 9.5% on bonds of this risk, how much would you pay for one of these bonds today?
a.
$1,000
b.
$1,094
c.
$1,034
d.
$1,058
65. Zimmer, Inc. issued zero coupon bonds that sold for $190 and are due in 15 years. Determine the yield
to maturity (to the nearest tenth of 1 percent) if you purchased the bond at the issue price.
a.
19.0%
b.
11.4%
c.
10.9%
d.
11.7%
66. King World zero coupon bonds were issued in 1994 at $124. These bonds will mature in 2014. What
will these bonds sell for in 2004 if the required rate of return in 2004 is 9.5%?
a.
$352
b.
$404
c.
$413
d.
$163
67. RJR issued a 10-year, 16% bond in 1999 that was callable at $1,100 in 5 years. In 2004 (today) the
required return on bonds of this risk was 11%. The bonds pay interest semi-annually. What would you
be willing to pay for one of these bonds today if you believe the bond will be called today?
a.
$1188
b.
$832.25
c.
$1,100
d.
$1,000
68. At what price will Gohm have to sell a 10-year zero coupon bond that will yield 8.75% if held to
maturity.
a.
$453
b.
$875.00
c.
$87.50
d.
$432
69. What is the issue price of a zero coupon bond with 15 years to maturity if it is sold to yield 7.55%?
a.
$250.00
b.
$362.31
c.
$335.62
d.
$1000.00
70. UOP, a petroleum processing technology firm, issued a 10% coupon, 20 year to maturity first
mortgage bond five years ago. If the current market rate of debt for UOP is 8%, at what price should
this bond sell? Assume a par value of $1,000, and pays interest semi-annually.
a.
$1,170.00
b.
$999.65
c.
$1,095.60
d.
$1,172.60
71. National Medical has a zero coupon bond outstanding that sells for $242.60 and has 15 years to
maturity. What is the yield to maturity on the bond to the nearest tenth of one percent?
a.
10.5%
b.
9.1%
c.
9.9%
d.
11.0%
72. An Exxon bond carries an 8 percent coupon, pays interest semiannually, and has 10 years to maturity.
If this bond is currently selling for $925, what is the exact yield to maturity(to the nearest tenth of 1
percent)?
a.
9.2%
b.
8.8%
c.
9.8%
d.
10.2%
73. The current required rate of return on a bond issued by Who LTD is 11 percent. “Who” has a bond
issue outstanding that pays interest semiannually, is selling for $845 and matures in 8 years. What is
the coupon rate on the outstanding bond?
a.
4.00%
b.
8.00%
c.
10.68%
d.
6.05%
74. An EAL bond has a coupon rate of 16 percent, pays interest semiannually, and matures in 15 years. If
the bond is selling for $968.82, what is its yield to maturity?
a.
8.3%
b.
16.1%
c.
16.6%
d.
5.17%
75. How many semiannual interest payments remain on a bond that is selling for $917.25? The coupon
rate of the bond is 8 percent, interest is payable semiannually, and the current market rate of return on
a similar risk bond is 10 percent.
a.
5
b.
10
c.
11
d.
7
76. CUP Company 8% bonds are currently selling for $950. These bonds (par value of $1,000) mature in
one year and pay interest annually. Determine the yield to maturity (to the nearest tenth of 1 percent)
on this bond issue.
a.
13.7%
b.
13.0%
c.
13.3%
d.
5.0%
77. What is the yield to maturity of a TVA bond that has a 9 1/2 percent coupon, pays interest semi–
annually, has 12 years to maturity, and sells for $871.50?
a.
11.3%
b.
11.5%
c.
11.8%
d.
12.1%
78. Grace Corp. has a zero-coupon bond outstanding that matures in 15 years. This bond is selling for
$327.50 today and will pay $1,000 at maturity. What is the yield to maturity to the investor who buys
the bond and holds it until maturity?
a.
7.73%
b.
9.33%
c.
9.23%
d.
9.77%
79. WPI has a bond issue outstanding that has a coupon rate of 10%, and a current yield of 11%. The yield
to maturity on this bond is 12%. What is the market price of the WPI bond if it pays interest semi-
annually and has 10 years to mature?
a.
$ 940.90
b.
$1020.75
c.
$1000.00
d.
$ 885.50
80. What is the yield to maturity of an RJR bond with 10 years to maturity, and a coupon of 15%? The
current price of this bond is $1,109. Assume interest is paid annually.
a.
12.0%
b.
12.5%
c.
13.0%
d.
13.5%
81. What is the yield-to–maturity of an Acme bond selling for $1107.50 with 5 years to maturity, a 12
1/2% coupon, and semi-annual compounding?
a.
10.36%
b.
11.29%
c.
9.73%
d.
10.20%
82. What is the yield-to–maturity of a Viacom bond which is selling for $948.75 with 6 years to maturity
and a 7% coupon?
a.
7.01%
b.
8.11%
c.
8.38%
d.
7.38%
83. WXAM has an outstanding bond issue with a coupon rate of 6 1/8%, and a current yield of 6.9%. The
yield to maturity on this bond is 7 5/8%. What is the market price of this bond if it pays interest semi-
annually and has 12 years to maturity?
a.
$883.42
b.
$937.45
c.
$943.65
d.
$1000.00
84. What would a GMA 6% coupon bond maturing in 14 years sell for if the current yield is 6.9% and the
yield-to-maturity is 7.48%?
a.
$950.20
b.
$920.02
c.
$1051.54
d.
$872.90
ESSAY
1. What is an indenture?
2. What are restrictive covenants? Give some examples.