Deck 12: Bond Fundamentals and Valuation

Question 1

A nonrefunding provision prohibits a call and premature retirement of an issue from the proceeds of a lower-coupon refunding bond.

Answer 1

True

Question 2

The market for short-term issues with maturities of one year or less is commonly known as the money market.

Answer 2

True

Question 3

Instruments for intermediate-term issues with maturities in excess of one year but less than 10 years are known as notes.

Answer 3

True

Question 4

In the case of a bond, the only contractual factor is the amount of interest payments, as beginning and ending bond prices are determined by market forces.

Question 5

High-yield bonds are considered "investment" grade.

Question 6

General obligation bonds (GOs) are serviced by the income generated from specific revenue-producing projects of the municipality.

Question 7

The three major theories explaining the term structure of interest rates are the expectations hypothesis, the liquidity differential hypothesis, and the segmented quality hypothesis.

Question 8

A bond's maturity is affected by call features, non-refunding provisions, and sinking fund provisions.

Question 9

Yield to maturity and current yield are equal when the bond is selling for exactly par value.

Question 10

Treasury Inflation Protected Securities (TIPS) ensures that investors will receive the promised yield in real terms by indexing bond principal and interest payments to the stock market.

Question 11

Most U.S. municipal bonds are serial issues that are subject to state and local taxes when they are issued in the investor's home state.

Question 12

Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds in which the bond principal and interest payments are indexed to the consumer price index.

Question 13

Samurai bonds are yen-denominated bonds sold in markets outside Japan by international syndicates.

Question 14

The coupon of a bond indicates the income that the bond investor will receive over the life of the bond.

Question 15

In most countries, sovereign bond issues are the smallest bond market segment.

Question 16

Bonds rated BB or above are considered to be investment-grade bonds.

Question 17

Bonds can have different types of collateral and can be secured, unsecured, or registered bonds.

Question 18

Public bonds differ from other debt because they are sold to the public rather than to a single investor.

Question 19

The major problem facing a bond analyst is the ability to forecast the basic interest rate level because yield spreads are generally inconsequential.

Question 20

Revenue bonds are essentially backed by the full faith and credit of the issuer and its entire taxing power.

Question 21

The refunding provision of an indenture allows bonds to be retired EXCEPT if

A) they are replaced with a lower coupon bond issue.
B) the remaining time to maturity is less than five years.
C) the remaining time to maturity is greater than five years.
D) the stated time period in the indenture has not passed.
E) the stated time period in the indenture has passed.

Question 22

The yield to maturity is normally equal to the coupon rate.

Question 23

The legal document setting forth the obligations of a bond's issuer is called a

A) debenture.
B) warrant.
C) indenture.
D) rights certificate.
E) trustee deed.

Question 24

The term structure of interest rates is a dynamic function that relates the term to maturity to the yield to maturity of bonds.

Question 25

If an investor buys a high coupon bond, and rates then fall, the investor has "locked up" that high yield as a realized yield.

Question 26

Which of the following statements is not true regarding bond ratings?

A) The ratings assigned are meant to indicate the probability of default for the bond issuer.
B) The bonds assigned one of the top four rating classes are considered investment grade bonds.
C) Once a rating is assigned to an issue it cannot be changed for the first two years after which it is reviewed on a regular basis.
D) Bonds rated BB and below are referred to as high yield or "junk" bonds.
E) The rating agencies modify the ratings with + and - signs or numbers after the letters.

Question 27

For a bond, the present value model incorporates both the coupon receipts and the capital gain or loss.

Question 28

According to the expectations hypothesis, a rising yield curve indicates that investors' demand for long maturity bonds is expected to rise.

Question 29

Which bond provision would be considered the riskiest for an investor who is concerned that market interest rates will drop dramatically over the life of the bond?

A) sinking fund
B) deferred call
C) freely callable
D) non-callable
E) None of these are correct.

Question 30

When a bond issue is secured by a legal claim on equipment it is known as a(n)

A) junior bond.
B) income bond.
C) bearer bond.
D) trust certificate.
E) perpetuity.

Question 31

There is a direct relationship between coupon and price.

Question 32

The fundamental determinants of interest rates are the real risk-free rate, inflation, and the risk premium.

Question 33

The expectations hypothesis is also known as both the institutional theory and the hedging pressure theory.

Question 34

The realized yield measures the expected rate of return of a bond that you expect to sell prior to its maturity.

Question 35

The internal rate of return is that discount rate that sets the present value of cash flows from an investment equal to its par value.

Question 36

According to the segmented market hypothesis, yields for a particular maturity segment depend on supply and demand within the maturity segment.

Question 37

Of the following provisions that may be found in a bond indenture, which would tend to reduce the coupon interest rate?

A) a call provision
B) no restrictive covenants
C) a sinking fund provision
D) change in bond rating from Aaa to Aa
E) an indenture provision

Question 38

A bond's price is determined by the issue's coupon rate, length to maturity, and the prevailing yield in the market.

Question 39

Issues that provide funds to retire another issue early are known as

A) bearer bonds.
B) secured debentures.
C) unsecured debentures.
D) revenue bonds.
E) refunding bonds.

Question 40

The annual interest paid on a bond relative to its prevailing market price is called its ____.

A) promised yield
B) yield to maturity
C) coupon rate
D) effective yield
E) current yield

Question 41

A security that has a coupon that is periodically adjusted is a(n)

A) variable note.
B) variation note.
C) adjustable coupon note.
D) money market certificate.
E) deep discount bond.

Question 42

Collateralized Mortgage obligations are

A) mortgage pass-through securities.
B) mortgage pass-through securities with varying maturities.
C) mortgage pass-through securities with no default risk.
D) mortgage pass-through securities with variable coupon rates.
E) mortgage pass-through securities with zero coupon rates.

Question 43

Which type of bond is backed by the full faith and credit of the issuer and its entire taxing power?

A) Fannie Mae
B) Freddie Mac
C) GSEs
D) general obligation bonds
E) revenue bonds

Question 44

When homeowners pay off mortgages when they sell their homes, or when homeowners refinance home mortgages, they effectively

A) make the maturities of GNMA securities longer.
B) make the maturities of GNMA securities shorter.
C) make the maturities of U.S. Treasury securities longer.
D) make the maturities of U.S. Treasury securities shorter.
E) default on their mortgages.

Question 45

General obligation bonds are

A) U.S. Treasury bonds backed by the full faith and credit of the issuer.
B) U.S. Treasury bonds backed by income generated form specific projects.
C) municipal bonds backed by the full faith and credit of the issuer.
D) municipal bonds backed by income generated from specific projects.
E) a type of U.S. agency security.

Question 46

Bond ratings are positively related to

A) leverage.
B) size.
C) type of business.
D) bond maturity.
E) coupon rate.

Question 47

Revenue bonds are

A) U.S. Treasury bonds backed by the full faith and credit of the issuer.
B) U.S. Treasury bonds backed by income generated form specific projects.
C) municipal bonds backed by the full faith and credit of the issuer.
D) municipal bonds backed by income generated from specific projects.
E) a type of U.S. agency security.

Question 48

Which of the following is NOT a major rating agency for bonds?

A) Moody's
B) Standard & Poor's
C) Fitch Investor Services
D) Value Line
E) Duff and Phelps

Question 49

TIPS are U.S Treasury securities where the coupon rate is

A) zero.
B) indexed to the rate of inflation.
C) indexed to the discount rate.
D) indexed to the prime rate.
E) indexed to the stock market.

Question 50

A bond denominated in U.S. dollars and sold in Japan to Japanese investors is called a

A) Samurai bond.
B) Eurobond.
C) Yankee bond.
D) Euroyen bond
E) foreign bond.

Question 51

Which factors indicate that in-depth credit analysis of high-yield bonds is important?

A) the large number of high-yield issues
B) the overall decline in quality of these bonds
C) the wide range of quality among these bonds
D) the growing complexity of these bonds
E) All of these are correct.

Question 52

The institutions that invest most heavily in corporate bond issues are

A) life insurance companies and commercial banks.
B) life insurance companies and property and liability insurance companies.
C) life insurance companies and pension funds.
D) commercial banks and property and liability insurance companies.
E) commercial banks and pension funds.

Question 53

If the yield to maturity for a par value TIPS bond with eight years to maturity is 3 percent, and the yield to maturity of a U.S Treasury note with 8 years is 4.25 percent, this implies that

A) the expected annual rate of inflation over the next eight years is -1.25 percent.
B) the expected annual rate of inflation over the next eight years is 1.25 percent.
C) the expected annual rate of inflation over the next eight years is -2.25 percent.
D) the expected annual rate of inflation over the next eight years is 2.25 percent.
E) the expected annual rate of inflation over the next eight years is 0 percent.

Question 54

Junk bonds are high yield bond bonds rated below

A) BBB.
B) BB.
C) B.
D) CCC.
E) CC.

Question 55

Which type of bond market is the largest sector in both Japan and the United States?

A) corporate
B) high yield/emerging market
C) securitized/collateralized
D) sovereign
E) quasi & foreign governments

Question 56

When a fixed income security is being traded at the price above its face value it is trading

A) at a discount.
B) at par.
C) at a premium.
D) flat.
E) no accrual.

Question 57

Collateralized mortgage obligations (CMOs) offset some of the problems associated with traditional mortgage pass-throughs because

A) they are overcollateralized.
B) they have variable rates.
C) they are collateralized by auto-loans.
D) they are deep discount instruments.
E) they are collateralized by credit card debt.

Question 58

The bonds issued by the Bank of England are known as

A) gilts.
B) bunds.
C) limies.
D) treasuries.
E) benchmarks.

Question 59

Bond ratings are negatively related to

A) profitability.
B) cash flow coverage.
C) earnings instability.
D) bond maturity.
E) coupon rate.

Question 60

Institutional investors typically account for about

A) 90 to 95 percent of bond market trading.
B) 40 to 50 percent of bond market trading.
C) 10 to 15 percent of bond market trading.
D) less than 5 percent of bond market trading.
E) less than 1 percent of bond market trading.

Question 61

According to the segmented-market hypothesis, a rising yield curve indicates that

A) demand for long term bonds has fallen and demand for short term bonds has fallen.
B) demand for long term bonds has risen and demand for short term bonds has fallen.
C) demand for long term bonds has fallen and demand for short term bonds has risen.
D) demand for long term bonds has risen and demand for short term bonds has risen.
E) None of these are correct.

Question 62

Which of the four major yield spreads defines the difference in yields between pure government agency bonds and corporate bonds?

A) segments
B) sectors
C) coupons
D) seasoning
E) maturity

Question 63

According to the liquidity preference hypothesis, yield curves generally slope upward because

A) investors prefer short maturity obligations to long maturity obligations.
B) investors prefer long maturity obligations to short maturity obligations.
C) investors prefer less volatile long maturity obligations.
D) investors prefer more volatile short maturity obligations.
E) None of these are correct.

Question 64

There are four major factors accounting for the existence of yield differentials. Which of the following is NOT a factor?

A) segments
B) sectors
C) indentures
D) coupons
E) maturities

Question 65

A 4.75 percent coupon bond issued by the State of Washington sells for $1,000. What coupon rate on a corporate bond selling at $1,000 par value would produce the same after-tax return to the investor as the municipal bond if the investor is in the 28 percent marginal tax bracket?

A) 1.1 percent
B) 5.8 percent
C) 6.6 percent
D) 7.3 percent
E) 9.7 percent

Question 66

The yield to call is a more conservative yield measure whenever the price of a callable bond is quoted at a value

A) equal to or greater than par plus one year's interest.
B) equal to par.
C) equal to par less one year's interest.
D) less than par.
E) 5 percent over par.

Question 67

Which of the following statements regarding Collateralized Debt Obligations (CDOs) is FALSE?

A) CDOs experienced rapid growth since the year 2000.
B) The assets used to back the CDOs are substantially diverse.
C) The credit quality within a CDO at the time of issue is diverse.
D) CDOs have generated significant credit and liquidity problems.
E) All of these are correct.

Question 68

Which of the following is NOT a major risk premium component for bond investors?

A) quality differentials
B) term to maturity
C) indenture provisions
D) yield to maturity
E) exchange rate risk differences

Question 69

A U.S. dollar-denominated bond sold in the United States by a Japanese-firm is called a(n)

A) Yankee bond.
B) homeland bond.
C) international bond.
D) U.S. Domestic bond.
E) Japanese U.S. Regional bond.

Question 70

What was developed in the early 1980s to offset some of the problems with traditional mortgage pass-throughs?

A) variable rate mortgages
B) collateralized mortgage obligations (CMOs)
C) leveraged buyouts (LBOs)
D) deep discount bonds (DDBs)
E) high yield bonds.

Question 71

An 8.5 percent coupon bond issued by the State of Ohio sells for $1,000. What coupon rate on a corporate bond selling at $1,000 par value would produce the same after-tax return to the investor as the municipal bond if the investor is in the 25 percent marginal tax bracket?

A) 2.13 percent
B) 12.25 percent
C) 11.33 percent
D) 13.53 percent
E) 34.71 percent

Question 72

The annual interest paid on a bond relative to its prevailing market price is called its

A) promised yield.
B) yield to maturity.
C) coupon rate.
D) effective yield.
E) current yield.

Question 73

The term structure of interest rates is a static function that relates the

A) term to call and the yield to maturity.
B) term to maturity and the yield to maturity.
C) term to call and the yield to call.
D) term to maturity and the coupon rate.
E) term to maturity and the current yield.

Question 74

According to the segmented-market hypothesis, a downward sloping yield curve indicates that

A) demand for long term bonds has fallen and demand for short term bonds has fallen.
B) demand for long term bonds has risen and demand for short term bonds has fallen.
C) demand for long term bonds has fallen and demand for short term bonds has risen.
D) demand for long term bonds has risen and demand for short term bonds has risen.
E) None of these are correct.

Question 75

A 6.5 percent coupon bond issued by the State of California sells for $1,000. What coupon rate on a corporate bond selling at $1,000 par value would produce the same after-tax return to the investor as the municipal bond if the investor is in the 26 percent marginal tax bracket?

A) 1.69 percent
B) 11.25 percent
C) 8.78 percent
D) 14.63 percent
E) 25 percent

Question 76

Which term-structure hypothesis suggests that any long-term interest rate simply represents the geometric mean of current and future on-year interest rates expected to prevail over the maturity of the issue?

A) expectations hypothesis
B) liquidity preference hypothesis
C) segmented market hypothesis
D) preferred habitat hypothesis
E) hedging pressure hypothesis

Question 77

Which set of conditions will result in a bond with the greatest volatility?

A) a high coupon and a short maturity
B) a high coupon and a long maturity
C) a low coupon and a short maturity
D) a low coupon and a long maturity
E) a deferred call feature and a sinking fund

Question 78

When a borrower pledges financial assets as collateral for a bond it is called a(n)

A) mortgage bond.
B) equipment trust certificate.
C) mortgage pass-through security.
D) collateral trust bond.
E) collateralized mortgage obligation (CMO).

Question 79

According to the expectations hypothesis, a rising yield curve indicates that investors expect

A) future short-term rates to fall.
B) future short-term rates to rise.
C) future long-term rates to rise.
D) future long-term rates to fall.
E) None of these are correct.

Question 80

A bond that only pays a principal payment at maturity date is known as a(n)

A) blank bond.
B) maturity bond.
C) interest free bond.
D) mini-coupon bond.
E) zero coupon bond.