Question 1

The bond market makes up what percentage of the total debt market?

Accepted Answer

D

Question 2

A corporate bond has an 8% interest rate. The saver faces a marginal tax rate of 28%. What is the equivalent tax-free rate?

Accepted Answer

The equivalent tax-free rate can be calculated using the formula: Tax-Free Rate = Taxable Rate * (1 - Marginal Tax Rate). Plugging in the numbers: 8% * (1 - 0.28) = 8% * 0.72 = 5.76%.

Question 3

Which of these is a disadvantage of municipal bonds?

Accepted Answer

D

Question 4

WordTechGuru Corporation issues bonds with a bond covenant that specifies a stated debt-to-equity ratio range that management must maintain and further requires management to provide financial information to bondholders, including the buying and selling of major assets. Which of these statements is most likely true of the bonds they are issuing?

Accepted Answer

The inclusion of a bond covenant that requires maintaining a specific debt-to-equity ratio and mandates the provision of financial information to bondholders makes the bonds less risky. This is because such covenants provide bondholders with additional security and oversight, ensuring that the company maintains a certain level of financial stability and transparency. As a result, these bonds are considered less risky and typically offer a lower interest rate compared to bonds without such covenants.

Question 5

When bonds are issued by Ginnie Mae, Fannie Mae, and Freddie Mac, for what purpose are the proceeds typically used?

Accepted Answer

Mortgages are purchased, pooled together in large groupings, and then the pooled groupings are sold in pieces to investors. This process helps in diversifying the risk and making the investment more accessible to a broader range of investors.

Question 6

William recently purchased $20,000 worth of Treasury bonds. The type of bonds that he purchased protect him from increases in the rate of inflation. William purchased

Accepted Answer

TIPS, or Treasury Inflation-Protected Securities, are designed to protect investors from inflation, as their principal value adjusts with the inflation rate.

Question 7

WordTechGuru issues bonds with a call provision, which allows them the option to pay off all or part of their bonds before the maturity date. Assuming WordTechGuru is like most companies whose bonds have a call provision, which of these statements best describes the WordTechGuru's call provision?

Accepted Answer

The call provision typically specifies call dates and prices, allowing the issuer to repurchase the bonds at predetermined times and prices before maturity. This gives the issuer flexibility to refinance the debt if interest rates fall.

Question 8

What were the big bond-rating agencies doing in the 2000s?

Accepted Answer

The big bond-rating agencies were criticized for their role in the financial crises of the early 2000s, particularly for not downgrading the bond ratings of Enron and WorldCom until after these companies had already failed, indicating a failure to adequately warn investors ahead of time.

Question 9

Which of these statements is true of the main bond-rating agencies today?

Accepted Answer

Each of the three main bond-rating agencies (Moody's, Standard & Poor's, and Fitch Ratings) has its own unique rating system, although they share some similarities. These systems are used to assess the creditworthiness of bond issuers.

Question 10

Northwest Power Corporation has a Caa bond rating according to Moody's. This means that Northwest's bonds are rated

Accepted Answer

Caa bond rating by Moody's indicates that the bonds are of poor grade, suggesting they are of high credit risk.

Question 11

Bonds with a call provision normally pay a lower call price the

Accepted Answer

Bonds with a call provision typically pay a lower call price the closer they are to their maturity date because the issuer benefits less from calling the bond early as it approaches maturity.

Question 12

A(n)__________ is a pool of money a corporation sets aside to help repay a bond issue.

Accepted Answer

A sinking fund is specifically established by a corporation to set aside money over time to repay a bond issue. This ensures that the company can meet its future repayment obligations, reducing the risk for bondholders.

Question 13

A corporate bond has a 7% interest rate. The saver faces a marginal tax rate of 32%. What is the equivalent tax-free rate?

Accepted Answer

The equivalent tax-free rate is calculated by multiplying the bond's interest rate by (1 - tax rate). So, 7% * (1 - 0.32) = 4.76%.

Question 14

Jordan recently purchased a 20-year bond from the federal government with a face value of $10,000. Jordan has purchased a

Accepted Answer

Treasury bonds are long-term government securities with a maturity period of 20 to 30 years. Jordan's purchase of a 20-year bond from the federal government aligns with the characteristics of a Treasury bond.

Question 15

Which of the following best describes the difference between a "financial" bond covenant and a "nonfinancial" bond covenant?

Accepted Answer

Financial covenants are related to the financial operations and health of the company, such as maintaining certain debt levels, while nonfinancial covenants deal with operational aspects like ensuring assets are insured.

Question 16

Kayla recently inherited a substantial sum of money and is looking to invest some of it in the bond market. She prefers to know exactly how much she will be paid when her bonds mature.  Of the following options, what type of bond should she purchase?

Accepted Answer

STRIPS (Separate Trading of Registered Interest and Principal of Securities) are a type of bond that allows investors to hold and trade the individual interest and principal components of eligible Treasury notes and bonds as separate securities. These are zero-coupon securities, meaning they are sold at a discount and do not pay interest before maturity. At maturity, the holder receives a payment equal to the face value of the bond. This makes STRIPS ideal for investors like Kayla, who prefer to know exactly how much they will be paid when their bonds mature.

Question 17

B&G Corporation issues convertible bonds. Convertible bonds allow B&G bondholders to do which of the following?

Accepted Answer

Convertible bonds give the bondholder the option to convert their bonds into shares of the issuer's common stock at predetermined terms, not preferred stock or cash on call dates.

Question 18

The local government of Clintonville wants to install a sewer system and use the revenue generated from providing the sewer services to residents. To raise the funds to install the sewer system, the local government might issue

Accepted Answer

Revenue bonds are issued by municipalities to finance projects that will generate revenue, such as sewer systems, and the revenue from the project is used to pay back the bondholders.

Question 19

Which of these best describes how bond-rating agencies affect the interest rate that bonds must provide to attract borrowers?

Accepted Answer

Bond rating agencies provide both initial and ongoing evaluations of bonds to inform investors about the risk level associated with those bonds. This helps investors make informed decisions and can affect the interest rate that issuers must offer to attract investors. Higher risk (lower-rated) bonds typically must offer higher interest rates to compensate for their increased risk.

Question 20

ABC Manufacturing Corporation has an AA bond rating according to Standard & Poor. This means that ABC's bonds are rated

Accepted Answer

An AA bond rating by Standard & Poor's indicates that the bonds are considered to be of high quality, with very low credit risk.

Quiz 16: Bond Markets