Deck 23: Credit Risk and the Value of Corporate Debt

Question 1

Which of the following rated bonds has the most risk?

A)Aaa
B)Aa
C)Baa
D)Ba

Answer 1

Ba

Question 2

What is the most important difference between a corporate bond and an equivalent U.S.Treasury bond?

A)Corporate cash flow is relatively smooth,whereas U.S.government revenue is more variable.
B)Corporate bonds are traded on the floor of the New York Stock Exchange,and Treasury bonds trade in the over-the-counter market.
C)In the case of corporate bonds,firms have sometimes defaulted whereas the U.S.government has not.
D)The beta of corporate bonds is usually less than the beta of a U.S.Treasury bond.

Answer 2

In the case of corporate bonds,firms have sometimes defaulted whereas the U.S.government has not.

Question 3

A corporate bond matures in one year.The bond promises interest of $50 and principal of $1,000 at maturity.Suppose the bond has a 10% probability of default and payment under default is $400.If an investor buys the bond for $890.19,calculate the promised yield on the bond.

A)6.6%
B)18.0%
C)7.0%
D)10.7%

Answer 3

18.0%

Question 4

The value of a bond is given by:
I.bond value = asset value - value of call option on assets
II.bond value = value of an equivalent default-free bond + value of put option on assets
III.bond value = value of an equivalent default-free bond + value of put option on the stock
IV.bond value = asset value + value of call option on the stock

A)I only.
B)I and II only.
C)III and IV only.
D)IV only.

Question 5

The U.S.Federal government has guaranteed loans to the following industries:
i.housing; II)airlines; III)ship owners and shipyards; IV)steel companies; V)oil and gas companies

A)I only
B)I and II only
C)I,II,III,and IV only
D)I,II,III,IV,and V

Question 6

A corporate bond matures in one year.The bond promises a coupon of $50 and principal of $1,000 at maturity.If the bond has a 10% probability of default and payment under default is $400,calculate the expected payment from the bond.

A)$1,050
B)$400
C)$985
D)$1,000

Question 7

The average yield spread based on promised yield on Aaa bonds rated by Moody's and the yield on Treasuries is about:

A)1%.
B)2%.
C)3%.
D)4%.

Question 8

A corporate bond matures in one year.The bond promises a $50 coupon and principal of $1,000 at maturity.Suppose the bond has a 10% probability of default and payment under default is $400.If an investor buys the bond for $907.14,calculate the promised yield on the bond.

A)6.6%
B)15.75%
C)5.0%
D)8.58%

Question 9

Generally,you can insure corporate bonds through a(an):

A)arrangement with the Treasury department.
B)arrangement with the state government.
C)credit default swap.
D)back-dated options contract.

Question 10

If the bond has a 15% probability of default and payment under default is $400,calculate the expected payment from the bond.

A)$1,050.00
B)$400.00
C)$952.50
D)$892.50

Question 11

If an investor buys the bond for $938.10,calculate the promised yield on the bond.

A)6.60%
B)11.93%
C)5.00%
D)5.33%

Question 12

Suppose that a bond with one-year maturity,a coupon rate of 5%,and face value of $1,000 sells for $881.94.Calculate the promised yield on the bond.

A)5.42%
B)8.07%
C)19.06%
D)5.67%

Question 13

The value of a corporate bond can be thought of as:

A)bond value without default - value of put.
B)bond value without default + value of put.
C)bond value without default + value of a stock.
D)bond value without default - value of call.

Question 14

If the discount rate on a bond is 5% and the expected payment in year 1 is $985,calculate the price of the bond.

A)$1050.00
B)$985.00
C)$938.10
D)$1,000

Question 15

Which of the following rated bonds has the least risk?

A)AAA
B)AA
C)A
D)BBB

Question 16

The value of a corporate bond can be thought of as:

A)asset value - value of call option on assets.
B)asset value + value of call option on assets.
C)asset value + value of a default-free bond.
D)asset value - value of put option on assets.

Question 17

If the discount rate on a bond is 8% and the expected payment in year 1 is $952.50,calculate the price of the bond.

A)$1050.00
B)$985.00
C)$907.14
D)$881.94

Question 18

If the discount rate on a bond is 7% and the expected payment in year 1 is $952.50,calculate the price of the bond.

A)$1,050
B)$985
C)$890
D)$935

Question 19

The U.S.government agrees to guarantee a bond issue planned by Demurrage Associates (DA).The value of this guarantee:
I.equals the value of the guaranteed loan minus the value of the loan without a guarantee;
II.is a subsidy to DA's equity investors;
III.is a windfall gain to the buyers of the bonds;
IV.equals the value of a put option on the firm's assets with an exercise price equal to the bond's promised payments

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

Question 20

The interest rate on a one-year risk-free bond is 5%.BAC Company issued a 5% coupon bond with a face value of $1,000,maturing in one year.If the bond is considered risk-free,what is the price of the bond?

A)$1,050
B)$1,000
C)$985
D)$950

Question 21

Use the following data: ROA = 10%; Total liabilities = 90% of assets; EBITDA = 10% of liabilities.Calculate the relative chance of failure using the following model: Log(relative chance of failure)= -6.445 - 1.192 ROA + 2.307 (liabilities/assets)- 0.346(EBITDA/liabilities).

A)1.7%
B)1.09%
C)0.16%
D)none of the options

Question 22

The three main bond rating agencies in the U.S.are:
i.Moody's; II)Standard and Poor's; III)A.M.Best; IV)Dominion Bond; V)Fitch

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

Question 23

Commercial banks and several other financial institutions are not permitted to invest in bonds unless they are investment grade.What is the definition of an investment-grade bond?

A)One with a triple-A rating.
B)One with a rating of Baa or better.
C)One with a rating of B or better.
D)One with a rating of C or better.

Question 24

Bonds rated below BBB (Baa)are termed junk bonds.

Question 25

Bonds rated below BBB (Baa)are called:

A)investment-grade bonds.
B)junk bonds.
C)default-free bonds.
D)intermediate bonds.

Question 26

Generally,promised yields are at least as great as expected yields.

Question 27

The median interest cover for industrial firms with AAA bond ratings is:

A)21.2.
B)19.5.
C)8.0.
D)4.7.

Question 28

The value of a risky bond equals: value of a bond without default - value of a put option on assets.

Question 29

The Z-score model was developed by Altman using:

A)multiple discriminant analyses.
B)real options analysis.
C)hazard analysis.
D)none of the options.

Question 30

It is extremely rare for a corporate bond to have a higher expected yield than a government bond.

Question 31

The value of a government guarantee of a bond equals the value of a put option on the firm's assets.

Question 32

During the period 1981-2010,the percentage of bonds that were rated AAA and remained AAA was:

A)86.48%.
B)87.91%.
C)87.29%.
D)84.55.

Question 33

The value of a risky bond equals: asset value - value of call option on assets.

Question 34

Investors can insure corporate bonds through an arrangement called a credit default swap.

Question 35

Beaver,McNichols and Rhie have developed the following model to predict the chance of failing during the next year relative to the chance of not failing for firms: log(relative chance of failure)= -6.445 - 1.192 ROA + 2.307 (liabilities/assets)- 0.346(EBITDA/liabilities)using:

A)multiple discriminant analyses.
B)real options analysis.
C)hazard analysis.
D)none of the options.

Question 36

The default rate on B rated bonds 10 years after issue is less than (choose best response):

A)5%.
B)10%.
C)20%.
D)30%.

Question 37

In 2012,the Greek government strong-armed private investors into replacing their existing bonds with new securities worth what percentage of their original bonds?

A)30%
B)40%
C)50%
D)60%

Question 38

The median total debt ratio (Total debt/(total debt + equity in %)for industrial firms with an A rating is:

A)12.4%.
B)28.3%.
C)37.5%.
D)43.7%.

Question 39

An analyst predicts that at the 95% confidence level a bank could lose 7% of its asset value.Given assets of $30 million,what is the value at risk?

A)$2.1 million
B)$27.9 million
C)$28.5 million
D)$30 million

Question 40

Generally,a corporate bond has a higher promised yield than the yield on a similar government bond.

Question 41

Briefly explain the term junk bonds.

Question 42

The firm's right to default on a bond generally increases with the maturity of the bond.

Question 43

What is a credit default swap? Briefly explain.

Question 44

What is a major drawback to value-at-risk calculations?

Question 45

Briefly explain the model developed by Beaver,McNichols,and Rhie to predict the chance of failure of a firm.

Question 46

Briefly explain the term credit scoring.

Question 47

Suppose that the possibility of default on a firm's bond is totally unrelated to other events in the economy.In this case,the beta of the bond will equal zero and the discount rate will equal the risk-free rate.

Question 48

Briefly explain how governmental loan guarantees can be valued using the option pricing model.

Question 49

Define the term credit risk.

Question 50

Bonds rated BBB (Baa)and above are called junk bonds.

Question 51

Briefly explain how the option pricing model can be used for pricing risky debt.

Question 52

Investment-grade bonds can usually be entered at face value on the books of banks and life insurance companies.

Question 53

Briefly describe bond ratings.