Fundamentals of Corporate Finance, 12e (Ross)
Chapter 7 Interest Rates and Bond Valuation
1) Allison just received the semiannual payment of $35 on a bond she owns. Which term refers
to this payment?
A) Coupon
B) Face value
C) Discount
D) Call premium
E) Yield
2) Bert owns a bond that will pay him $45 each year in interest plus $1,000 as a principal
payment at maturity. What is the $1,000 called?
A) Coupon
B) Face value
C) Discount
D) Yield
E) Dirty price
3) A discount bond’s coupon rate is equal to the annual interest divided by the:
A) call price.
B) current price.
C) face value.
D) clean price.
E) dirty price.
4) A bond’s principal is repaid on the ________ date.
A) coupon
B) yield
C) maturity
D) dirty
E) clean
5) The bond market requires a return of 9.8 percent on the 5-year bonds issued by JW Industries.
The 9.8 percent is referred to as the:
A) coupon rate.
B) face rate.
C) call rate.
D) yield to maturity.
E) current yield.
6) The current yield is defined as the annual interest on a bond divided by the:
A) coupon rate.
B) face value.
C) market price.
D) call price.
E) par value.
7) A $1,000 par value corporate bond that pays $60 annually in interest was issued last year.
Which one of these would apply to this bond today if the current price of the bond is $996.20?
A) The bond is currently selling at a premium.
B) The current yield exceeds the coupon rate.
C) The bond is selling at par value.
D) The current yield exceeds the yield to maturity.
E) The coupon rate has increased to 7 percent.
8) Which one of these equations applies to a bond that currently has a market price that exceeds
par value?
A) Market value < Face value
B) Yield to maturity = Current yield
C) Market value = Face value
D) Current yield > Coupon rate
E) Yield to maturity < Coupon rate
9) All else constant, a bond will sell at ________ when the coupon rate is ________ the yield to
maturity.
A) a premium; less than
B) a premium; equal to
C) a discount; less than
D) a discount; higher than
E) par; less than
10) DLQ Inc. bonds mature in 12 years and have a coupon rate of 6 percent. If the market rate of
interest increases, then the:
A) coupon rate will also increase.
B) current yield will decrease.
C) yield to maturity will be less than the coupon rate.
D) market price of the bond will decrease.
E) coupon payment will increase.
11) Which one of the following applies to a premium bond?
A) Yield to maturity > Current yield > Coupon rate
B) Coupon rate = Current yield = Yield to maturity
C) Coupon rate > Yield to maturity > Current yield
D) Coupon rate < Yield to maturity < Current yield
E) Coupon rate > Current yield > Yield to maturity
12) Which one of the following relationships applies to a par value bond?
A) Yield to maturity > Current yield > Coupon rate
B) Coupon rate > Yield to maturity > Current yield
C) Coupon rate = Current yield = Yield to maturity
D) Coupon rate < Yield to maturity < Current yield
E) Coupon rate > Current yield > Yield to maturity
13) Which one of the following relationships is stated correctly?
A) The coupon rate exceeds the current yield when a bond sells at a discount.
B) The call price must equal the par value.
C) An increase in market rates increases the market price of a bond.
D) Decreasing the time to maturity increases the price of a discount bond, all else constant.
E) Increasing the coupon rate decreases the current yield, all else constant.
14) Round Dot Inns is preparing a bond offering with a coupon rate of 6 percent, paid
semiannually, and a face value of $1,000. The bonds will mature in 10 years and will be sold at
par. Given this, which one of the following statements is correct?
A) The bonds will become discount bonds if the market rate of interest declines.
B) The bonds will pay 10 interest payments of $60 each.
C) The bonds will sell at a premium if the market rate is 5.5 percent.
D) The bonds will initially sell for $1,030 each.
E) The final payment will be in the amount of $1,060.
15) A newly issued bond has a coupon rate of 7 percent and semiannual interest payments. The
bonds are currently priced at par. The effective annual rate provided by these bonds must be:
A) 3.5 percent.
B) greater than 3.5 percent but less than 7 percent.
C) 7 percent.
D) greater than 7 percent.
E) less than 3.5 percent.
16) The price sensitivity of a bond increases in response to a change in the market rate of interest
as the:
A) coupon rate increases.
B) time to maturity decreases.
C) coupon rate decreases and the time to maturity increases.
D) time to maturity and coupon rate both decrease.
E) coupon rate and time to maturity both increase.
17) Which one of the following bonds is the least sensitive to interest rate risk?
A) 3-year; 4 percent coupon
B) 3-year; 6 percent coupon
C) 5-year; 6 percent coupon
D) 7-year; 6 percent coupon
E) 7-year; 4 percent coupon
18) As a bond’s time to maturity increases, the bond’s sensitivity to interest rate risk:
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.
19) You own a bond that pays an annual coupon of 6 percent that matures five years from now.
You purchased this 10-year bond at par value when it was originally issued. Which one of the
following statements applies to this bond if the relevant market interest rate is now 5.8 percent?
A) The current yield to maturity is greater than 6 percent.
B) The current yield is 6 percent.
C) The next interest payment will be $30.
D) The bond is currently valued at one-half of its issue price.
E) You will realize a capital gain on the bond if you sell it today.
20) You expect interest rates to decline in the near future even though the bond market is not
indicating any sign of this change. Which one of the following bonds should you purchase now
to maximize your gains if the rate decline does occur?
A) Short-term; low coupon
B) Short-term; high coupon
C) Long-term; zero coupon
D) Long-term; low coupon
E) Long-term; high coupon
21) A premium bond that pays $60 in interest annually matures in seven years. The bond was
originally issued three years ago at par. Which one of the following statements is accurate in
respect to this bond today?
A) The face value of the bond today is greater than it was when the bond was issued.
B) The bond is worth less today than when it was issued.
C) The yield to maturity is less than the coupon rate.
D) The coupon rate is less than the current yield.
E) The yield to maturity equals the current yield.
22) Which one of these statements is correct?
A) Most long-term bond issues are referred to as unfunded debt.
B) Bonds often provide tax benefits to issuers.
C) The risk of a company financially failing decreases when the company issues bonds.
D) All bonds are treated equally in a bankruptcy proceeding.
E) A debenture is a senior secured debt.
23) Hot Foods has an investment-grade bond issue outstanding that pays $30 semiannual interest
payments. The bonds sell at par and are callable at a price equal to the present value of all future
interest and principal payments discounted at a rate equal to the comparable Treasury rate plus
.50 percent. Which one of the following correctly describes this bond?
A) The bond rating is B.
B) Market value is less than face value.
C) The coupon rate is 3 percent.
D) The bond has a “make whole” call price.
E) The interest payments are variable.
24) Last year, Lexington Homes issued $1 million in unsecured, noncallable debt. This debt pays
an annual interest payment of $55 and matures six years from now. The face value is $1,000 and
the market price is $1,020. Which one of these terms correctly describes a feature of this debt?
A) Semiannual coupon
B) Discount bond
C) Note
D) Trust deed
E) Collateralized
25) Callable bonds generally:
A) grant the bondholder the option to call the bond any time after the deferment period.
B) are callable at par as soon as the call-protection period ends.
C) are called when market interest rates increase.
D) are called within the first three years after issuance.
E) have a sinking fund provision.
26) An example of a negative covenant that might be found in a bond indenture is a statement
that the company:
A) shall maintain a current ratio of 1.1 or higher.
B) cannot lease any major assets without bondholder approval.
C) must maintain the loan collateral in good working order.
D) shall provide audited financial statements in a timely manner.
E) shall maintain a cash surplus of $100,000 at all times.
27) Protective covenants:
A) apply to short–term debt issues but not to long–term debt issues.
B) only apply to privately issued bonds.
C) are a feature found only in government–issued bond indentures.
D) only apply to bonds that have a deferred call provision.
E) are primarily designed to protect bondholders.
28) Which one of these is most apt to be included in a bond’s indenture one year after the bond
has been issued?
A) Current yield
B) Written record of all the current bond holders
C) List of collateral used as bond security
D) Current market price
E) Price at which a bondholder can resell a bond to another bondholder
29) Road Hazards has 12-year bonds outstanding. The interest payments on these bonds are sent
directly to each of the individual bondholders. These direct payments are a clear indication that
the bonds can accurately be defined as being issued:
A) at par.
B) in registered form.
C) in street form.
D) as debentures.
E) as callable bonds.
30) A bond that is payable to whomever has physical possession of the bond is said to be in:
A) new–issue condition.
B) registered form.
C) bearer form.
D) debenture status.
E) collateral status.
31) Jason’s Paints just issued 20-year, 7.25 percent, unsecured bonds at par. These bonds fit the
definition of which one of the following terms?
A) Note
B) Discounted
C) Zero–coupon
D) Callable
E) Debenture
32) A note is generally defined as:
A) a secured bond with an initial maturity of 10 years or more.
B) a secured bond that initially matures in less than 10 years.
C) any bond secured by a blanket mortgage.
D) an unsecured bond with an initial maturity of 10 years or less.
E) any bond maturing in 10 years or more.
33) A sinking fund is managed by a trustee for which one of the following purposes?
A) Paying bond interest payments
B) Early bond redemption
C) Converting bonds into equity securities
D) Paying preferred dividends
E) Reducing bond coupon rates
34) A bond that can be paid off early at the issuer’s discretion is referred to as being which type
of bond?
A) Par value
B) Callable
C) Senior
D) Subordinated
E) Unsecured
35) A $1,000 face value bond can be redeemed early at the issuer’s discretion for $1,030, plus
any accrued interest. The additional $30 is called the:
A) dirty price.
B) redemption value.
C) call premium.
D) original–issue discount.
E) redemption discount.
36) A deferred call provision:
A) requires the bond issuer to pay the current market price, minus any accrued interest, should
the bond be called.
B) allows the bond issuer to delay repaying a bond until after the maturity date should the issuer
so opt.
C) prohibits the issuer from ever redeeming bonds prior to maturity.
D) prohibits the bond issuer from redeeming callable bonds prior to a specified date.
E) requires the bond issuer pay a call premium that is equal to or greater than one year’s coupon
should the bond be called.
37) A call–protected bond is a bond that:
A) is guaranteed to be called.
B) can never be called.
C) is currently being called.
D) is callable at any time.
E) cannot be called at this point in time.
38) The items included in an indenture that limit certain actions of the issuer in order to protect a
bondholder’s interests are referred to as the:
A) trustee relationships.
B) bylaws.
C) legal bounds.
D) trust deed.
E) protective covenants.
39) Which one of the following statements concerning bond ratings is correct?
A) Investment grade bonds are rated BB or higher by Standard & Poor’s.
B) Bond ratings assess both interest rate risk and default risk.
C) Split-rated bonds are called crossover bonds.
D) The highest rating issued by Moody’s is AAA.
E) A “fallen angel” is a term applied to all “junk” bonds.
40) A “fallen angel” is a bond that has moved from:
A) being publicly traded to being privately traded.
B) being a long-term obligation to being a short-term obligation.
C) being a premium bond to being a discount bond.
D) senior status to junior status for liquidation purposes.
E) investment grade to speculative grade.
41) Bonds issued by the U.S. government:
A) are considered to be free of interest rate risk.
B) generally have higher coupons than comparable bonds issued by a corporation.
C) are considered to be free of default risk.
D) pay interest that is exempt from federal income taxes.
E) are called “munis.”
42) Treasury bonds are:
A) issued by any governmental agency in the U.S.
B) issued only on the first day of each fiscal year by the U.S. Department of Treasury.
C) bonds that offer the best tax benefits of any bonds currently available.
D) generally issued as semiannual coupon bonds.
E) totally risk free.
43) Municipal bonds:
A) are totally risk free.
B) generally have higher coupon rates than corporate bonds.
C) pay interest that is federally tax free.
D) are rarely callable.
E) are free of default risk.
44) The break-even tax rate between a taxable corporate bond yielding 7 percent and a
comparable nontaxable municipal bond yielding 5 percent can be expressed as:
A) .05/(1 − t*) = .07.
B) .05 − (1 − t*) = .07.
C) .07 + (1 − t*) = .05.
D) .05 (1 − t*) = .07.
E) .05 (1 + t*) = .07.
45) A zero coupon bond:
A) is sold at a large premium.
B) pays interest that is tax deductible to the issuer at the time of payment.
C) can only be issued by the U.S. Treasury.
D) has more interest rate risk than a comparable coupon bond.
E) provides no taxable income to the bondholder until the bond matures.
46) Which one of the following risks would a floating-rate bond tend to have less of as compared
to a fixed-rate coupon bond?
A) Real rate risk
B) Interest rate risk
C) Default risk
D) Liquidity risk
E) Taxability risk
47) The collar of a floating-rate bond refers to the minimum and maximum:
A) call periods.
B) maturity dates.
C) market prices.
D) coupon rates.
E) yields to maturity.
48) Last year, you purchased a TIPS at par. Since that time, both market interest rates and the
inflation rate have increased by .25 percent. Your bond has most likely done which one of the
following since last year?
A) Decreased in value due to the change in inflation rates
B) Experienced an increase in its bond rating
C) Maintained a fixed real rate of return
D) Increased in value in response to the change in market rates
E) Increased in value due to a decrease in time to maturity
49) Recently, you discovered a convertible, callable bond with a semiannual coupon of 5
percent. If you purchase this bond you will have the right to:
A) force the issuer to repurchase the bond prior to maturity.
B) convert the bond into equity shares.
C) defer all taxable income until the bond matures.
D) convert the bond into a perpetuity paying 5 percent.
E) have the principal amount adjusted for inflation.