Test bank corporate finance 8e ros chap007

Chapter 007 Interest Rates and Bond Valuation Multiple Choice Questions The stated interest payment, in dollars, made on a bond each period is called the bond's: A coupon b face value c maturity d yield to maturity e coupon rate SECTION: 7.1 TOPIC: COUPON TYPE: DEFINITIONS The principal amount of a bond that is repaid at the end of the term is called the: a coupon B face value c maturity d yield to maturity e coupon rate SECTION: 7.1 TOPIC: FACE VALUE TYPE: DEFINITIONS The specified date on which the principal amount of a bond is repaid is called the: a coupon b face value C maturity d yield to maturity e coupon rate SECTION: 7.1 TOPIC: MATURITY TYPE: DEFINITIONS 7-1 Chapter 007 Interest Rates and Bond Valuation The rate of return required by investors in the market for owning a bond is called the: a coupon b face value c maturity D yield to maturity e coupon rate SECTION: 7.1 TOPIC: YIELD TO MATURITY TYPE: DEFINITIONS The annual coupon divided by the face value of a bond is called the: a coupon b face value c maturity d yield to maturity E coupon rate SECTION: 7.1 TOPIC: COUPON RATE TYPE: DEFINITIONS The annual coupon payment divided by the market price of a bond is called the: a coupon rate B current yield c yield to maturity d bid-ask spread e capital gains yield SECTION: 7.1 TOPIC: CURRENT YIELD TYPE: DEFINITIONS 7-2 Chapter 007 Interest Rates and Bond Valuation An indenture is: a the annual amount which a bond issuer agrees to pay as interest on the debt b the written record of the original and all subsequent holders of each individual bond comprising a debt issue c a bond which is past its maturity date but has yet to be repaid d a bond which is secured by the fixed assets which are owned by the bond issuer E the written agreement between the bond issuer and the bondholders which details the terms of the debt issue SECTION: 7.2 TOPIC: INDENTURE TYPE: DEFINITIONS A bond for which the registrar of the issuer records ownership and for which payments are made directly to the owner of record is said to be in: a new-issue condition B registered form c bearer form d debenture status e collateral status SECTION: 7.2 TOPIC: REGISTERED FORM TYPE: DEFINITIONS A bond which is issued without recording of the owner's name and for which payments are made 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 SECTION: 7.2 TOPIC: BEARER FORM TYPE: DEFINITIONS 7-3 Chapter 007 Interest Rates and Bond Valuation 10 An unsecured debt of a firm with a maturity of 10 years or more is called a(n): a unfunded liability b sinking funds c blanket bond d note E debenture SECTION: 7.2 TOPIC: DEBENTURE TYPE: DEFINITIONS 11 An unsecured debt of a firm with a maturity of less than 10 years is called a(n): a unfunded liability b sinking fund c blanket bond D note e debenture SECTION: 7.2 TOPIC: NOTE TYPE: DEFINITIONS 12 An account managed by a bond trustee for early bond redemption payments is called a: A sinking fund b collateral payment account c deed in trust account d call provision account e conversion fund SECTION: 7.2 TOPIC: SINKING FUND TYPE: DEFINITIONS 7-4 Chapter 007 Interest Rates and Bond Valuation 13 An agreement giving the bond issuer the option to repurchase the bond at a specified price prior to maturity is the _ provision a sinking fund B call c seniority d collateral e debenture SECTION: 7.2 TOPIC: CALL PROVISION TYPE: DEFINITIONS 14 The amount by which the call price exceeds the bond's par value is the: a coupon rate b redemption value C call premium d original-issue discount e call rate SECTION: 7.2 TOPIC: CALL PREMIUM TYPE: DEFINITIONS 15 A deferred call provision refers to the: a requirement that a bond issuer pay the current market price should they decide to call a bond b ability of a bond issuer to delay repaying a bond until after the maturity date should the issuer so opt c prohibition placed on an issuer which prevents that issuer from ever redeeming bonds prior to maturity D prohibition which prevents bond issuers from redeeming callable bonds prior to a specified date e requirement that a bond issuer pay a call premium which is equal to or greater than one year's coupon should that issuer decide to call a bond SECTION: 7.2 TOPIC: DEFERRED CALL PROVISION TYPE: DEFINITIONS 7-5 Chapter 007 Interest Rates and Bond Valuation 16 A bond which currently cannot be called but is eligible for a call at a later date is referred to as a: a premium call bond B call-protected bond c no-call bond d call-in-waiting bond e postponed callable bond SECTION: 7.2 TOPIC: CALL-PROTECTED BOND TYPE: DEFINITIONS 17 Parts of the indenture limiting certain actions that might be taken during the term of the loan to protect the interests of the lender are called: a trustee relationships b sinking funds provisions c bond ratings d deferred call provisions E protective covenants SECTION: 7.2 TOPIC: PROTECTIVE COVENANT TYPE: DEFINITIONS 18 A bond that makes no coupon payments and is initially sold at a deep discount is called a _ bond a debenture b callable c floating-rate d junk E zero coupon SECTION: 7.4 TOPIC: ZERO COUPON BOND TYPE: DEFINITIONS 7-6 Chapter 007 Interest Rates and Bond Valuation 19 The price a dealer is willing to pay for a security is called the: a equilibrium price b asked price C bid price d bid-ask spread e auction price SECTION: 7.5 TOPIC: BID PRICE TYPE: DEFINITIONS 20 The price at which a dealer is willing to sell a security is called the: a equilibrium price b auction price c bid price D asked price e bid-ask spread SECTION: 7.5 TOPIC: ASKED PRICE TYPE: DEFINITIONS 21 The difference between the price which a dealer is willing to pay and the price at which the dealer is willing to sell is called the: a equilibrium bid b auction premium c bid price d asked price E bid-ask spread SECTION: 7.5 TOPIC: BID-ASK SPREAD TYPE: DEFINITIONS 7-7 Chapter 007 Interest Rates and Bond Valuation 22 The quoted price of a bond is referred to as the _ price a coupon b spread C clean d dirty e wholesale SECTION: 7.5 TOPIC: CLEAN PRICE TYPE: DEFINITIONS 23 The price a buyer actually pays to purchase a bond is called the _ price a coupon b spread c clean D dirty e retail SECTION: 7.5 TOPIC: DIRTY PRICE TYPE: DEFINITIONS 24 A real rate is a nominal rate which has been adjusted for: A inflation b interest rate risk c accrued interest d changes in the market rate of interest e both inflation and interest rate risk SECTION: 7.6 TOPIC: REAL RATES TYPE: DEFINITIONS 7-8 Chapter 007 Interest Rates and Bond Valuation 25 Interest rates that have not been adjusted for inflation are called _ rates a coupon b stripped c effective d real E nominal SECTION: 7.6 TOPIC: NOMINAL RATES TYPE: DEFINITIONS 26 The relationship between nominal rates, real rates, and inflation is known as the: a Miller and Modigliani theorem B Fisher effect c Gordon growth model d term structure of interest rates e interest rate risk premium SECTION: 7.6 TOPIC: FISHER EFFECT TYPE: DEFINITIONS 27 The pure time value of money is known as the: a liquidity effect b Fisher effect C term structure of interest rates d inflation factor e interest rate factor SECTION: 7.7 TOPIC: TERM STRUCTURE OF INTEREST RATES TYPE: DEFINITIONS 7-9 Chapter 007 Interest Rates and Bond Valuation 28 The _ premium is that portion of a nominal interest rate or bond yield that represents compensation for expected future overall price appreciation a default risk b taxability c liquidity D inflation e interest rate risk SECTION: 7.7 TOPIC: INFLATION PREMIUM TYPE: DEFINITIONS 29 The interest rate risk premium is the: a additional compensation paid to investors to offset rising prices B compensation investors demand for accepting interest rate risk c difference between the yield to maturity and the current yield d difference between the market interest rate and the coupon rate e difference between the coupon rate and the current yield SECTION: 7.7 TOPIC: INTEREST RATE RISK PREMIUM TYPE: DEFINITIONS 30 A Treasury yield curve is defined as the plotting of the yields on Treasury securities relative to: a market interest rates b comparable corporate bond yields c the risk-free rate d inflation E maturity SECTION: 7.7 TOPIC: TREASURY YIELD CURVE TYPE: DEFINITIONS 7-10 Chapter 007 Interest Rates and Bond Valuation 95 Milner's Tools has a 9-year, percent annual coupon bond outstanding with a $1,000 par value Carter's Tools has a 10-year, percent annual coupon bond with a $1,000 par value Both bonds currently have a yield to maturity of 6.5 percent Which of the following statements is correct if the market yield increases to 6.75 percent? a Both bonds would decrease in value by 2.50 percent b The Milner's bond will increase in value by $16.82 c The Milner's bond will increase in value by 1.63 percent D The Carter's bond will decrease in value by 1.80 percent e The Carter's bond will decrease in value by $16.82 7-41 Chapter 007 Interest Rates and Bond Valuation The correct answer states that the Carter's bond will decrease in value by 1.80 percent 7-42 Chapter 007 Interest Rates and Bond Valuation AACSB TOPIC: ANALYTIC SECTION: 7.1 TOPIC: INTEREST RATE RISK TYPE: PROBLEMS 96 Barkstone Candies bonds have a face value of $1,000 and a current market price of $1,047.20 The bonds have a percent coupon rate What is the current yield on these bonds? a 2.53 percent b 2.86 percent C 5.73 percent d 6.0 percent e 11.46 percent AACSB TOPIC: ANALYTIC SECTION: 7.1 TOPIC: CURRENT YIELD TYPE: PROBLEMS 97 The outstanding bonds of Jacksen Global Freight carry an percent coupon and have a current market price of $1,054 The bonds have a face value of $1,000 What is the current yield on these bonds? a 2.47 percent b 3.80 percent c 4.00 percent D 7.59 percent e 8.00 percent AACSB TOPIC: ANALYTIC SECTION: 7.1 TOPIC: CURRENT YIELD TYPE: PROBLEMS 7-43 Chapter 007 Interest Rates and Bond Valuation 98 The bonds offered by Glenwood Studios are callable in years at a quoted price of 106 What is the amount of the call premium on a $1,000 par value bond? a $30 b $40 c $50 D $60 e $70 Call premium = (1.06 $1,000) $1,000 = $60 AACSB TOPIC: ANALYTIC SECTION: 7.2 TOPIC: CALL PREMIUM TYPE: PROBLEMS 99 A corporate bond is quoted at a current price of 103.68 What is the market price if the face value is $5,000? a $4,785.00 b $4,822.53 c $5,103.68 D $5,184.00 e $5,210.68 Market price = 1.0368 $5,000 = $5,184.00 AACSB TOPIC: ANALYTIC SECTION: 7.5 TOPIC: CORPORATE BOND QUOTE TYPE: PROBLEMS 7-44 Chapter 007 Interest Rates and Bond Valuation 100 Atlas Movers is issuing $1,000 face value zero coupon bonds at a quoted price of 38.70 What is the amount you would pay to purchase one of these bonds? a $38.70 B $387.00 c $961.30 d $1,000.00 e $1,038.70 Market price = 3870 $1,000 = $387.00 AACSB TOPIC: ANALYTIC SECTION: 7.5 TOPIC: ZERO COUPON BOND QUOTE TYPE: PROBLEMS 101 A Treasury bond is quoted at a price of 105:21 What is the market price of this bond if the face value is $1,000? a $105.21 b $106.56 c $1,052.10 D $1,056.56 e $1,065.60 105:21 = 105 and 21/32% = 1.0565625; Market price = 1.0565625 AACSB TOPIC: ANALYTIC SECTION: 7.5 TOPIC: TREASURY BOND QUOTE TYPE: PROBLEMS 7-45 $1,000 = $1,056.56 Chapter 007 Interest Rates and Bond Valuation 102 A Treasury bond is quoted at a price of 100:07 with a current yield of 6.4858 percent What is the coupon rate? a 5.50 percent b 5.75 percent c 6.00 percent d 6.25 percent E 6.50 percent 064858 =Annual dividend / (100 and /32 percent of $1,000) = Annual dividend / ($1,002.1875); Annual dividend = $64.9999; Coupon rate = $64.9999 / $1,000 = 6.50 percent AACSB TOPIC: ANALYTIC SECTION: 7.1 AND 7.5 TOPIC: TREASURY BOND QUOTE AND COUPON RATE TYPE: PROBLEMS 103 A corporate bond is quoted at a price of 96.48 and carries a 5.75 percent coupon The bond pays interest semiannually What is the current yield on one of these bonds? a 5.87 percent b 5.91 percent C 5.96 percent d 6.03 percent e 6.08 percent Current yield = (.0575 $1,000) / (.9648 $1,000) = 5.96 percent AACSB TOPIC: ANALYTIC SECTION: 7.1 AND 7.5 TOPIC: CORPORATE QUOTE AND CURRENT YIELD TYPE: PROBLEMS 7-46 Chapter 007 Interest Rates and Bond Valuation 104 A Treasury bond is quoted at a price of 104:18 with a 4.75 percent coupon The bond pays interest semiannually What is the current yield on one of these bonds? a 4.49 percent B 4.54 percent c 4.61 percent d 4.64 percent e 4.72 percent Current yield = (.0475 4.54 percent $1,000) / (104 and 18/32 percent of $1,000) = $47.50 / $1,045.625 = AACSB TOPIC: ANALYTIC SECTION: 7.1 AND 7.5 TOPIC: TREASURY QUOTE AND CURRENT YIELD TYPE: PROBLEMS 105 A Treasury bond is quoted as 102:19 asked and 102:17 bid What is the bid-ask spread in dollars on a $1,000 face value bond? a $.020 b $.200 C $.625 d $2.00 e $6.25 Bid-ask spread = 102:19 102:17 = 2/32 of 1% of $1,000 = 000625 AACSB TOPIC: ANALYTIC SECTION: 7.5 TOPIC: BID-ASK SPREAD TYPE: PROBLEMS 7-47 $1,000 = $.625 Chapter 007 Interest Rates and Bond Valuation 106 The semiannual, 12-year bonds of Tracey United are selling at par and have an effective annual yield of 4.6529 percent What is the amount of each interest payment if the face value of the bonds is $1,000? a $22.50 b $22.75 C $23.00 d $23.27 e $23.50 r = 046; Because the bond is selling at par, the APR and the coupon rate are equal Thus, the semiannual interest payment = ; Semiannual interest payment = $23.00 AACSB TOPIC: ANALYTIC SECTION: 7.1 TOPIC: EFFECTIVE ANNUAL RATES AND INTEREST PAYMENTS TYPE: PROBLEMS 107 A bond that pays interest annually yields a 6.875 percent rate of return The inflation rate for the same period is 4.35 percent What is the real rate of return on this bond? a 2.38 percent B 2.42 percent c 2.53 percent d 2.61 percent e 2.64 percent AACSB TOPIC: ANALYTIC SECTION: 7.6 TOPIC: FISHER EFFECT TYPE: PROBLEMS 7-48 Chapter 007 Interest Rates and Bond Valuation 108 Tri-County Hauling has bonds outstanding that pay a percent coupon, have a 5.47 percent yield to maturity, and a face value of $1,000 The current rate of inflation is 3.2 percent What is the real rate of return on these bonds? a 0.53 percent B 2.20 percent c 2.27 percent d 2.71 percent e 2.80 percent AACSB TOPIC: ANALYTIC SECTION: 7.6 TOPIC: FISHER EFFECT TYPE: PROBLEMS 109 The outstanding bonds of Frank's Welding provide a real rate of return of 2.87 percent The current rate of inflation is 4.64 percent What is the nominal rate of return on these bonds? a 7.33 percent b 7.46 percent c 7.51 percent D 7.64 percent e 7.71 percent (1 + 0287) (1 + 0464) -1 = 07643 = 7.64 percent AACSB TOPIC: ANALYTIC SECTION: 7.6 TOPIC: FISHER EFFECT TYPE: PROBLEMS 7-49 Chapter 007 Interest Rates and Bond Valuation 110 The yield to maturity on a bond is currently 6.48 percent The real rate of return is 2.87 percent What is the rate of inflation? a 3.47 percent B 3.51 percent c 3.57 percent d 3.61 percent e 3.67 percent AACSB TOPIC: ANALYTIC SECTION: 7.6 TOPIC: FISHER EFFECT TYPE: PROBLEMS 111 A zero coupon bond with a face value of $1,000 is issued with an initial price of $387.50 The bond matures in 30 years What is the implicit interest, in dollars, for the first year of the bond's life? a $10.38 B $12.44 c $14.42 d $18.79 e $22.50 ; r = 3.2106 percent; Implicit interest = $399.94 $387.50 = $12.44 AACSB TOPIC: ANALYTIC SECTION: 7.4 TOPIC: ZERO COUPON BOND AND IMPLICIT INTEREST TYPE: PROBLEMS 7-50 Chapter 007 Interest Rates and Bond Valuation 112 Steubenville Liquidators wants to raise $6.2 million to expand their business To accomplish this, they plan to sell 20-year, $1,000 face value, zero-coupon bonds The bonds will be priced to yield 9.5 percent What is the minimum number of bonds they must sell to raise the $6.2 million they need? A 38,078 b 42,500 c 54,500 d 57,500 e 61,333 AACSB TOPIC: ANALYTIC SECTION: 7.4 TOPIC: ZERO COUPON BOND PRICING TYPE: PROBLEMS 7-51 Chapter 007 Interest Rates and Bond Valuation 113 You plan on depositing $10,000 a year in real terms into your investment account for the next four years The relevant nominal discount rate is 7.5 percent and the inflation rate is 4.2 percent What are these deposits worth in today's dollars? a $36,418.02 b $36,787.78 C $37,023.49 d $38,021.21 e $38,504.19 AACSB TOPIC: ANALYTIC SECTION: 7.6 TOPIC: INFLATION AND PRESENT VALUES TYPE: PROBLEMS 7-52 Chapter 007 Interest Rates and Bond Valuation 114 You purchased an investment which will pay you $15,000, in real dollars, a year for the next three years The nominal discount rate is percent and the inflation rate is 3.6 percent What is the present value of these payments? A $41,431.91 b $42,607.19 c $43,333.33 d $43,711.14 e $44,008.16 AACSB TOPIC: ANALYTIC SECTION: 7.6 TOPIC: INFLATION AND PRESENT VALUES TYPE: PROBLEMS 7-53 Chapter 007 Interest Rates and Bond Valuation Essay Questions 115 Explain liquidity risk, default risk, and taxability risk as they relate to bonds Liquidity risk is the inability to sell a bond for its actual value This risk exists primarily in thinly traded issues Default risk is the likelihood the issuer will default on its bond obligations Taxability risk reflects the fact that some bonds are taxed disadvantageously compared to others When these risks apply to a particular bond, investors will require higher rates of return as compensation for assuming the additional risk AACSB TOPIC: REFLECTIVE THINKING SECTION: 7.7 TOPIC: BOND YIELD PREMIUMS 116 Interest rates have been rising over the past year but you believe rates are going to decrease over the next eighteen months Assume that you have reached this conclusion prior to other investors reaching the same conclusion How might you adjust your bond portfolio such that you can profit assuming that interest rates fall? You should purchase long-term, zero coupon bonds and sell your short-term, high coupon bonds This will allow you to realize the greatest price appreciation when rates decline AACSB TOPIC: REFLECTIVE THINKING SECTION: 7.1 TOPIC: INTEREST RATE RISK 117 Explain the conditions that would need to exist for the Treasury yield curve to be downward sloping A downward sloping Treasury yield curve exists when current inflation rates are high but are expected to decline in the future The decline in the inflation premium must be significant enough to overcome the rising interest rate risk premium as the time to maturity increases AACSB TOPIC: REFLECTIVE THINKING SECTION: 7.7 TOPIC: YIELD CURVE 7-54 Chapter 007 Interest Rates and Bond Valuation 118 Interest rate risk is often explained by using the concept of a teeter-totter Explain interest rate risk and how it is related to the movements of a teeter-totter Interest rates sit on one end of the teeter-totter while bond prices sit on the other end As interest rates move up, bond prices move down as seen by the movements of a teeter-totter Movement in the opposite direction also applies In addition, short-term bonds are located a short distance from the fulcrum while long-term bonds are situated towards the end of the teeter-totter illustrating that long-term bonds move further in reaction to a change in interest rates than short-term bonds AACSB TOPIC: REFLECTIVE THINKING SECTION: 7.1 TOPIC: INTEREST RATE RISK 119 Describe the relationships that exist between the coupon rate, the yield to maturity, and the current yield for both a discount bond and a premium bond A discount bond has a yield to maturity that exceeds the coupon rate A premium bond has a yield to maturity that is less than the coupon rate The current yield lies between the yield to maturity and the coupon rate AACSB TOPIC: REFLECTIVE THINKING SECTION: 7.1 TOPIC: DISCOUNT VERSUS PREMIUM BOND 7-55 ... plotting of the yields on Treasury securities relative to: a market interest rates b comparable corporate bond yields c the risk-free rate d inflation E maturity SECTION: 7.7 TOPIC: TREASURY YIELD... Chapter 007 Interest Rates and Bond Valuation 34 Which of the following are normal features of a corporate bond? I quarterly interest payments II interest-only loan III level coupon IV $1,000 par... SECTION: 7.1 TOPIC: INTEREST RATE RISK TYPE: CONCEPTS 44 Which one of the following bonds has the greatest interest rate risk? a 3-year; percent coupon b 3-year; percent coupon c 5-year; percent coupon