Deck 13: The Bond Market Private

Question 1

The indenture specifies the terms of a bond.

Answer 1

True

Question 2

A bond's seller pays accrued interest to the buyer.

Answer 2

False

Question 3

A publicly held bond has a trustee who enforcesthe terms of the indenture.

Answer 3

True

Question 4

When an investor purchases a bond, that individual receives accrued interest from the seller.

Question 5

Bonds with comparable ratings but different terms tomaturity tend to have different yields.

Question 6

Federal government bonds are among the least risky bonds because the federal government has the power to tax and print money.

Question 7

A negatively sloped yield curve occurs whenshort-term rates exceed long term rates.

Question 8

A bond that is traded "flat" has a fixed coupon.

Question 9

Bonds pay a flow of income called "interest."

Question 10

Mortgage bonds are secured by property.

Question 11

Debentures are bonds that secured by equipment.

Question 12

The coupon on the variable interest rate bond varieswith changes in interest rates.

Question 13

One source of risk associated with investments inbonds is the possibility of default.

Question 14

Under current law, American corporations may notissue bearer bonds with coupons attached.

Question 15

The current yield and the yield to maturity are equal if a bond sells for its par value.

Question 16

Default means the failure to meet any of the terms of a bond's indenture.

Question 17

In most cases, interest accrues daily on long term bonds but distributed only twice a year.

Question 18

Since bonds are legal obligations, their prices aredetermined when issued and do not change.

Question 19

The structure of yields generally suggests that long term bonds have greater yields.

Question 20

Since bonds are legal obligations, there is littlerisk associated with purchasing these securities.

Question 21

A Euro bond is denominated in the currency of aEuropean nation.

Question 22

Interest on a convertible bond may be exchanged for stock instead of cash.

Question 23

Income taxation on the interest earned from an investment in a zero coupon bond occurs when the bond matures.

Question 24

An investor concerned with safety of principal maypurchase preferred stock instead of bonds issued by the same company.

Question 25

A bond with a balloon payment cannot not have a sinking fund.

Question 26

A zero coupon only pays interest when it is sold.

Question 27

A strong sinking fund makes the bond riskier because it is harder for the firm to retire the debt.

Question 28

A "fallen angel" was once a quality bond whoseissuing firm is currently having financial problems.

Question 29

A split coupon bond combines a zero coupon bond with a regular coupon bond.

Question 30

One advantage to the issuing firm of a split couponbond is that cash is initially conserved.

Question 31

If an American investor buys a Euro bond and the value of the dollar rises, that individual earns a larger return on the investment.

Question 32

If a firm repurchases bonds at a discount, thedifference between the principal amount and the purchase price produces taxable income.

Question 33

Interest accrues on a zero coupon bond but not on a term bond.

Question 34

Split coupon bonds offer investors special tax advantages.

Question 35

The term of an extendible bond is known with certainty.

Question 36

A diversified portfolio of high yield securities may be achieved with ten or fewer bonds.

Question 37

If a firm repurchases debt at a discount, its netincome is increased.

Question 38

Euro-bonds are denominated in dollars.

Question 39

Calculation of the returns earned on a high yield security should include the sale price of bond as well as interest received.

Question 40

A firm may not repurchase bonds at a discount.

Question 41

Risk to bondholders comes from1. possibility of default2. higher interest rates3. higher inflation

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 42

If a bond has a call feature, it often has a call penalty, which must be paid to the bondholder in partial compensation for the early retirement of the bond.

Question 43

When an investor purchases a bond, he or she

A) pays accrued interest
B) receives accrued interest
C) pays accrued dividends
D) receives accrued dividends

Question 44

Virtually all bonds have each of the following except

A) interest payments
B) maturity date
C) voting rights
D) an indenture

Question 45

A fallen angel is

A) a quality bond whose credit rating has declined
B) a firm in financial difficulty
C) a junk bond in default
D) a firm being liquidated

Question 46

A high yield bond

A) pays no interest
B) pays interest only at maturity
C) is a high?risk debt instrument
D) is a bond in default

Question 47

In general, income bonds are less risky than

A) mortgage bonds
B) secured debt
C) preferred stock
D) short?term debt obligations

Question 48

Zero coupon bonds

A) are sold at a discount
B) are sold for a premium
C) accrue interest at maturity
D) cannot be called

Question 49

Serial bonds

A) have a sinking fund
B) are issued and retired in a series
C) are a type of income bond
D) are primarily issued by the federal government

Question 50

Bonds may be retired by1. being called2. a sinking fund3. being repurchased

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 51

Zero coupon and split coupon bonds

A) experience stable prices
B) conserve the firm's cash
C) reduce the firm's use of financial leverage
D) pay interest only at maturity

Question 52

A negatively sloped yield curve suggests1. short term rates exceed long term rates2. long term rates exceed short term rates3. the Federal Reserve is following a tightmonetary policy4. the Federal Reserve is following an easymonetary policy

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

Question 53

Equipment trust certificates are

A) riskier than convertible bonds
B) secured debt obligations
C) a type of debenture
D) bonds with low credit ratings

Question 54

In a typical bond classification

A) "A" are investment grade bonds
B) "B" stands for a "bearer" bond
C) "C" stands for a convertible bond
D) "D" represents a debenture

Question 55

Variable interest rate bonds

A) do not mature
B) are an example of a discount bond
C) have fluctuating coupons
D) are nonmarketable securities

Question 56

A call feature is an option while a sinking fund requires a mandatory payment by the firm.

Question 57

A firm will exercise its option to call a bond ifinterest rates rise.

Question 58

A split coupon bond

A) distributes interest in cash and additional debt
B) combines features of zero coupon bonds and secured bonds
C) has a period of no coupon and a period with a high coupon
D) conserves the investor's cash

Question 59

A call penalty protects the firm from early retirement of the bond.

Question 60

As the length of time to maturity (i.e., the term)of a bond increases, generally

A) the coupon rate rises
B) the coupon rate falls
C) the riskiness of the bond falls
D) the price of the bond rises

Question 61

A call penalty (i.e., call premium) protects the

A) investor against premature retirement of the bond
B) investor from default
C) issuer from rising interest rates
D) issuer from the bondholder requesting payment

Question 62

The accrued interest on a bond

A) avoids personal income taxation
B) is paid by the buyer of the bond to the seller of the bond
C) is the result of the possibility of the bond defaulting
D) applies only to zero coupon bonds

Question 63

A company may call a bond if

A) interest rates have risen
B) interest rates have fallen
C) the company's dividend is increased
D) the company's dividend is decreased
PROBLEMS
1) A bond matures in 2020 and has an annual coupon of 3.65 percent, payable on January 1 and July 1. The current price of the $1,000 bond is $978. On February 1, you purchase $10,000 face amount, and your broker charges a $25 commission. How much must you remit for the purchase?
2) You own a $10,000 bond that pays interest of 5.6 percent annually. If you are in the 30 percent federal income tax bracket, what is the annual tax owed if the bond is (a) in your regular personal account or (b) in your traditional retirement account (IRA)?
3) A $1,000 zero coupon bond matures in five years and sells for $784 to yield 5 percent. The accrued interest for the first year is $39. You are in the 30 percent federal income tax bracket. What is tax owed in the interest if the bond is (a) in your regular personal account or (b) in your Roth retirement account (IRA)?
SOLUTIONS TO PROBLEMS
1) Since the bond pays $365 a year ($10,000 x 0.0365), the accrued interest owed is $31 (31 days x $365/365). The total that has to be remitted is
$9,780 + 25 + 31 = $9,836.
(This problem does not consider any time between the purchase and settlement date which may alter the accrued interest owed.)
2) Problem 2 and 3 offer an opportunity to review retirement accounts. The tax on the interest in the regular account is
($10,000 x 0.056)(0.3) = $168.
There is no tax on the current interest payment in the IRA. The tax will be levied when the funds are distributed.
3) The tax on the interest earned (but not received) in the regular account is $39 x 0.3 = $11.70. There is no tax obligation for the Roth account. Unlike the traditional IRA, the initial contribution to the Roth IRA was not tax-deductible. Accrued interest and withdrawals are not subject to federal income taxation.