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Chapter 06: Fixed Income Securities: Characteristics and Valuation
Multiple Choice
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 higher risk substitutes
c.
increased interest in equity securities
d.
None of these are correct
4. Extendable notes are redeemable at par at the option of the ___________.
a.
holder only
b.
company only
c.
trustee only
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
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
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
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 the
____________.
a.
current price
b.
required rate of return on the bond
c.
uniform annual interest payments
d.
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.
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
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
d.
supply; average
13. By the capitalization of cash flow method, the value of an asset is a function of ____________.
a.
the book value of the asset
b.
required rate of return
c.
the age of the asset
d.
All of these are correct
14. Which of the following is NOT a characteristic of long-term debt?
a.
Interest paid to bondholders is a tax-deductible expense to the firm.
b.
The firm is not legally required to pay interest to bondholders.
c.
It usually has a specific maturity.
d.
Its holders have a fixed claim on the firm’s assets in the event of bankruptcy.
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.
coupon rate of the debenture
d.
length of time to maturity
16. The indenture is a contract between the issuer and lenders that does all the following EXCEPT ______.
a.
specify the manner in which the principal must be repaid
b.
detail the nature of the debt issue
c.
give management’s expectations about return of the proceeds
d.
list 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 a lower coupon bond
d.
All of 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
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
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
a
20. Junk bonds are ______.
a.
usually rated Ba or higher by Moody’s
b.
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
21. Large companies build up short-term debt over the period of 1 to 2 years and 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.
decreased financial risk
b.
relatively low after-tax cost
c.
firm owners’ ability to maintain control over their firm
d.
increased earnings per share through financial leverage
a
23. The value of a 15-year bond will change ____ for a given change in the required rate of return than will the value of a
5 year bond.
a.
more
b.
less
c.
the same percentage
d.
exactly the same
a
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.
not equal to
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
25. Equipment trust certificates are used mainly by ______.
a.
equipment manufacturers
b.
oil drilling companies
c.
state governments
d.
railroad and trucking companies
26. All of the following types of bonds are secured EXCEPT ______.
a.
collateral trust
b.
mortgage
c.
debentures
d.
equipment trust certificates
c
27. The call feature is an advantage to the issuing firm if _______.
a.
the bond has a floating rate
b.
interest rates decline
c.
the bond has a low par value
d.
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
c
30. The ____ represents the debtholders in dealings with the issuing company.
a.
trustee
b.
stakeholders
c.
broker
d.
investment banker
a
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
31. If an American Water Company bond has a coupon rate of 9 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
a
32. “Junk bond” is a term used to describe a bond that _____.
a.
is in default
b.
is rated Ba or lower by Moody’s
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
c
34. Preferred stock has a priority over common stock with regard to the company’s ______.
a.
assets only
b.
voting rights only
c.
dividends only
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
a
36. ____ are not secured by specific assets.
a.
Equipment trust certificates
b.
Mortgage bonds
c.
Debentures
d.
Collateral trust bonds
c
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
37. A zero coupon bond is NOT an example of a(n) ____.
a.
fixed income security
b.
original issue deep discount bond
c.
tax-exempt bond
d.
All of these are correct
c
38. Junk bonds (i.e., bonds issued by companies with weak financial positions) are rated ____ or lower by Standard &
Poor’s.
a.
Baa
b.
BB
c.
Ba
d.
CCC
39. The required rate of return on an asset is NOT a function of the ____.
a.
risk associated with the asset
b.
risk-free interest rate
c.
age of the asset
d.
All of these are correct
c
40. Common stock is a(n) ______-income security.
a.
variable
b.
fixed
c.
after-tax
d.
split
a
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
c
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
c
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Chapter 06: 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
c
44. A zero coupon bond is a bond that ______.
a.
originally sells at a discount
b.
will sell for a premium
c.
is a premium value bond
d.
has a high current yield
a
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
8.34
8.29
8.58
a.
bid
b.
asked
c.
yield
d.
None of these are correct
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
48. Treasury notes typically have initial maturities ranging from _____.
a.
1 to 3 years
b.
1 to 5 years
c.
1 to 10 years
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
d.
10 to 30 years
c
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.
All of these are correct
c
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.
capital-intensive companies undergoing expansion
c.
large commercial banks
d.
All of these are correct
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?
a.
5.84%
b.
4.64%
c.
4.28%
d.
5.49%
53. If an Allied Chemical zero coupon bond due in 12 years is selling for $420, what is its yield to maturity?
a.
7.50%
b.
4.64%
c.
6.51%
d.
5.26%
a
54. The State of New York 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
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
c.
$10
d.
$50
55. A General Electric 7½ bond closed at 98. What is the current yield?
a.
7.65%
b.
7.81%
c.
7.50%
d.
7.34%
a
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%
a
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
c
59. A Treasury bill with a July 11 maturity date is quoted today at 8.46 bid and 8.40 asked. How much would you pay
today (January 11) 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.
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
These bonds were issued in $1,000 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
c
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%
c
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
a
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%
c
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%
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Chapter 06: Fixed Income Securities: Characteristics and Valuation
c.
11%
d.
9%
c
66. What is the value of a $1,000 par value Consul perpetual bond with a 6 percent coupon rate if the required rate of
return is 9 percent?
a.
$1,000.00
b.
$666.67
c.
$333.33
d.
$540.00
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.
$1,000.00
d.
$1,080.00
c
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%