Chapter 7: Bonds Conceptual M/C Page 247
64. 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.
65. 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 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.
66. Which of the following statements is CORRECT?
a. All else equal, secured debt is more risky than unsecured debt.
b. The expected return on a corporate bond must be greater than its
promised return if the probability of default is greater than zero.
c. All else equal, senior debt has more default risk than subordinated
debt.
d. A company’s bond rating is affected by its financial ratios but not
by provisions in its indenture.
e. Under Chapter 11 of the Bankruptcy Act, the assets of a firm that
declares bankruptcy must be liquidated, and the sale proceeds must
be used to pay off claims against it according to the priority of
the claims as spelled out in the Act.
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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.
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 7: Bonds Conceptual M/C Page 249
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.
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.
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
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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.
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.
Chapter 7: Bonds M/C Problems Page 251
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 capital loss than
the capital gain stemming from a 1.0 percentage point decrease in
the interest rate.
Multiple Choice: Problems
75. Morin Company’s bonds mature in 8 years, have a par value of $1,000,
and make an annual coupon interest payment of $65. The market requires
an interest rate of 8.2% on these bonds. What is the bond’s price?
a. $903.04
b. $925.62
c. $948.76
d. $972.48
e. $996.79
76. Ryngaert Inc. recently issued noncallable bonds that mature in 15
years. They have a par value of $1,000 and an annual coupon of 5.7%.
If the current market interest rate is 7.0%, at what price should the
bonds sell?
a. $817.12
b. $838.07
c. $859.56
d. $881.60
e. $903.64
77. Adams Enterprises’ noncallable bonds currently sell for $1,120. They
have a 15-year maturity, an annual coupon of $85, and a par value of
$1,000. What is their yield to maturity?
a. 5.84%
b. 6.15%
c. 6.47%
d. 6.81%
Page 252 M/C Problems Chapter 7: Bonds
e. 7.17%
Chapter 7: Bonds M/C Problems Page 253
78. Dyl Inc.’s bonds currently sell for $1,040 and have a par value of
$1,000. They pay a $65 annual coupon and have a 15-year maturity, but
they can be called in 5 years at $1,100. What is their yield to
maturity (YTM)?
a. 5.78%
b. 6.09%
c. 6.39%
d. 6.71%
e. 7.05%
79. Radoski Corporation‘s bonds make an annual coupon interest payment of
7.35%. The bonds have a par value of $1,000, a current price of
$1,130, and mature in 12 years. What is the yield to maturity on these
bonds?
a. 5.52%
b. 5.82%
c. 6.11%
d. 6.41%
e. 6.73%
80. Sadik Inc.’s bonds currently sell for $1,180 and have a par value of
$1,000. They pay a $105 annual coupon and have a 15-year maturity, but
they can be called in 5 years at $1,100. What is their yield to call
(YTC)?
a. 6.63%
b. 6.98%
c. 7.35%
d. 7.74%
e. 8.12%
81. Malko Enterprises’ bonds currently sell for $1,050. They have a 6–year
maturity, an annual coupon of $75, and a par value of $1,000. What is
their current yield?
a. 7.14%
b. 7.50%
c. 7.88%
d. 8.27%
e. 8.68%
82. Assume that you are considering the purchase of a 20-year, noncallable
bond with an annual coupon rate of 9.5%. The bond has a face value of
$1,000, and it makes semiannual interest payments. If you require an
8.4% nominal yield to maturity on this investment, what is the maximum
price you should be willing to pay for the bond?
Page 254 M/C Problems Chapter 7: Bonds
a. $1,105.69
b. $1,133.34
c. $1,161.67
d. $1,190.71
e. $1,220.48
83. Grossnickle Corporation issued 20-year, noncallable, 7.5% annual coupon
bonds at their par value of $1,000 one year ago. Today, the market
interest rate on these bonds is 5.5%. What is the current price of the
bonds, given that they now have 19 years to maturity?
a. $1,113.48
b. $1,142.03
c. $1,171.32
d. $1,201.35
e. $1,232.15
84. McCue Inc.’s bonds currently sell for $1,250. They pay a $90 annual
coupon, have a 25-year maturity, and a $1,000 par value, but they can
be called in 5 years at $1,050. Assume that no costs other than the
call premium would be incurred to call and refund the bonds, and also
assume that the yield curve is horizontal, with rates expected to remain
at current levels on into the future. What is the difference between
this bond’s YTM and its YTC? (Subtract the YTC from the YTM; it is
possible to get a negative answer.)
a. 2.62%
b. 2.88%
c. 3.17%
d. 3.48%
e. 3.83%
85. Taussig Corp.’s bonds currently sell for $1,150. They have a 6.35%
annual coupon rate and a 20-year maturity, but they can be called in 5
years at $1,067.50. Assume that no costs other than the call premium
would be incurred to call and refund the bonds, and also assume that
the yield curve is horizontal, with rates expected to remain at current
levels on into the future. Under these conditions, what rate of return
should an investor expect to earn if he or she purchases these bonds?
a. 3.42%
b. 3.60%
c. 3.79%
d. 3.99%
e. 4.20%
86. A 25-year, $1,000 par value bond has an 8.5% annual payment coupon.
The bond currently sells for $925. If the yield to maturity remains at
its current rate, what will the price be 5 years from now?
Chapter 7: Bonds M/C Problems Page 255
a. $884.19
b. $906.86
c. $930.11
d. $953.36
e. $977.20
Page 256 M/C Problems Chapter 7: Bonds
87. Moerdyk Corporation’s bonds have a 15-year maturity, a 7.25% semiannual
coupon, and a par value of $1,000. The going interest rate (rd) is
6.20%, based on semiannual compounding. What is the bond’s price?
a. $1,047.19
b. $1,074.05
c. $1,101.58
d. $1,129.12
e. $1,157.35
88. In order to accurately assess the capital structure of a firm, it is
necessary to convert its balance sheet figures from historical book
values to market values. KJM Corporation’s balance sheet (book values)
as of today is as follows:
Long-term debt (bonds, at par) $23,500,000
Preferred stock 2,000,000
Common stock ($10 par) 10,000,000
Retained earnings 4,000,000
Total debt and equity $39,500,000
The bonds have a 7.0% coupon rate, payable semiannually, and a par
value of $1,000. They mature exactly 10 years from today. The yield
to maturity is 11%, so the bonds now sell below par. What is the
current market value of the firm’s debt?
a. $17,436,237
b. $17,883,320
c. $18,330,403
d. $ 7,706,000
e. $ 7,898,650
89. Keenan Industries has a bond outstanding with 15 years to maturity, an
8.25% nominal coupon, semiannual payments, 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 $1,120. What is the bond’s nominal yield to call?
a. 6.20%
b. 6.53%
c. 6.85%
d. 7.20%
e. 7.55%
90. O’Brien Ltd.’s outstanding bonds have a $1,000 par value, and they
mature in 25 years. Their nominal yield to maturity is 9.25%, they pay
interest semiannually, and they sell at a price of $975. What is the
bond’s nominal coupon interest rate?
a. 7.32%
b. 7.71%
Chapter 7: Bonds M/C Problems Page 257
c. 8.12%
d. 8.54%
e. 8.99%