Question 1

A 20-year original maturity bond with 1 year left to maturity has more interest rate price risk than a 10-year original maturity bond with 1 year left to maturity.(Assume that the bonds have equal default risk and equal coupon rates.)

Accepted Answer

Both bonds have the same duration (time left to maturity) and therefore the same interest rate price risk, assuming all other factors like coupon rates and default risk are equal.

Question 2

There is an inverse relationship between bond ratings and the required return on a bond.The required return is lowest for AAA rated bonds,and required returns increase as the ratings get lower (worse).

Accepted Answer

This statement is true. Bond ratings reflect the creditworthiness of the bond issuer, and the required return on a bond reflects the perceived risk of investing in that bond. Higher-rated bonds are considered less risky, and therefore require a lower return, while lower-rated bonds are considered more risky and require a higher return to compensate investors for that risk.

Question 3

Foreign debt is a debt instrument sold by a foreign borrower but denominated in the currency of the country in which it is sold.

Accepted Answer

Foreign debt is typically issued by foreign borrowers in the currency of the country in which it is sold, which is known as the currency denomination of the debt. This is done to attract investors in that country and to potentially benefit from lower interest rates in that currency.

Question 4

The motivation for floating rate bonds arose out of the costly experience of the early 1980s when inflation pushed interest rates to very high levels causing sharp declines in the prices of long-term bonds.

Accepted Answer

This statement accurately describes the motivation behind the creation of floating rate bonds.

Question 5

Regardless of the size of the coupon payment,the price of a bond moves in the opposite direction from interest rate movements.For example,if interest rates rise,bond prices fall.

Accepted Answer

This statement is true. Bond prices and interest rates have an inverse relationship, meaning when one goes up, the other goes down.

Question 6

One of the disadvantages to a firm in issuing zero coupon bonds is that the tax shield associated with the bonds' appreciation cannot be claimed until the bond matures.

Accepted Answer

The tax shield associated with the interest expense of zero coupon bonds is recognized annually, even though the interest is not paid until maturity, because the issuer can deduct the imputed interest expense each year for tax purposes.

Question 7

Issuing zero coupon bonds might appeal to a company that is considering investing in a long-term project that will not generate positive cash flows for several years.

Accepted Answer

Issuing zero coupon bonds allows the company to raise funds without having to make interest payments until the bonds mature. This can be advantageous for a company that does not anticipate generating positive cash flows in the near term, as they can avoid the burden of making interest payments while still securing the long-term financing needed for the project.

Question 8

If a firm raises capital by selling new bonds,the buyer is called the "issuing firm," and the coupon rate is generally set equal to the required rate.

Accepted Answer

The buyer is not called the "issuing firm," rather, the issuer is the firm selling the bonds. Additionally, the coupon rate is not necessarily set equal to the required rate, as it depends on the market conditions at the time of issuance.

Question 9

Restrictive covenants are designed so as to protect both the bondholder and the issuer even though they may constrain the actions of the firm's managers.Such covenants are contained in the bond's indenture.

Accepted Answer

This statement is true. Restrictive covenants are included in a bond's indenture in order to protect the interests of both the bondholder and the issuer by limiting the actions of the firm's management.

Question 10

Because junk bonds are such high-risk instruments,the returns on such bonds aren't very high and the existence of this market detracts from social welfare.

Accepted Answer

This statement is false. While junk bonds do carry a higher level of risk, they also offer higher returns to investors who are willing to take that risk. This can be beneficial for some investors and can contribute to overall economic growth. The existence of a junk bond market may not necessarily detract from social welfare, as it can provide financing opportunities to companies that may not have access to traditional lending sources.

Question 11

Eurocredits are bank loans that are denominated in the currency of a country other than where the lending bank is located.

Accepted Answer

Eurocredits are typically denominated in euro, regardless of the location of the lending bank.

Question 12

A call provision gives bondholders the right to demand,or "call for," repayment of a bond.Typically,calls are exercised if interest rates rise,because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates.

Accepted Answer

A call provision gives the issuer of the bond the right, not the bondholder, to repay the bond before its maturity date, typically when interest rates fall, allowing the issuer to refinance at a lower cost.

Question 13

Foreign debt is debt sold in a country other than the one in whose currency the debt is denominated.

Accepted Answer

The answer of Foreign debt is debt sold in a...

Question 14

Eurobonds have a higher level of required disclosure than normally is found for bonds issued in domestic markets,particularly the United States.

Accepted Answer

The answer of Eurobonds have a higher level of required...

Question 15

Floating rate debt is advantageous to investors because the interest rate moves up if market rates rise.Floating rate debt shifts interest rate risk to companies and thus has no advantages for issuers.

Accepted Answer

While it is true that floating rate debt is advantageous to investors because the interest rate moves up if market rates rise, it is not true that it has no advantages for issuers. In fact, issuers can benefit from floating rate debt because it allows them to avoid locking in a fixed interest rate for a long period of time, which can be disadvantageous if market rates rise. With floating rate debt, the interest rate adjusts periodically to reflect market conditions, so issuers can potentially pay a lower interest rate if market rates are lower than when they issued the debt. Additionally, some investors may view floating rate debt as less risky than fixed rate debt, which can make it easier for issuers to attract investors and raise capital.

Question 16

Typically,debentures have higher interest rates than mortgage bonds primarily because the mortgage bonds are backed by assets while debentures are unsecured.

Accepted Answer

This is because the lack of collateral or security makes debentures riskier for investors, and therefore they receive a higher interest rate to compensate for this increased risk. In contrast, mortgage bonds have a specific asset (such as a property) backing them up, making them a lower risk investment, and thus giving them a lower interest rate.

Question 17

LIBOR is an acronym for London Interbank Offer Rate,which is an average of interest rates offered by London banks to U.S.corporations.

Accepted Answer

LIBOR is an average of interest rates offered by London banks to each other, not to U.S. corporations.

Question 18

Although common stock represents a riskier investment to an individual than do bonds,in the sense of exposing the firm to the risk of bankruptcy,bonds represent a riskier method of financing to a corporation than does common stock.

Accepted Answer

Bonds represent a riskier method of financing to a corporation than common stock because they come with a fixed interest rate that must be paid regardless of the company's performance. Additionally, if the company defaults on its bond payments, it may have to declare bankruptcy. On the other hand, common stock represents ownership in the company and does not come with a fixed interest rate or maturity date. While common stockholders are exposed to the risk of bankruptcy, they also have the potential to earn higher returns if the company performs well.

Question 19

Eurobonds are typically issued as registered bonds rather than bearer bonds.

Accepted Answer

The answer of Eurobonds are typically issued as registered bonds...

Question 20

In general,long-term unsecured debt is less costly than long-term secured for a particular firm.

Accepted Answer

Long-term secured debt typically has lower interest rates than long-term unsecured debt because the lender has collateral to seize if the borrower defaults. However, this is not always the case and can depend on the creditworthiness of the borrower and market conditions. Additionally, secured debt puts the borrower at risk of losing their collateral if they are unable to make payments, which can be more costly in the long run. Therefore, in general, long-term unsecured debt may be less costly for a particular firm.

Quiz 6: Bonds Debt-Characteristics and Valuation