CHAPTER 6: FIXED-INCOME SECURITIES: CHARACTERISTICS
AND VALUATION
1. Which of the following types of debt securities protect investors against interest rate risk?
a. floating rate bonds
b. extendible notes
c. original issue deep discount bonds
d. floating rate bonds and extendible notes
2. Zero coupon bonds are an example of
a. original issue deep discount bonds
b. extendible notes
c. convertible bonds
d. floating rate notes
3. Original issue deep discount bonds have decreased in popularity over the last several years due to:
a. changes in tax laws
b. issuance by brokerage firms of lower risk substitutes
c. increased interest in equity securities
d. changes in tax laws and issuance by brokerage firms of lower risk substitutes
4. Extendable notes are redeemable at par at the option of the
a. holder
b. company
c. trustee
d. holder and trustee
5. 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
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
6. When the market for an asset is in equilibrium, the expected rate of return on the asset is equal to the:
a. risk-free rate
b. marginal investor‘s required rate of return
c. historical cost of capital
d. perpetual capitalization rate
7. 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
8. 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
9. 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
10. Which of the following statements concerning preferred stocks is true?
a. Preferred stockholders have a prior claim on the income and assets of the firm as compared to the claims of
lenders.
b. Preferred stock dividends per share are normally increased as the earnings of the firm increase.
c. Preferred dividends per share are usually not cut or suspended unless the firm is faced with serious
financial problems.
d. The par value of a stock is always the same as the initial selling price.
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
11. Rank in ascending order (lowest to highest) the relative risk associated with holding the preferred stock, common
stock and bonds of a firm:
a. preferred stock, bonds, common stock
b. bonds, common stock, preferred stock
c. common stock, preferred stock, bonds
d. bonds, preferred stock, common stock
12. Potential sellers of an asset can be represented as a schedule showing the prices at which they are willing
to sell given quantities of the asset.
a. supply, maximum
b. demand, maximum
c. supply, minimum
d. supply, average
13. By the capitalization–of–cash flows method, the value of an asset is a function of
a. the book value of the asset
b. the risk of the asset’s cash flows
c. the age of the asset
d. both the book value and the age of the asset
14. 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
15. 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
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
16. 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
17. 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
18. 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
19. 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
20. 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. issued by firms with a low debt ratio
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
21. Large companies build up short-term debt over the period of 1 to 2 years, then sell long-term debt using a portion
of the proceeds to repay the short-term borrowings. This procedure is called:
a. “drawing down” long-term credit
b. funding short–term debt
c. reducing the tax bite
d. extending the rates
22. 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
23. The value of a 15-year bond will change for a given change in the required rate of return than the value of a
5 year bond.
a. more
b. less
c. the same percentage
d. exactly the same
24. 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
25. Equipment trust certificates are used mainly by
a. equipment manufacturers
b. oil drilling companies
c. state governments
d. trucking companies
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
26. All of the following types of bonds are secured except
a. collateral trust
b. mortgage
c. debentures
d. equipment trust certificates
27. 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
28. Which of the following is the highest risk debt issue?
a. senior debt
b. mortgage bond
c. equipment trust certificate
d. debenture
29. 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
30. The represents the debtholders in dealings with the issuing company.
a. trustee
b. stakeholders
c. broker
d. investment banker
31. 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
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
32. “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
33. 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
34. Preferred stock has a priority over common stock with regard to the company’s
a. assets
b. voting rights
c. dividends
d. assets and dividends
35. The principal disadvantage of preferred stock financing is
a. its high after-tax cost as compared with long-term debt
b. the decrease in the firm’s degree of financial leverage
c. the required payment of dividends
d. the reduction in control
36. ____ are not secured by specific assets.
a. Equipment trust certificates
b. Mortgage bonds
c. Debentures
d. Collateral trust bonds
37. A zero coupon bond is an example of a(n) .
a. fixed income security
b. original issue deep discount bond
c. tax-exempt bond
d. fixed income security and an original issue deep discount bond
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
38. Junk bonds (i.e., bonds issued by companies with weak financial positions) are rated or lower by Moody’s.
a. Baa
b. BBB
c. Ba
d. CCC
39. The required rate of return on an asset is a function of the .
a. risk associated with the asset
b. risk-free interest rate
c. age of the asset
d. risk associated with the asset and the risk-free interest rate
40. 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. after-tax cost
41. Which of the following features (if any) of debt securities provides the investor with a measure of
protection against inflation?
a. sinking fund
b. call feature
c. floating coupon rates
d. poison put covenant
42. 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
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
43. bonds normally are denominated in the currency of the country of sale.
a. Eurodollar
b. International
c. Foreign
d. LIBOR
44. 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
45. The following bond quotation indicates that the holder expects to receive in interest annually:
PACEI 11s 09
11.6
20
95
-1
a. $90
b. $116
c. $95
d. $110
46. In the Treasury bill quote that follows, the price of the bill can be calculated from the price.
Mat. date
Bid
Asked
Yield
9-24
a. bid
8.34
8.29
8.58
b. asked
c. yield
d. none of these
47. Treasury bills
a. have a stated interest rate
b. pay no explicit interest
c. are sold for exactly $10,000
d. are quoted in terms of yield to maturity
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
48. Treasury notes typically have initial maturities ranging from
a. 1 to 3 years
b. 1 to 5 years
c. 1 to 10 years
d. 10 to 30 years
49. An AT&T 5½05 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
50. In reading price quotes on U.S. Treasury bills, you would expect to find the “asked” price higher than the
“bid”.
a. always
b. never
c. sometimes
d. seldom
51. Users of preferred stock include:
a. Utility companies
b. Acquiring firm in mergers and acquisitions
c. Large commercial banks
d. All listed answers are users
52. What is the yield to maturity for a Poughkeepsie Gypsy Fortune Tellers’ 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%
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
53. 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. 5.26%
54. The State of Adaven issued $50 million of perpetual bonds in 1990. 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
55. A General Electric 7½25 bond closed at 98. What is the current yield?
a. 7.65%
b. 7.81%
c. 7.50%
d. 7.34%
56. The State of Adaven issued $50 million of perpetual bonds in 1990. The bonds were issued in $100
denominations with an annual coupon interest rate of 5%. Determine the rate of return or current 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%
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
57. A Treasury bill with 182 days to maturity is quoted at 5.62 bid, 5.60 asked, and an asked yield of 5.84.
How much would you pay for this security?
a. $9,440
b. $9,720
c. $9,708
d. $9,438
58. How much would you have to pay for a U.S. Government bond ($1,000 maturity value) scheduled to
mature in February, 2020 and quoted at 118:07 “bid” and 118:15 “asked”?
a. $1,182.19
b. $1,181.50
c. $1,184.69
d. $1,180.70
59. A Treasury bill with a July 11th maturity date is quoted today at 8.46 bid and 8.40 asked. How much
would you pay today (January 11th) for one bill?
a. $9,577
b. $9,580
c. $9,588
d. $8,400
60. 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. $897
d. $270
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
61. 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%
62. Assume that the dividend on Central Power Company‘s $3.25 preferred stock issue is paid annually at the
end of the year. Determine the value of this preferred stock to an investor who requires a 12 percent rate
of return.
a. $3.25
b. $39
c. $12
d. $27.08
63. An Allied Northern preferred stock pays a $3.84 annual dividend. What is the value of the stock to an
investor who requires a 9.5 percent return?
a. $40.42
b. $42.67
c. $38.40
d. $37.60
64. What is the rate of return on a preferred stock that has a par value of $50, a market price of $46.50, and a
dividend of $4.10?
a. 8.20%
b. 11.34%
c. 8.82%
d. 12.20%
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
65. 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%
66. 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
67. 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
68. 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. $1,080
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
69. Up in Smoke Tobacco Shops’ 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 (rounded to the nearest
whole percent)?
a. 8.0%
b. 10.0%
c. 9.0%
d. 7.0%
70. 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%
71. 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. $1,000
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
72. 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. 13.7%
d. 14%
73. 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. $853.30
74. 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. $577
Chapter 6: Fixed-Income Securities: Characteristics and Valuation
75. 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
76. What is the required rate of return to the investor who is willing to purchase a Duke Power preferred stock
with an $8.70 dividend, a par value of $100, and a current market price of $87?
a. 10.7%
b. 8.7%
c. 9.4%
d. 10.0%
77. 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%