Deck 16: The Valuation of Fixed-Income Securities

Question 1

If a bond sells for a premium,the current yield exceeds the yield to maturity.

Answer 1

True

Question 2

The prices of low coupon bonds tend to fluctuate more than the prices of high coupon bonds.

Answer 2

True

Question 3

If interest rates increase,a bond may be called.

Answer 3

False

Question 4

If bond prices were to decline,the current yield would increase.

Question 5

If a $1,000 bond with a 7 percent coupon were to sell for $978,interest rates exceed 7 percent.

Question 6

A call feature will have no impact on the value of a bond if interest rates rise.

Question 7

A bond is more likely to be called after interest rates have fallen.

Question 8

If bond prices rise,the yield to maturity declines.

Question 9

An investor may expect a bond to be called if its current yield exceeds the yield to maturity.

Question 10

Bonds that are callable often have a call penalty.

Question 11

As interest rates increase,the prices of existing bonds increase.

Question 12

A call penalty is a payment made to the firm to encourage early retirement of the bond.

Question 13

The value of a bond depends on the amount of principal,when it matures,and the interest it pays.

Question 14

A few bonds called "perpetuals" never mature.

Question 15

The current yield exceeds the yield to maturity if interest rates fall.

Question 16

If interest rates have fallen,a firm may prefer to repurchase the bonds on the market instead of calling and redeeming them.

Question 17

If investors expect interest rates to decline,they should buy bonds.

Question 18

Most bonds pay interest semi-annually.

Question 19

If a $1,000 bond has a coupon of 8 percent and matures after eight years,the price of the bond will exceed $1,000 if interest rates are 9 percent.

Question 20

If a bond sells for a discount,the yield to maturity exceeds the current yield.

Question 21

Preferred stock pays a fixed amount of interest.

Question 22

The term and duration of a bond are equal for zero coupon bonds.

Question 23

The spread between the yields on AAA-rated bonds and B-rated bonds tends to rise when yields increase.

Question 24

Fluctuations in yields is one means by which the economy allocates scarce credit.

Question 25

If interest rates decline after a bond is issued and the investor reinvests the interest payment,the realized yield exceeds the yield to maturity.

Question 26

Preferred stock is legally equity and represents ownership.

Question 27

The possibility of default is higher when interest rates are higher.

Question 28

The prices of twenty-year bonds tend to fluctuate less than bonds with five years to maturity.

Question 29

The smaller the duration,the more volatile the bond's price.

Question 30

The prices of zero coupon bonds fluctuate less than bonds with large coupons.

Question 31

Matching a bond's duration with the time the funds are needed reduces reinvestment risk.

Question 32

Since preferred stock represents equity,it generally has the right to vote.

Question 33

If a cumulative preferred stock pays a dividend,it is said to be in arrears.

Question 34

The concept of duration stresses when a bond will make its payments to bondholders.

Question 35

Preferred stock dividends are usually cumulative.

Question 36

A conservative investor will prefer a bond with a smaller duration even though it may have a longer term to maturity.

Question 37

Since preferred stock is equity,it cannot have a sinking fund.

Question 38

The smaller a bond's coupon implies a longer duration.

Question 39

From the viewpoint of the firm,preferred stock is both cheaper and less risky than bonds.

Question 40

Since preferred stock pays a fixed dividend,it is often analyzed as if it were debt.

Question 41

A bond's call feature may be exercised if
1)the yield to maturity exceeds the current yield
2)the yield to maturity is less than the current yield
3)interest rates have risen
4)interest rates have fallen

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 42

The concept of duration considers the

A) timing of interest payments
B) timing of principal repayment
C) current rate of interest
D) timing of both interest and principal repayment

Question 43

While bond prices fluctuate,

A) yields are constant
B) coupons are constant
C) the spread between yields is constant
D) short-term bond prices fluctuate more

Question 44

The current yield on a long-term bond is the

A) coupon interest divided by the price of the bond
B) coupon
C) interest paid, adjusted for price changes
D) going rate of interest

Question 45

Preferred stock dividend payments are exempt from federal income taxation.

Question 46

If investors expect interest rates to rise,they should sell preferred stock and buy bonds.

Question 47

If preferred stock is subject to mandatory retirement,its price is more volatile than preferred stock without the retirement feature.

Question 48

The yield to call

A) is important if interest rates have fallen
B) is important if interest rates have risen
C) equals the yield to maturity
D) equals the current yield

Question 49

The market price of preferred stock moves directly with changes in interest rates.

Question 50

The analysis of the coverage of preferred stock dividends uses earnings before interest and taxes.

Question 51

If an investor were to anticipate that interest rates were going to fall,that individual should

A) take no action
B) buy bonds
C) sell bonds
D) acquire money market securities

Question 52

If a bond pays $90 interest annually,matures after ten years,and costs $1,100,the current yield is
4)If a $1,000 bond costs $1,000 and pays $90 interest,
1)the current yield is 9 percent
2)the yield to maturity is 9 percent
3)the bond is selling for par

A) 8.2 percent
B) 10.1 percent
C) 9.0 percent
D) 9.6 percent

Question 53

If interest rates in general were to fall,
1)the prices of existing bonds would rise
2)the prices of existing bonds would fall
3)yields to maturity would rise
4)yields to maturity would fall

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 54

The value of a bond depends on the
1)coupon rate
2)terms of the indenture
3)maturity date

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices

Question 55

If a $1,000 bond costs $1,000 and pays $90 interest,
1)the current yield is 9 percent
2)the yield to maturity is 9 percent
3)the bond is selling for par

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices

Question 56

If a 7 percent,$1,000 bond matures after ten years and current interest rates are 9 percent,the current price of the bond should not be
1)$1,000
2)$872
3)$1,140

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) only 2

Question 57

If a bond is selling for a premium,

A) the yield to maturity exceeds the current yield
B) the current yield exceeds the yield to maturity
C) the current yield has risen
D) the bond cannot be called

Question 58

From the viewpoint of the investor,preferred stock is riskier than bonds issued by the same firm.

Question 59

If a firm's earnings grow,the dividends paid by preferred stock also are increased.

Question 60

Buying a bond with a duration equal to when the funds are needed

A) reduces reinvestment rate risk
B) increases impact of higher interest rates
C) reduces the impact of default
D) increases the bond's yield

Question 61

If a preferred stock pays an annual $4.50 dividend,what should be the price of the stock if comparable yields are 10 percent? What would be the loss if yields rose to 12 percent?

Question 62

In general firms prefer to issue bonds instead of preferred stock because
1)debt is less risky to the firm
2)dividends are not tax deductible
3)effective cost of debt is cheaper

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices

Question 63

Junk Corp.'s high-yield bond has the following features:
a.If interest rates are currently 12 percent on comparable high-yield securities and are not expected to change,what is the price of this bond?

b.If interest rates are currently 9 percent on comparable high-yield securities and are not expected to change,what is the price of this bond?

c.If interest rates are currently 9 percent on comparable high-yield securities but the investor has no forecast as to future rates,what is the possible range of prices for this bond?

Question 64

If interest rates rise,the price of preferred stock

A) rises
B) falls
C) is not affected
D) rises or falls

Question 65

A bond with a 5 percent coupon ($50 a year)that matures after eight years is selling for $779.What is the yield to maturity?

Question 66

Preferred stock and long-term bonds are similar because

A) they both have voting power
B) interest and dividend payments are fixed
C) interest and dividend payments are legal obligations
D) interest and dividend payments are tax-deductible expenses

Question 67

Analysis of preferred stock uses

A) operating income (EBIT)
B) earnings after dividends to common stock
C) earnings after taxes
D) earnings after interest but before taxes

Question 68

Compute the durations of the following bonds and rank them on the basis of their price volatility.Assume that the current rate of interest is 8 percent.
Confirm your ranking by calculating the percentage change in the price of each bond when interest rates rise from 8 to 12 percent.

Question 69

Preferred stock dividends are
1)a legal obligation
2)not a legal obligation
3)exempt from federal income taxation
4)not exempt from federal income taxation

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 70

Earnings per preferred share are

A) earnings before interest and taxes
B) the ratio of earnings to number of preferred shares
C) the ratio of EBIT to number of preferred shares
D) the ratio of preferred shares to common shares

Question 71

A bond has the following terms:
a.What is the current price of the bond if comparable yields are 7 percent?

b.What are the current yield and yield to maturity given the price of the bond in the previous question?

c.If you expect the bond to be called at the end of the year,what would be the maximum price you should pay for the bond?

d.Is there a reason to expect that the bond will be called?

Question 72

If you purchase a $5 preferred stock for $40 a share,what is the current yield? If you anticipate that yields will decline to 10 percent,what will be the anticipated capital gain on this investment?

Question 73

An individual may purchase preferred stock
1)in anticipation of lower interest rates
2)in anticipation of higher interest rates
3)to receive a flow of tax-free income
4)to receive a flow of income

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 74

Preferred stock generally pays

A) a variable dividend
B) a fixed dividend
C) a stock dividend
D) no dividend

Question 75

If a $100 par value preferred stock pays an annual dividend of $5 and comparable yields are 10 percent,the price of this preferred stock will be

A) $100
B) $75
C) $50
D) $25

Question 76

Features of preferred stock may include
1)cumulative dividends
2)a call feature
3)mandatory retirement

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices