CHAPTER 07—BONDS AND THEIR VALUATION
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.
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Bond concepts
Bloom’s: Application
Multiple Choice: Conceptual
52. 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.
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.
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Bond concepts
Bloom’s: Comprehension
Multiple Choice: Conceptual
53. 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.
CHAPTER 07—BONDS AND THEIR VALUATION
MODERATE
Comprehensive
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Bond concepts
Bloom’s: Application
Multiple Choice: Conceptual
54. 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.
e
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Bond concepts
Bloom’s: Application
Multiple Choice: Conceptual
55. 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.
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.
a
MODERATE
Comprehensive
FOFM.BRIG.16.07.00 – Comprehensive
CHAPTER 07—BONDS AND THEIR VALUATION
56. 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.
a
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Bond concepts
Bloom’s: Application
Multiple Choice: Conceptual
57. 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.
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Bond concepts
Bloom’s: Comprehension
Multiple Choice: Conceptual
CHAPTER 07—BONDS AND THEIR VALUATION
58. 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%.
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Bond concepts
Bloom’s: Application
Multiple Choice: Conceptual
59. 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.
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Bond concepts
Bloom’s: Application
Multiple Choice: Conceptual
CHAPTER 07—BONDS AND THEIR VALUATION
60. 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.
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Bond yields
Bloom’s: Comprehension
Multiple Choice: Conceptual
61. 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.
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Bond yields and prices
Bloom’s: Comprehension
Multiple Choice: Conceptual
62. 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?
Bond yields
Bloom’s: Comprehension
Multiple Choice: Conceptual
CHAPTER 07—BONDS AND THEIR VALUATION
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.
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Bond rates and prices
Bloom’s: Application
Multiple Choice: Conceptual
63. 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.
64. Which of the following statements is CORRECT?
CHAPTER 07—BONDS AND THEIR VALUATION
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.
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Types of debt
Bloom’s: Comprehension
Multiple Choice: Conceptual
65. 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.
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Miscellaneous concepts
Bloom’s: Comprehension
Multiple Choice: Conceptual
66. 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
CHAPTER 07—BONDS AND THEIR VALUATION
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.
c
MODERATE
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Miscellaneous concepts
Bloom’s: Comprehension
Multiple Choice: Conceptual
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.
CHAPTER 07—BONDS AND THEIR VALUATION
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.
CHAPTER 07—BONDS AND THEIR VALUATION
70. Which of the following statements is CORRECT?
a.
A zero coupon bond of any maturity will have more price risk than any coupon bond, even a perpetuity.
b.
If their maturities and other characteristics were the same, a 5% coupon bond would have more price risk than
a 10% coupon bond.
c.
A 10-year coupon bond would have more reinvestment risk than a 5-year coupon bond, but all 10-year coupon
bonds have the same amount of reinvestment risk.
d.
A 10-year coupon bond would have more price risk than a 5-year coupon bond, but all 10-year coupon bonds
have the same amount of price risk.
e.
If their maturities and other characteristics were the same, a 5% coupon bond would have less price risk than a
10% coupon bond.
7-7 Assessing a Bond’s Riskiness
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Price and reinvest. risk
Bloom’s: Application
Multiple Choice: Conceptual
71. Listed below are some provisions that are often contained in bond indentures. Which of these provisions, viewed
alone, would tend to reduce the yield to maturity that investors would otherwise require on a newly issued bond?
1.
Fixed assets are used as security for a bond.
2.
A given bond is subordinated to other classes of debt.
3.
The bond can be converted into the firm’s common stock.
4.
The bond has a sinking fund.
5.
The bond has a call provision.
6.
The indenture contains covenants that restrict the use of additional debt.
7-5 Changes in Bond Values over Time
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Int. rates and bond prices
Bloom’s: Application
Multiple Choice: Conceptual
CHAPTER 07—BONDS AND THEIR VALUATION
a.
1, 3, 4, 6
b.
1, 4, 6
c.
1, 2, 3, 4, 6
d.
1, 2, 3, 4, 5, 6
e.
1, 3, 4, 5, 6
7-8 Default Risk
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Bond indenture
Bloom’s: Application
Multiple Choice: Conceptual
72. Suppose a new company decides to raise a total of $200 million, with $100 million as common equity and $100
million as long-term debt. The debt can be mortgage bonds or debentures, but by an iron-clad provision in its charter, the
company can never raise any additional debt beyond the original $100 million. Given these conditions, which of the
following statements is CORRECT?
a.
The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and,
consequently, the higher the firm’s total dollar interest charges will be.
b.
If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could
be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100
million of debentures.
c.
In this situation, we cannot tell for sure how, or even whether, the firm’s total interest expense on the $100
million of debt would be affected by the mix of debentures versus first mortgage bonds. The interest rate on
each type of bond would increase as the percentage of mortgage bonds used was increased, but the average
cost might well be such that the firm’s total interest charges would not be affected materially by the mix
between the two.
d.
The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the
required rate of return on the debentures.
e.
If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could
be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100
million of first mortgage bonds.
CHAPTER 07—BONDS AND THEIR VALUATION
73. A company is planning to raise $1,000,000 to finance a new plant. Which of the following statements is CORRECT?
a.
The company would be especially eager to have a call provision included in the indenture if its management
thinks that interest rates are almost certain to rise in the foreseeable future.
b.
If debt is used to raise the million dollars, but $500,000 is raised as first mortgage bonds on the new plant and
$500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the
entire $1 million were raised by selling first mortgage bonds.
c.
If two classes of debt are used (with one senior and the other subordinated to all other debt), the subordinated
debt will carry a lower interest rate.
d.
If debt is used to raise the million dollars, the cost of the debt would be lower if the debt were in the form of a
fixed-rate bond rather than a floating-rate bond.
e.
If debt is used to raise the million dollars, the cost of the debt would be higher if the debt were in the form of a
mortgage bond rather than an unsecured term loan.
74. Assuming all else is constant, which of the following statements is CORRECT?
a.
Other things held constant, a 20-year zero coupon bond has more reinvestment risk than a 20-year coupon
bond.
b.
Other things held constant, for any given maturity, a 1.0 percentage point decrease in the market interest rate
would cause a smaller dollar capital gain than the capital loss stemming from a 1.0 percentage point increase
in the interest rate.
c.
From a corporate borrower’s point of view, interest paid on bonds is not tax-deductible.
d.
Other things held constant, price sensitivity as measured by the percentage change in price due to a given
change in the required rate of return decreases as a bond’s maturity increases.
e.
For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (rd) causes a larger dollar
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Costs of types of debt
Bloom’s: Application
Multiple Choice: Conceptual