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Corporate Finance: Core Principles & Apps, 5e (Ross)
Chapter 5 Interest Rates and Bond Valuation
1) All else constant, a bond will sell at ________ when the yield to maturity is ________ the
coupon rate.
A) par; less than
B) a premium; equal to
C) par; higher than
D) a discount; higher than
E) a premium; higher than
2) All else constant, a coupon bond that is selling at a premium, must have
A) a yield to maturity that is less than the coupon rate.
B) a coupon rate that is equal to the yield to maturity.
C) a market price that is less than par value.
D) semiannual interest payments.
E) a coupon rate that is less than the yield to maturity.
3) Assume a discount bond has a few years until maturity and a positive yield. All else constant,
the bond’s yield to maturity is
A) directly related to the time to maturity.
B) equal to the coupon rate.
C) inversely related to the bond’s market price.
D) unrelated to the time to maturity.
E) less than its coupon rate.
4) Interest rate risk increases as
A) the time to maturity decreases.
B) the coupon rate increases.
C) a bond matures.
D) the coupon payment decreases.
E) either the time to maturity or the coupon rate increases.
5) Interest rate risk ________ as the time to maturity increases.
A) increases at an increasing rate
B) increases at a decreasing rate
C) increases at a constant rate
D) decreases at an increasing rate
E) decreases at a decreasing rate
6) Last year, Theo purchased a fixed-rate, 7-year bond at par that has a coupon rate of 6.5 percent.
If the current market rate for this type and quality of bond is 6.8 percent, then he should expect
A) his interest payments to increase.
B) the bond’s yield to maturity to remain constant.
C) the current yield today to be less than 6.5 percent.
D) the bond’s current market price to exceed its face value.
E) to realize a capital loss if he sold the bond at today’s market price.
7) All else constant, as the market price of a bond increases the current yield ________ and the
yield to maturity ________.
A) decreases; decreases
B) increases; decreases
C) increases; increases
D) decreases; increases
E) remains constant; increases
8) The yield to maturity on a bond is the rate
A) computed as the annual interest divided by the bond’s market price.
B) an investor earns if the bond is sold prior to the maturity date.
C) of annual interest initially offered when the bond was issued.
D) of return currently required by the market.
E) of annual interest paid on the bond.
9) A discount bond has a coupon rate that
A) exceeds its current yield.
B) is less than the bond’s yield to maturity.
C) exceeds both its current yield and its yield to maturity.
D) equals its current yield.
E) equals its current yield provided the bond pays interest annually.
10) A bond with both a face value and a market value of $1,000 is called a ________ bond.
A) par value
B) premium
C) discount
D) zero coupon
E) floating rate
11) ABC bonds have a coupon rate of 9 percent, pay interest semiannually, and sell at par. Each of
these bonds has a market price of ________ and interest payments of ________.
A) $1,045; $90
B) $1,045; $45
C) $1,090; $90
D) $1,000; $90
E) $1,000; $45
12) Which one of these definitions is correct?
A) Negative covenant: a “thou shalt” agreement
B) Premium bond: bond that sells for less than face value
C) Dirty price: market price, excluding accrued interest
D) Call provision: issuer’s right to repurchase a bond prior to maturity
E) Unfunded debt: long-term corporate debt
13) The written, legally binding agreement between a corporate borrower and its lenders detailing
all of the terms of a bond issue is called the
A) indenture.
B) covenant.
C) terms of trade.
D) put provision.
E) call provision.
14) A deferred call provision is designed to
A) guarantee a bond will be repaid on a certain date prior to maturity.
B) prohibit the calling of a bond prior to a certain date.
C) ensure bond holders receive full value when a bond is called.
D) ensure any bankruptcy of the issuer is deferred until a bond is repaid in full.
E) ensure the owner of a bond agrees to the call before a bond is called.
15) A “make-whole” call provision on a bond provides for
A) call prices that vary with the funds available in a sinking fund.
B) a call price equal to the bond’s approximate market value at the time of call.
C) decreasing call prices as interest rates decrease.
D) a call price equal to the face value plus all accrued interest to date.
E) a call price equal to the face value.
16) The parts of an indenture that protect the interests of the lender by limiting certain actions that
a company might take during the term of the loan are called
A) deferred call provisions.
B) sinking funds provisions.
C) protective covenants.
D) trustee relationships.
E) bond ratings.
17) Which of the following are generally included in a bond indenture?
A) Market price and face value
B) Repayment arrangements and market price
C) Yield to maturity on any given date
D) Security description and basic terms
E) Protective covenants and lenders identities
18) Protective covenants
A) are primarily designed to protect bondholders from future actions of the bond issuer.
B) only apply to bonds that have a deferred call provision.
C) are limited to stating actions that a firm must take.
D) are consistent for all bonds issued by a corporation within the United States.
E) are designed to protect the issuer should it default.
19) Debt securities
A) increase a firm’s cost of doing business.
B) pay tax-deductible dividends.
C) are treated the same as equity securities in a bankruptcy proceeding.
D) represent a minority ownership interest in the issuer.
E) are considered a liability only at the time payment is actually due.
20) Long-term debt securities that are issued but not offered to the general public are referred to as
A) privately placed.
B) zero coupon bonds.
C) internal debt.
D) equity securities.
E) unfunded debt.
21) Debentures
A) are a claim on assets not otherwise pledged as security.
B) represent a mortgage claim on real estate.
C) are a form of subordinated equity.
D) is another term for trust deeds.
E) are best defined as bearer bonds.
22) A sinking fund
A) is a claim on assets not otherwise pledged as security.
B) is used solely to retain funds until a bond issue matures.
C) is managed by a trustee.
D) is established during a bankruptcy proceeding to repay secured debts.
E) ensures all bonds are repaid prior to the original maturity date.
23) Bond ratings
A) are provided solely by Moody’s.
B) only assess the possibility of default.
C) of B or higher are considered investment-grade ratings.
D) consider interest rate risk.
E) of C indicate an average level of risk.
24) The lowest Moody’s bond rating that is considered to be an investment-grade rating is
A) A.
B) Baa.
C) BBB.
D) Ba.
E) BB.
25) A crossover bond is a bond that
A) was previously in default but is now current with its debt obligations.
B) was issued by a non-U.S. entity but is held by a U.S. party.
C) has both an investment-grade and a low-grade rating.
D) was issued as investment-grade but is currently rated as low-grade.
E) is rated by both a U.S. and a non-U.S. rating agency.
26) Bonds issued by the U.S. government
A) are considered to be default-free.
B) are exempt from interest-rate risk.
C) provide totally tax-free income.
D) pay interest that is exempt from federal income tax.
E) are taxed the same as municipal bonds.
27) For tax purposes, the implicit annual interest for any one year on a zero coupon bond is equal to
A) zero.
B) the annual change in the bond’s value as determined by amortizing the loan.
C) the current yield.
D) the face value multiplied by the current market rate of interest.
E) the face value minus the current market value.
28) The upper and lower limits on the coupon rate of a floating-rate bond are referred to as the
bond’s
A) put.
B) “make-whole” provision.
C) call.
D) income limit.
E) collar.
29) Municipal bonds
A) primarily appeal to high tax-bracket investors.
B) generally pay a higher pretax rate of return than corporate bonds.
C) are issued only by local municipalities, such as a city or a borough.
D) are rarely callable.
E) pay interest that is exempt from all income tax.
30) ______bonds pay interest that is taxed only at the federal level.
A) Municipal
B) Corporate
C) Treasury
D) Mortgage
E) Zero coupon
31) Floating-rate bonds generally have
A) an unlimited variable rate of interest.
B) a fixed coupon rate and a variable principal balance.
C) both a call and a put provision.
D) both a put provision and a collar.
E) a collar only on the bond’s principal.
32) Two of the primary differences between a corporate bond and a Treasury bond with identical
maturity dates are related to
A) interest rate risk and time value of money.
B) time value of money and inflation.
C) taxes and potential default.
D) taxes and inflation.
E) inflation and interest rate risk.
33) Bonds backed by assets with long-term payments are referred to as
A) payment bonds.
B) time value bonds.
C) securitized bonds.
D) cash-flow bonds.
E) inflation bonds.
34) Bonds that protect insurance companies from losses arising from natural disasters are called
________ bonds.
A) death
B) CAT
C) hurricane
D) flood insurance
E) DOG
35) A convertible bond can be exchanged for
A) cash equal to par value at any time.
B) shares of company stock.
C) any other outstanding bond.
D) a newly issued bond if it carries a higher coupon rate.
E) a new bond if the current bond’s rating falls to low-grade.
36) If the bond holder has any rights that can force repayment of the bond prior to maturity, the
bond
A) is an income bond.
B) has a call provision.
C) is convertible.
D) is a structured note.
E) has a put provision.
37) The U.S. corporate bond market
A) provides end-of-day values for all privately and publicly issued bonds.
B) is the largest securities market in the world based on trading volume.
C) is based on bond dealers who trade in a face-to-face market.
D) is more transparent than it was in the 1990s.
E) provides daily price quotes through BDEX, the bond dealers exchange.
38) Newspaper bond quotes are least apt to list a bond’s
A) coupon rate.
B) maturity date.
C) bid price.
D) par value.
E) asked price.
39) What does the spread between the bid and asked bond prices represent?
A) Difference between the coupon rate and the current yield
B) Difference between the current yield and the yield to maturity
C) Accrued interest
D) Dealer’s profit
E) Bondholder’s profit
40) Assume you purchase a bond with a quoted price of 98.6208 on June 30. The bond pays
interest on February 1 and August 1. The invoice price you pay for this purchase will equal the
A) clean price.
B) asked price.
C) dirty price.
D) par value.
E) bid price.
41) Bond prices are quoted as a percentage of the
A) issue price.
B) total interest and principal payments.
C) face value.
D) dirty value.
E) clean value.
42) A bond has a coupon rate of 6 percent and matures in 10 years. The next semiannual interest
payment will be paid 1 month from now. Which one of the following do you know with certainty
concerning this bond?
A) The bond sells at a discount.
B) The bond sells at a premium.
C) The dirty price is higher than the clean price.
D) The clean price is higher than the dirty price.
E) The market price exceeds the par value.
43) The increase you realize in buying power as a result of owning a bond is referred to as the
________ rate of return.
A) inflated
B) market
C) nominal
D) real
E) risk-free
44) Which formula computes the actual real rate of return on an investment?
A) r = (1 + R ) – (1 + h)
B) r = (1 + R ) / (1 + h)
C) r = (1 + R ) – (1 + h) – 1
D) r = (1 + R ) / (1 + h) – 1
E) R = (1 + r) × (1 + h) – 1
45) The percentage change in the amount of money you have as the result of an investment is
called the ________ rate of return.
A) real
B) nominal
C) effective
D) stripped
E) coupon
46) According to the Fisher effect, a decrease in the rate of inflation will
A) increase the real rate but not affect the nominal rate.
B) decrease the nominal rate but not affect the real rate.
C) not affect either the real or the nominal rate.
D) decrease both the nominal and the real rate.
E) increase the nominal rate but not affect the real rate.
47) Which one of these is included in the term structure of interest rates and remains constant over
the term?
A) Default risk premium
B) Interest rate risk premium
C) Liquidity premium
D) Real rate of interest
E) Inflation premium
48) The term structure of interest rates reflects the
A) pure time value of money for various lengths of time.
B) actual risk premium being paid for corporate bonds of varying maturities.
C) pure inflation adjustment applied to bonds of various maturities.
D) interest rate risk premium applicable to bonds of varying maturities.
E) nominal interest rates applicable to coupon bonds of varying maturities.
49) The ________ premium is that portion of a nominal interest rate or bond yield that represents
compensation for the possibility of nonpayment by the bond issuer.
A) interest rate risk
B) taxability
C) liquidity
D) inflation
E) default risk
50) An upward sloping yield curve indicates
A) interest rates are declining.
B) lower quality bonds have higher yields.
C) short-term rates will rise sharply in the near future.
D) an inverse relationship between bond prices and yields.
E) long-term rates are higher than medium-term rates.
51) The overall level of interest rates is primarily affected by the
A) real rate.
B) inflation rate.
C) interest rate risk premium.
D) liquidity premium.
E) default risk premium.
52) An increase in which one of these is most apt to decrease the nominal interest rate?
A) Liquidity
B) Interest rate risk
C) Default risk
D) Expected future inflation
E) The relevant tax rate
53) A year ago, Jasper Inc. sold 20-year bonds at par with a coupon rate of 4.5 percent and
semiannual payments. The face value of each bond is $1,000 and the yield to maturity is now 5.6
percent. What is the current value of each bond?
A) $923.09
B) $880.92
C) $872.35
D) $905.92
E) $868.66
54) The Rose Shoppe offers 10-year, 6 percent coupon bonds with semiannual payments and a
yield to maturity of 5.72 percent. What is the current market price if the face value is $1,000?
A) $990.32
B) $1,021.10
C) $1,108.16
D) $987.64
E) $1,000.00
55) North & South RR bonds bear a coupon rate of 5.5 percent, payable annually. The bonds
mature in 6.5 years, sell at par, and have a $1,000 face value. What is the yield to maturity?
A) 5.59%
B) 5.86%
C) 5.50%
D) 5.42%
E) 5.71%
56) A General Co. bond has a coupon rate of 6 percent and pays interest annually. The face value is
$1,000, and the current market price is $1,006.49. The bond matures in 16 years. What is the yield
to maturity?
A) 6.08%
B) 5.94%
C) 6.11%
D) 6.03%
E) 5.97%
57) A bond currently sells for $924.58, matures in 11 years, pays $27.50 every 6 months in
interest, and has a face value of $1,000. What is the yield to maturity?
A) 6.47%
B) 5.98%
C) 5.01%
D) 3.23%
E) 4.07%