Deck 7: The Valuation and Characteristics of Bonds

Question 1

Which of the following statements concerning junk bonds is most correct?

A) A rational investor will always prefer a AAA-rated bond to a junk bond.
B) Junk bonds have higher interest rates than AAA-rated bonds because of the higher risk.
C) Junk bonds may also be called low-yielding securities.
D) Junk bonds are priced higher than AAA-rated bonds because junk bonds are more risky.

Answer 1

Junk bonds have higher interest rates than AAA-rated bonds because of the higher risk.

Question 2

Put the following in order of their claim on assets of a firm,starting with the LAST to have a claim:
A.Subordinated debentures
B.Debentures (unsubordinated)
C.Common Stock
D.Preferred stock

A) C, B, A, D
B) C, D, A, B
C) B, A, C, D
D) D, C, B, A
E) D, C, A, B

Answer 2

C, D, A, B

Question 3

Which of the following statements is true regarding convertible bonds?

A) The holder has the right to sell these bonds back to the issuer if the bonds don't perform well.
B) The holder can convert these bonds into an equal number of new bonds if they choose to do so.
C) These bonds are convertible into common stock of the issuing firm at a prespecified price.
D) These bonds have a variable interest rate.

Answer 3

These bonds are convertible into common stock of the issuing firm at a prespecified price.

Question 4

Other things being equal,investors will value which of the following bonds the highest?

A) Callable bonds
B) Convertible bonds
C) Bonds that are both callable and convertible
D) Unsecured, callable bonds

Question 5

The expected yield on junk bonds is higher than the yield on AAA-rated bonds because of the higher default risk associated with junk bonds.

Question 6

An example of a Eurobond is a bond issued in Asia by a U.S.Corporation with interest and principal payments made in U.S.dollars.

Question 7

Which of the following is true of a zero coupon bond?

A) The bond makes no coupon payments.
B) The bond sells at a premium prior to maturity.
C) The bond has a zero par value.
D) The bond has no value until the year it matures because there are no positive cash flows until then.

Question 8

If a firm were to experience financial insolvency,the legal system provides an order of hierarchy for the payment of claims.Assume that a firm has the following outstanding securities: mortgage bonds,common stock,debentures,and preferred stock.Rank the order in which investors that own mortgage bonds would have their claim paid?

A) First
B) Second
C) Third
D) Fourth

Question 9

Convertible bonds are debt securities that can be converted into a firm's stock at a prespecified price.

Question 10

Shafer Corporation issued callable bonds.The bonds are most likely to be called if

A) interest rates decrease.
B) interest rates increase.
C) Shafer Corporation needs additional financing.
D) Shafer Corporation's stock price increases dramatically.

Question 11

Subordinated debentures are more risky than unsubordinated debentures because the claims of subordinated debenture holders are less likely to be honored in the event of liquidation.

Question 12

Junk bonds are also called high-yield bonds.

Question 13

If a corporation were to choose between issuing a debenture,a mortgage bond,or a subordinated debenture,which would have the highest yield to maturity,everything else equal?

A) the debenture
B) the mortgage bond
C) the subordinated debenture
D) all of the above

Question 14

Restrictive provisions in bond indenture agreements are designed to protect bondholders and lessen the agency problems between bondholders and stockholders.

Question 15

In general,interest on bonds,like dividends on preferred stock,may be deferred until a later date at the discretion of management,making debt financing more appealing to corporate managers.

Question 16

A bond with a par value of $1,000 is listed in the Wall Street Journal at a price of 100.50.This bond is selling for $1,005.

Question 17

Convertible bonds decrease in value whenever the price of the company's stock increases.

Question 18

Bonds issued in a country different from the one in which the currency of the bond is denominated are called Eurobonds.

Question 19

A mortgage bond is secured by a lien on real property.

Question 20

A company with a AAA bond rating will command a higher interest rate on its bonds than a company with a lesser BBB bond rating.

Question 21

Junk bonds typically have an interest rate of between 3 and 5 percent more than AAA-rated long-term debt.

Question 22

A common protective provision in a bond indenture is the limitation of dividends on the issuing firm's common stock.

Question 23

The Wall Street Journal bond quotes indicate that the net close for a bond with a $1,000 par value is 100¾.The closing price for that bond was $100.75.

Question 24

The value of a bond is inversely related to changes in the investor's present required rate of return.

Question 25

Federal regulations make it impossible for rating agencies to drop a company's credit rating more than two notches at a time in order to prevent panic in bond markets.

Question 26

If a bond's rating declines,the interest rate demanded by investors,called the required return,also decreases.

Question 27

Liquidation value is of primary importance to investors because it represents the true amount of cash that an investor is likely to receive.

Question 28

Bonds generally have a maturity date while preferred stocks do not.

Question 29

In the case of insolvency,the claims of debt are honored prior to those of common stock and after those of preferred stock.

Question 30

If the demand for a new bond issue increases,it is likely that the coupon rate will be adjusted upward by the issuing company.

Question 31

A firm's bond rating would be favorably affected if they have a low use of financial leverage (debt).

Question 32

Other things held equal,a bond with a call provision is worth more to investors than a bond without a call provision.

Question 33

A bond is a long-term promissory note issued by the firm.

Question 34

Debentures are expected to have a lower yield than secured bonds because the debentures are more risky and therefore less desirable.

Question 35

A corporate bond has a coupon rate of 12%,a yield to maturity of 10.55%,a face value of $1,000,and a market price of $850.Therefore,the annual interest payment is

A) $101.75
B) $102
C) $105.50.
D) $120.0

Question 36

Bond prices are inversely related to market interest rates.

Question 37

If a bond has a market value that is higher than its par value,then the required return on the bond must be less than the bond's coupon rate.

Question 38

Which of the following statements concerning bonds and risk is true?

A) Because the interest payments and maturing value are known, the only risk associated with investing in bonds is default risk.
B) Zero coupon bonds are always more risky than bonds with high coupon rates because of the time value of money.
C) Bonds are generally less risky than common stock because of the preference for debt over equity in the event of bankruptcy and liquidation.
D) B-rated bonds are above average for risk, i.e., less risky than the average bond.

Question 39

Which of the following bond provisions will make a bond more desirable to investors,other things being equal?

A) The bond is convertible.
B) The bond is callable.
C) The coupon rate is lower.
D) The bond is subordinated.

Question 40

A bond rating of "BB" indicates that the company's financial position is above average and hence the default risk on the bonds is very low.

Question 41

A corporate bond is currently selling for $850.The bond matures in 20 years,has a face value of $1,000,and a yield to maturity of 10.55%.The bond's coupon rate is

A) 10%.
B) 11%.
C) 12%.
D) 13%.

Question 42

Speculative,or non-investment-grade,bonds have an S&P bond rating of

A) C or less.
B) CCC or less.
C) BB or less.
D) BBB or less.

Question 43

If a corporation were to choose between issuing a debenture,a mortgage bond,or a subordinated debenture,everything else equal (such as coupon rate,maturity,etc.)which would sell for the greatest price?

A) The debenture
B) The mortgage bond
C) The subordinated debenture
D) All of the above types of bonds would sell for the same price.

Question 44

Market efficiency implies which of the following?

A) book value = intrinsic value
B) market value = intrinsic value
C) book value = market value
D) liquidation value = book value

Question 45

In an efficient market,the market value and intrinsic value of a security should be equal.

Question 46

The par value of a corporate bond indicates the payment that the issuer promises to make to the bondholder at maturity.

Question 47

In an efficient securities market the market value of a security is equal to:

A) its liquidation value.
B) its book value.
C) its intrinsic value.
D) par value.

Question 48

Unlike market value,the intrinsic value of an asset is estimated independently of risk.

Question 49

When the intrinsic value of an asset exceeds the market value

A) the asset is undervalued to the investor.
B) the asset is overvalued to the investor.
C) market value and intrinsic value are always the same; therefore, this could not happen.
D) liquidation value must be higher than book value.

Question 50

John owns a corporate bond with a coupon rate of 8% that matures in 10 years.Bill owns a corporate bond with a coupon rate of 12% that matures in 25 years.If interest rates go down,then

A) the value of John's bond will decrease and the value of Bill's bond will increase.
B) the value of both bonds will increase.
C) the value of Bill's bond will decrease more than the value of John's bond due to the longer time to maturity.
D) the value of both bonds will remain the same because they were both purchased in an earlier time period before the interest rate changed.

Question 51

As market rates of interest rise,investors move their funds into bonds,thus increasing their price and lowering their yield.

Question 52

An individual investor considers investing in an XYZ Corp.bond and decides not to purchase the bond.Which of the following statements is most correct?

A) The intrinsic value of the bond for the investor is less than the market value of the bond.
B) The liquidation value of the bond is greater than the market value of the bond.
C) The intrinsic value of the bond for the investor is less than the par value of the bond.
D) The intrinsic value of the bond for the investor is greater than the book value of the bond.

Question 53

You want to invest in bonds.Explain whether or not each provision listed will make the bonds more or less desirable as an investment:
call provision,convertible bond provision,subordinated debt

Question 54

Which of the following is FALSE concerning bonds?

A) The indenture spells out the obligations of the bond issuer.
B) Mortgage bonds are secured by assets such as real estate.
C) Debentures are secured by specific assets other than real estate.
D) Subordinated debentures are riskier than unsubordinated debentures.

Question 55

A company with a bond rating of BBB is more likely to have which of the following qualities compared to a company with a bond rating of B?

A) greater reliance on equity financing
B) high variability in past earnings
C) little use of subordinated debt
D) small firm size

Question 56

SWH Corporation issued bonds on January 1,2004.The bonds had a coupon rate of 5.5%,with interest paid semiannually.The face value of the bonds is $1,000 and the bonds mature on January 1,2019.What is the intrinsic value of an SWH Corporation bond on January 1,2010 to an investor with a required return of 7%?

A) $901.08
B) $902.27
C) $1,000.00
D) $1,104.28

Question 57

The present value of the expected future cash flows of an asset represents the asset's

A) liquidation value.
B) book value.
C) intrinsic value.
D) par value.

Question 58

To determine the periodic interest payments that a bond makes,multiply the bond's stated coupon rate by its par value and divide by the number of coupon payments per year.

Question 59

The sum of the present values of an investment's expected future cash flows is known as the investment's intrinsic value.

Question 60

PDQ bonds have a par value of $1,000.The bonds pay $40 in interest every six months and will mature in 10 years.
a.Calculate the price if the yield to maturity on the bonds is 7,8,and 9 percent,respectively.
b.Explain the impact on price if the required rate of return decreases.
c.Compute the coupon rate on the bonds.How does the relationship between the coupon rate and the yield to maturity determine how a bond's price will compare to it par value?

Question 61

Finance theory suggests that the current market value of a bond is based upon which of the following?

A) The future value of interest paid on a bond.
B) The sum total of principal and interest paid on a bond.
C) The sum of the present value of the bond's interest payments and the present value of the principal.
D) The present value of a bond's par value plus the future value of the bond's present value.

Question 62

Swanson,Inc.bonds have a 10% coupon rate with semi-annual coupon payments.They have 12 and 1/2 years to maturity and a par value of $1,000.Compute the value of Swanson's bonds if investors' required rate of return is 8%.

A) $1,156.22
B) $1,239.33
C) $1,137.10
D) $1,084.44

Question 63

In an efficient market,two investors may agree on the amount and timing of a bond's expected cash flows and also on the bond's risk level,as measured by its debt rating,and still determine two different values for the bond.

Question 64

Aaron Corporation has two bonds outstanding.Both bonds mature in 10 years,have a face value of $1,000,and have a yield to maturity of 8%.One bond is a zero coupon bond and the other bond has a coupon rate of 8%.Which of the following statements is true?

A) Both bonds must sell for the same price if markets are in equilibrium.
B) The zero coupon bond must have a higher price because of its greater capital gain potential.
C) The zero coupon bond must sell for a lower price than the bond with an 8% coupon rate.
D) All rational investors will prefer the 8% bond because it pays more interest.

Question 65

Suppose interest rates have been at historically low levels the past two years.A reasonable strategy for bond investors during this time period would be to

A) invest in long-term bonds to reduce interest rate risk.
B) invest in short-term bonds to reduce interest rate risk.
C) buy only junk bonds which have higher interest rates.
D) invest in long-term bonds to lock in a bond position for when interest rates increase in the future.

Question 66

As interest rates,and consequently investors' required rates of return,change over time the ________ of outstanding bonds will change as a result.

A) maturity date
B) coupon interest payment
C) par value
D) price

Question 67

What is the value of a bond that matures in 17 years,makes an annual coupon payment of $50,and has a par value of $1,000? Assume a required rate of return of 6%.

A) $822.90
B) $856.29
C) $895.23
D) $904.87

Question 68

If markets were entirely efficient (perfect),which of the following would we conclude?

A) There would be no inflation.
B) Book value would be the same as market value.
C) No firms would ever default on their bonds.
D) Market value and intrinsic value would be the same.

Question 69

Which of the following affect an asset's value to an investor?
I.Amount of an asset's expected cash flow
II.The riskiness of the cash flows
III.Timing of an asset's cash flows
IV.Investor's required rate of return

A) I, II, III
B) I, III, IV
C) I, II, IV
D) I, II, III, IV

Question 70

John and Karen are both considering buying a corporate bond with a coupon rate of 8%,a face value of $1,000,and a maturity date of January 1,2025.Which of the following statements is most correct?

A) Because both John and Karen will receive the same cash flows if they each buy a bond, they both must assign the same value to the bond.
B) If John decides to buy the bond, then Karen will also decide to buy the bond, if markets are efficient.
C) John and Karen will only buy the bonds if the bonds are rated BBB or above.
D) John may determine a different value for a bond than Karen because each investor may have a different level of risk aversion, and hence a different required return.

Question 71

Homer's Trucking Company bonds have a 11% coupon rate.Interest is paid semi-annually.The bonds have a par value of $1,000 and will mature 8 years from now.Compute the value of Homer's Trucking Company bonds if investors' required rate of return is 9.5%.

A) $1,197.27
B) $1,133.05
C) $1,098.99
D) $1,082.75

Question 72

Two investors are considering the purchase of Corporation XYZ bonds.The bonds are selling at a price of $1,100 each.Investor A decides to buy the bonds and Investor B does not buy the bonds.

A) Investor A must have a required return lower than the required return for Investor B.
B) The yield to maturity for Investor A must be higher than the yield to maturity for Investor B.
C) The yield to maturity for Investor A must be less than the yield to maturity for Investor B.
D) The yield to maturity for this bond must be higher than the coupon rate.

Question 73

What is the value of a bond that matures in 5 years,has an annual coupon payment of $110,and a par value of $2,000? Assume a required rate of return of 7%.

A) $938.50
B) $1,876.99
C) $1,890.07
D) $1,750.00

Question 74

Podunk Communications bonds mature in 6 1/2 years with a par value of $1,000.They pay a coupon rate of 9% with semi-annual payments.If the required rate of return on these bonds is 11% what is the bond's value?

A) $1,026.73
B) $973.76
C) $1,022.74
D) $908.83

Question 75

In the present value bond valuation model,risk is generally incorporated into the

A) maturity amount.
B) timing of cash flows (assuming more risky cash flows are received early).
C) discount rate or required return.
D) cash flows (making some smaller if they are more risky).

Question 76

Which of the following will cause the value of a bond to increase,other things held the same?

A) investors' required rate of return increases.
B) the company's debt rating drops from AAA to BBB.
C) interest rates decrease.
D) the bond is callable.

Question 77

Assume that Brady Corp.has an issue of 18-year $1,000 par value bonds that pay 7% interest,annually.Further assume that today's required rate of return on these bonds is 5%.How much would these bonds sell for today? Round off to the nearest $1.

A) $1,233.79
B) $1,201.32
C) $1,134.88
D) $1,032.56

Question 78

A bond issued by Barney,Inc.10 years ago has a coupon rate of 8% and a face value of $1,000.The bond will mature in 15 years.What is the value to an investor with a required return of 12.5%?

A) $800
B) $750.86
C) $658.94
D) $701.52

Question 79

Which type of value is shown on the firm's balance sheet?

A) book value
B) liquidation value
C) market value
D) intrinsic value

Question 80

What is the value of a bond that has a par value of $1,000,a coupon of $120 (annually),and matures in 10 years? Assume a required rate of return of 7.8%.

A) $1,198.45
B) $1,200.43
C) $1,284.38
D) $1,349.76