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Ch 05 Bonds, Bond Valuation, and Interest Rates
60. Field Industries' outstanding bonds have a 25-year maturity and $1,000 par value. Their nominal yield to maturity is
9.25%, they pay interest semiannually, and they sell at a price of $850. What is the bond's nominal (annual) coupon
interest rate?
a.
6.27%
b.
6.60%
c.
6.95%
d.
7.32%
e.
7.70%
Ch 05 Bonds, Bond Valuation, and Interest Rates
61. Jerome Corporation's bonds have 15 years to maturity, an 8.75% coupon paid semiannually, and a $1,000 par value.
The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,050. What is the bond's
nominal yield to call?
a.
5.01%
b.
5.27%
c.
5.54%
d.
5.81%
e.
6.10%
Ch 05 Bonds, Bond Valuation, and Interest Rates
62. Assume that interest rates on 15-year noncallable Treasury and corporate bonds with different ratings 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.
Tax effects.
b.
Default risk differences.
c.
Maturity risk differences.
d.
Inflation differences.
e.
Real risk-free rate differences.
63. 5-year Treasury bonds yield 5.5%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-
year bonds is 0.4%. What is the real risk-free rate, r*?
a.
2.59%
b.
2.88%
c.
3.20%
d.
3.52%
e.
3.87%
Ch 05 Bonds, Bond Valuation, and Interest Rates
64. The Gergen Group's 5-year bonds yield 6.85%, and 5-year T-bonds yield 4.75%. The real risk-free rate is r* = 2.80%,
the default risk premium for Gergen's bonds is DRP = 0.85% versus zero for T-bonds, the liquidity premium on Gergen's
bonds is LP = 1.25%, and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) × 0.1%, where
t = number of years to maturity. What is the inflation premium (IP) on 5-year bonds?
a.
1.40%
b.
1.55%
c.
1.71%
d.
1.88%
e.
2.06%
Ch 05 Bonds, Bond Valuation, and Interest Rates
65. 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
66. 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
Ch 05 Bonds, Bond Valuation, and Interest Rates
67. 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
68. "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
Ch 05 Bonds, Bond Valuation, and Interest Rates
69. Cornwall Corporation is planning to raise $1,000,000 to finance a new plant. Which of the following statements is
CORRECT?
a.
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.
b.
If two tiers of debt are used (with one senior and one subordinated debt class), the subordinated debt will carry
a lower interest rate.
c.
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.
d.
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.
e.
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.
Ch 05 Bonds, Bond Valuation, and Interest Rates
70. 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 prevent the use of additional debt.
a.
1, 4, 6
b.
1, 2, 3, 4, 6
c.
1, 2, 3, 4, 5, 6
d.
1, 3, 4, 5, 6
e.
1, 3, 4, 6
71. Suppose International Digital Technologies decides to raise a total of $200 million, with $100 million as long-term
debt and $100 million as common equity. 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.
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.
b.
In this situation, we cannot tell for sure how, or 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 of
the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result
Ch 05 Bonds, Bond Valuation, and Interest Rates
might well be such that the firm's total interest charges would not be affected materially by the mix between
the two.
c.
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.
d.
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.
e.
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.
72. If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-
year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds,
what is the default risk premium on the corporate bond?
a.
1.90%
b.
2.09%
c.
2.30%
d.
2.53%
e.
2.78%
Ch 05 Bonds, Bond Valuation, and Interest Rates
73. Chandler Co.'s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the
inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Chandler's bonds is LP = 0.75% versus zero
for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) × 0.1%, where t =
number of years to maturity. What is the default risk premium (DRP) on Chandler's bonds?
a.
0.99%
b.
1.10%
c.
1.21%
d.
1.33%
e.
1.46%
Ch 05 Bonds, Bond Valuation, and Interest Rates
74. Squire Inc.'s 5-year bonds yield 6.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the
inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Squire's bonds is DRP = 1.20% versus
zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) × 0.1%, where t =
number of years to maturity. What is the liquidity premium (LP) on Squire's bonds?
a.
0.49%
b.
0.55%
c.
0.61%
d.
0.68%
e.
0.75%
Ch 05 Bonds, Bond Valuation, and Interest Rates
75. A bond that had a 20-year original maturity with 1 year left to maturity has more interest rate 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
76. 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 interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.
a.
True
b.
False
Ch 05 Bonds, Bond Valuation, and Interest Rates
77. 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
78. Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?
a.
20-year, 10% coupon bond.
b.
20-year, 5% coupon bond.
c.
1-year, 10% coupon bond.
d.
20-year, zero coupon bond.
e.
10-year, zero coupon bond.
Ch 05 Bonds, Bond Valuation, and Interest Rates
79. 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.
A 1-year bond with a 15% coupon.
b.
A 3-year bond with a 10% coupon.
c.
A 10-year zero coupon bond.
d.
A 10-year bond with a 10% coupon.
e.
An 8-year bond with a 9% coupon.
80. Which of the following bonds has the greatest interest rate price risk?
Ch 05 Bonds, Bond Valuation, and Interest Rates
a.
A 10-year, $1,000 face value, zero coupon bond.
b.
A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
c.
All 10-year bonds have the same price risk since they have the same maturity.
d.
A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.
81. 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 bond with an 8% coupon.
b.
A 10-year bond with an 8% coupon.
c.
A 10-year bond with a 12% coupon.
d.
A 10-year zero coupon bond.
e.
A 1-year zero coupon bond.
