Part 3 Valuation Basics
CHAPTER 6
BOND VALUATION AND INTEREST RATES
CHAPTER LEARNING OBJECTIVES
6.1 Describe the basic structure and the various features of different types of bonds.
6.2 Explain how to value a bond given an appropriate discount rate.
6.3 Determine the discount rate or yield for a given market value of a bond.
6.4 List and describe the factors, both domestic and global, that affect interest rates.
6.5 List and describe the characteristics and pricing of other debt instruments.
6.6 Explain how interest rate parity works.
6.7 Determine the discount rate or yield for a callable bond.
Valuation Basics 6 – 2
MULTIPLE CHOICE QUESTIONS
1. Which of the following is generally not stated in a bond indenture?
a) The interest payment dates.
b) The principal repayment date.
c) The call date.
d) The maturity date.
2. Which of the following is not a true statement?
a) Mortgage bonds are debt instruments that are secured by real assets.
b) Callable bonds give the issuer the option to “call” or repurchase outstanding bonds at
predetermined call prices at specified times.
c) Retractable bonds allow the bondholder to sell the bonds back to the issuer at
predetermined prices at specified times earlier than the maturity date.
d) Extendible bonds allow the issuer to extend the maturity date of the bond.
3. Which of the following statements is TRUE?
a) Protective covenants are clauses that restrict the actions of the issuer.
b) Convertible bonds are debt instruments that can be converted into preferred shares
at predetermined conversion prices.
c) Sinking fund provisions require the trustee to set money aside each year so that
funds are available at maturity to pay off the debt.
d) Purchase fund provisions require the repurchase of a certain amount of debt only if it
can be repurchased at or above a given price.
4. Which one of the following is not a bond provision?
a) Pledging financial assets as collateral to the bond issue.
b) Limiting dividend payments to equity holders.
c) Limiting payments to other existing bondholders.
d) Pledging equipment as collateral for the issue.
5. Bonds that are classified as unsecured obligations are called:
a) callable bond.
b) treasury bond.
c) debenture.
d) all of the above.
6. Which of the following statements is false?
a) The bullet (balloon) payment refers to the principal payment made in one lump sum
at maturity.
b) Collateral trust bonds are debt instruments that are secured by real assets.
c) Protective covenants can be positive or negative.
d) Debentures are debt instruments that are generally unsecured.
7. Which of the following bonds is secured by real assets?
a) A collateral trust bond.
b) A bullet bond.
c) A debenture.
d) None of the above.
8. Which of the following is (are) needed to price a bond?
a) The coupon rate.
b) The face value amount.
c) The yield to maturity.
d) All of the above.
9. Which of the following statements is false?
a) When the prevailing market interest rate is lower than the coupon rate, the bond will
be traded at a premium.
b) When the prevailing market interest rate is higher than the coupon rate, the bond will
be traded at a discount.
c) The longer the time to maturity, the less sensitive the market price of the bond
becomes to changes in prevailing market rates.
d) The higher the coupon rate, the less sensitive the market price of the bond becomes
to changes in prevailing market rates.
6 – 5 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
10. The convex shape of the bond price-yield curve shows:
I) For a given change in interest rates, bond prices will increase more when rates
decrease than they will decrease when rates increase.
II) The curve is steeper for higher interest rates.
III) The curve is always downward sloping.
a) I, III are correct, II is incorrect.
b) I is incorrect, II, III are correct.
c) I, II and III are correct.
d) I and II are correct, III is incorrect.
11. Use the following three statements to answer this question:
I) The prices of bonds with higher durations are more sensitive to interest rate changes
than are those with lower durations.
II) All else being equal, durations will be higher when (1) market yields are lower, (2)
bonds have longer maturities, and (3) bonds have lower coupons.
III) Duration is a measure of risk of the bond
a) I is correct, II, III are incorrect.
b) I is incorrect, II, III are correct.
c) I, II and III are correct.
d) I, II and III are incorrect.
12. Which of the following statements is TRUE?
a) The quoted price of a bond is the actual price an investor pays for the bond whenever
the bond is sold at a date other than the date of a coupon payment.
b) The quoted price of a bond is the actual price an investor pays for the bond when the
bond is sold on the date of a coupon payment.
c) A bond purchaser must pay the bond seller the cash price plus the accrued interest
on the bond.
d) The cash price plus the accrued interest on the bond is the quoted price of the bond.
13. Which of the following statements is true?
a) The price of bonds with lower coupon rates will be less sensitive to interest rates than
the price of higher-coupon-paying bonds will be.
b) The price of bonds with lower coupon rates will be more sensitive to interest rates than
the price of higher-coupon-paying bonds will be.
c) None of the above.
14. Which one of the following increases the sensitivity of the bond prices?
a) Increase in maturity
b) Decrease in maturity
c) Decrease in yield to maturity
d) Increase in coupon payment
15. The price of a ten-year semi-annual pay bond with a par value of $1,000 and a 7.5
percent annual coupon and yield to maturity of 8.25 percent is closest to:
a) $949.60
b) $950.24
c) $1,051.48
d) $1,052.11
16. An investor bought a bond at par and held it for one year. If the coupon rate is 5
percent, residual maturity of the bond is 8 years, and the yield to maturity of the bond
when it was sold was 6 percent, what is the holding period return of the bond?
a) 5%
b) 6%
c) –1.21%
d) –1.23%
17. An investor bought a bond at par (=$1,000) and held it for one month. If the coupon
rate is 5 percent, residual maturity of the bond is 8 years, and the selling price was
$937.90, what is the holding period return?
a) 5%
b) 5.79%
c) –5.79%
d) –1.79%
18. Toronto Skates Corp. has 6 percent annual-pay coupon bonds that trade with a
yield to maturity of 5.5 percent. The bonds have eight years to maturity. What is the
current bond price closest to?
a) $1,032.01
b) $1,031.67
c) $968.95
d) $968.60
19. Two years ago, St. Laurent Shippers Co. issued seven year semi-annual pay bonds
with a coupon rate of 8 percent. At issue, the yield to maturity was 7.5%. Today the
market rate on the bonds is 9 percent. The current price of the bond is closest to:
a) $1,026.85
b) $1,020.53
c) $960.44
d) $948.89
20. A five-year annual pay bond is quoted at 93.011 with a market yield of 8 percent.
The coupon rate is closest to
a) 4.12%
b) 6.25%
c) 6.28%
d) 9.19%
21. LaMaudite Lager Inc. has semi-annual pay bonds that trade with a yield to maturity
of 7 percent. The bonds have a six-year term to maturity and are currently selling for
$1,067.20. The coupon rate of the bond is closest to:
a) 4.95%
b) 8.39%
c) 8.41%
d) 15.69%
22. A ten-year annual pay bond with a 5% coupon rate is trading with a market yield of
7.75 percent. What is the percentage change in price if the market yield decreases by
75 basis points?
a) 5.37%
b) 5.61%
c) 5.67%
d) 5.77%
23. A five-year bond paying 8 percent semi-annual-pay coupons is trading on the
market at a yield of 6.75 percent. What is the percentage change in price if the market
yield increases by 75 basis points?
a) –2.98%
b) –3.02%
c) –3.05%
Valuation Basics 6 – 10
d) –3.11%
24. It is now October 25. Jenny has just purchased a ten-year 4.5 percent Canadian
government bond quoted at 96.894. The last semi-annual coupon payment was made
on June 30 in the same year. How much will Jenny actually pay for this bond?
a) $954.52
b) $968.94
c) $976.15
d) $983.36
25. The yield to maturity (YTM) is:
a) the discount rate used to evaluate bonds.
b) the bond’s internal rate of return.
c) the yield that an investor would expect to make if he or she bought the bond at the
current price, held it to maturity, received all the promised payments on their scheduled
dates, and reinvested all the cash flows received at YTM.
d) All of the above.
26. The current yield (CY) is:
a) The ratio of the semi-annual coupon interest divided by the bond’s maturity value.
6 – 11 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
b) The ratio of the semi-annual coupon interest divided by the bond’s current market
price.
c) The ratio of the annual coupon interest divided by the bond’s current market price.
d) The ratio of the annual coupon interest divided by the bond’s maturity value.
27. What is the current yield of a four-year semi-annual pay bond with a par value of
$1,000 and a 4 percent coupon rate when the bond is priced at $932.35?
a) 4.29%
b) 4.00%
c) 5.95%
d) 2.14%
28. What is the YTM of a four-year annual pay bond with a par value of $1,000 and a 4
percent coupon rate when the bond is priced at $932.35?
a) 2.96%
b) 5.92%
c) 5.95%
d) 11.90%
29. What is the YTM of a four-year annual pay bond with a par value of $1,000 and a 4
percent coupon rate when the bond is priced at $1,000?
a) 2.96%
b) 4.00%
c) 5.95%
d) 11.90%
30. A 5-year bond with 10% coupon rate and $1000 face value is selling for $1100.
Calculate the yield to maturity on the bond assuming annual interest payments.
a) 8.53%
b) 8.62%
c) 10%
d) None of the above
31. What is the YTM of a four-year semi-annual pay bond with a par value of $1,000
and a 4 percent coupon rate when the bond is priced at $932.35?
a) 2.96%
b) 5.92%
c) 5.95%
d) 11.90%
32. A fifteen-year 7 percent semi-annual-pay coupon bond that is callable in five years
at a call price of $1,070 is selling for $1,036.53. What is the YTC of this bond?
a) 7.30%
b) 6.61%
c) 6.14%
d) 6.00%
33. The market yield of a 12-year 8 percent semi-annual-pay bond is 6.6 percent. The
bond is callable in four years and its yield to call is 6.48 percent. What is the call price
of the bond?
a) $1,125.46
b) $1,114.81
c) $1,085.94
d) $1,080.01
34. The market yield of a twelve-year 7 percent annual-pay bond is 6 percent. The
bond is callable in three years and its yield to call is 5.7 percent. What is the call price
of the bond?
a) 1057.74
b) 1083.84
c) 1089.59
d) 1026.73
Valuation Basics 6 – 14
35. A four-year 6 percent semi-annual-pay bond with a maturity value of $1,000 is
trading at the YTM of 7 percent. What is this bond’s current yield?
a) 5.80%
b) 6.21%
c) 6.76%
d) 7.25%
36. The nominal interest rate is:
a) the difference between the real rate and expected inflation.
b) low when expected inflation is low and high when expected inflation is high.
c) high when expected inflation is low and low when expected inflation is high.
d) None of the above
37. refers to the relationship between interest rates and the term to maturity
on underlying debt instruments.
a) The Expectations theory
b) The Liquidity preference theory
6 – 15 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
c) The Market segmentation theory
d) The Term structure of interest rates
38. A one-year bond offers a 12.5% yield to maturity and a two-year bond offers an 11%
yield to maturity. Which of the following is true?
a) The term structure is upward sloping.
b) The term structure is flat.
c) The term structure is downward sloping.
d) The term structure cannot be determined.
39. Which of the following is not a correct statement of the interest rate parity (IRP)
theory?
a) It states the relationship between inflation and interest rates.
b) It states that forward currency contracts can be used to eliminate foreign exchange
risk.
c) It demonstrates how differences in interest rates across countries are offset by
expected changes in exchange rates.
d) It describes the relationship between interest rates and currency levels by using
forward currency exchange rates.
40. Which one of the following will occur during an increase in the supply of loanable
funds?
a) A decrease in interest rates.
b) A decrease of the money supply in the economy.
c) A decrease in insured deposit amounts.
d) A decrease in the saving rate in the economy.
41. Which of the following is not a theory of the term structure of interest rates?
a) Expectations theory
b) Interest rate parity theory
c) Liquidity preference theory
d) Market segmentations theory
42. Which of the following risks may be included in the spread that compensates
corporate bond investors for the assumption of additional risks over domestic
government bond investors?
a) Default risk
b) Foreign exchange rate risk
c) Interest rate risk
d) All of these
43. Which of the following rated bonds has the least risk?
a) AA
b) AAA
c) BB
d) A
44. Which one of the following ratios is the most correlated to default risk?
a) Account receivables collection period
b) Inventory collection period
c) Debt to equity ratio
d) Profit margin
45. Debt ratings assigned by professional debt-rating services are a measure of the
bond issuers’
a) currency risk.
b) interest rate risk.
c) foreign exchange rate risk.
d) default risk.