Deck 7: Fixed Income Securities: Characteristics and Valuation

Question 1

Which of the following is NOT a characteristic of long-term debt?

A) Interest paid to bondholders is a tax-deductible expense to the firm.
B) The firm is not legally required to pay interest to bondholders.
C) It usually has a specific maturity.
D) Its holders have a fixed claim on the firm's assets in the event of bankruptcy.

Answer 1

B

Question 2

If a firm could sell a mortgage bond at an 8% interest rate, it could sell an otherwise identical debenture at ___________.

A) a rate less than 8%
B) 8%
C) a rate greater than 8%
D) Cannot be determined

Answer 2

C

Question 3

The value of a perpetual bond is equal to the annual interest payment divided by the ___________.

A) risk-free rate
B) required rate of return
C) bank interest rate
D) after-tax historical cost of capital

Answer 3

B

Question 4

When the market for an asset is in equilibrium, the expected rate of return on the asset is equal to the ____________.

A) risk-free rate
B) marginal investor's required rate of return
C) historical cost of capital
D) perpetual capitalization rate

Question 5

Zero coupon bonds are an example of ___________.

A) original issue deep discount bonds
B) extendible notes
C) convertible bonds
D) floating rate notes

Question 6

The ____ the investor's required rate of return on a bond, the ____ will be the value of the bond to the investor.

A) lower; higher
B) higher; higher
C) lower; lower
D) higher; lower

Question 7

The indenture is a contract between the issuer and lenders that does all the following EXCEPT ______.

A) specify the manner in which the principal must be repaid
B) detail the nature of the debt issue
C) give management's expectations about return of the proceeds
D) list any restrictive covenants

Question 8

By the capitalization of cash flow method, the value of an asset is a function of ____________.

A) the book value of the asset
B) required rate of return
C) the age of the asset
D) All of these are correct

Question 9

Which of the following types of debt securities protect investors against interest rate risk?

A) floating rate bonds
B) extendible notes
C) original issue deep discount bonds
D) floating rate bonds and extendible notes

Question 10

Normally the coupon rates on new bonds ______.

A) do not change over the life of the issue
B) are set equal to the market rate plus an inflation premium
C) float with changes in the prime rate
D) are set just over the prevailing prime rate

Question 11

Which of the following statements concerning preferred stocks is true?

A) Preferred stockholders have a prior claim on the income and assets of the firm as compared to the claims of lenders.
B) Preferred stock dividends per share are normally increased as the earnings of the firm increase.
C) Preferred dividends per share are usually not cut or suspended unless the firm is faced with serious financial problems.
D) The par value of a stock is always the same as the initial selling price.

Question 12

Original issue deep discount bonds have decreased in popularity over the last several years due to:

A) changes in tax laws
B) issuance by brokerage firms of higher risk substitutes
C) increased interest in equity securities
D) None of these are correct

Question 13

The yield-to-maturity of a bond with a finite maturity date is a function of all of the following variables EXCEPT the ____________.

A) current price
B) required rate of return on the bond
C) uniform annual interest payments
D) maturity value

Question 14

The quality of a debenture depends on the ____________.

A) general credit-worthiness of the issuing company
B) value of the assets used as collateral
C) coupon rate of the debenture
D) length of time to maturity

Question 15

A sinking fund allows the issuer to ______.

A) redeem an entire debt issue prior to maturity
B) purchase a portion of the debt each year in the open market or call a portion of the debt for mandatory redemption
C) call the entire debt issue
D) accumulate interest expenses into a sinking fund account

Question 16

The call feature of a long-term bond _______.

A) is an optional retirement provision
B) states the call price
C) allows the issuer to replace a high coupon bond with a lower coupon bond
D) All of these are correct

Question 17

Potential sellers of an asset can be represented as a ____ schedule showing the ____ prices at which they are willing to sell given quantities of the asset.

A) supply; maximum
B) demand; maximum
C) supply; minimum
D) supply; average

Question 18

Extendable notes are redeemable at par at the option of the ___________.

A) holder only
B) company only
C) trustee only
D) holder and trustee

Question 19

Rank in ascending order (lowest to highest) the relative risk associated with holding the preferred stock, common stock, and bonds of a firm.

A) preferred stock, bonds, common stock
B) bonds, common stock, preferred stock
C) common stock, preferred stock, bonds
D) bonds, preferred stock, common stock

Question 20

Junk bonds are ______.

A) usually rated Ba or higher by Moody's
B) issued by firms with a high debt ratio
C) issued with coupon rates at least 8 percentage points or more above the highest quality issues
D) issued by firms with a low debt ratio

Question 21

A zero coupon bond is NOT an example of a(n) ____.

A) fixed income security
B) original issue deep discount bond
C) tax-exempt bond
D) All of these are correct

Question 22

The major advantages of long-term debt include all the following EXCEPT _______.

A) decreased financial risk
B) relatively low after-tax cost
C) firm owners' ability to maintain control over their firm
D) increased earnings per share through financial leverage

Question 23

Common stock is a(n) ______-income security.

A) variable
B) fixed
C) after-tax
D) split

Question 24

The basic relationship in bond valuation is for a given percentage point change in the required rate of return, the ____ the time to maturity, the ____ the change in value.

A) shorter; greater
B) longer; smaller
C) longer; greater
D) shorter; smaller

Question 25

The ____ represents the debtholders in dealings with the issuing company.

A) trustee
B) stakeholders
C) broker
D) investment banker

Question 26

There is a(n) ____ relationship between the value of a bond and its required rate of return.

A) direct
B) distant
C) inverse
D) turgid

Question 27

The value of a 15-year bond will change ____ for a given change in the required rate of return than will the value of a 5 year bond.

A) more
B) less
C) the same percentage
D) exactly the same

Question 28

Equipment trust certificates are used mainly by ______.

A) equipment manufacturers
B) oil drilling companies
C) state governments
D) railroad and trucking companies

Question 29

The principal disadvantage of preferred stock financing is ______.

A) its high after-tax cost as compared with long-term debt
B) the decrease in the firm's degree of financial leverage
C) the required payment of dividends
D) the reduction in control

Question 30

"Junk bond" is a term used to describe a bond that _____.

A) is in default
B) is rated Ba or lower by Moody's
C) is currently paying interest
D) has been downgraded by Moody's

Question 31

Preferred stock has a priority over common stock with regard to the company's ______.

A) assets only
B) voting rights only
C) dividends only
D) assets and dividends

Question 32

The required rate of return on an asset is NOT a function of the ____.

A) risk associated with the asset
B) risk-free interest rate
C) age of the asset
D) All of these are correct

Question 33

Which of the following is the highest risk debt issue?

A) senior debt
B) mortgage bond
C) equipment trust certificate
D) debenture

Question 34

When the required rate of return is ____ the coupon rate, the bond will sell at a discount.

A) less than
B) greater than
C) the same as
D) not equal to

Question 35

The call feature is an advantage to the issuing firm if _______.

A) the bond has a floating rate
B) interest rates decline
C) the bond has a low par value
D) interest rates increase

Question 36

____ are not secured by specific assets.

A) Equipment trust certificates
B) Mortgage bonds
C) Debentures
D) Collateral trust bonds

Question 37

Large companies build up short-term debt over the period of 1 to 2 years and then sell long-term debt using a portion of the proceeds to repay the short-term borrowings. This procedure is called ______.

A) "drawing down" long-term credit
B) funding short-term debt
C) reducing the tax bite
D) extending the rates

Question 38

Junk bonds (i.e., bonds issued by companies with weak financial positions) are rated ____ or lower by Standard & Poor's.

A) Baa
B) BB
C) Ba
D) CCC

Question 39

All of the following types of bonds are secured EXCEPT ______.

A) collateral trust
B) mortgage
C) debentures
D) equipment trust certificates

Question 40

If an American Water Company bond has a coupon rate of 9 percent and is selling for $920, then the yield to maturity must be _____.

A) greater than 9%
B) equal to 9%
C) less than 9%
D) Cannot be determined

Question 41

Users of preferred stock include ______.

A) utility companies
B) capital-intensive companies undergoing expansion
C) large commercial banks
D) All of these are correct

Question 42

A Treasury bill with a July 11 maturity date is quoted today at 8.46 bid and 8.40 asked. How much would you pay today (January 11) for one bill?

A) $9,577
B) $9,580
C) $9,588
D) $8,400

Question 43

Treasury notes typically have initial maturities ranging from _____.

A) 1 to 3 years
B) 1 to 5 years
C) 1 to 10 years
D) 10 to 30 years

Question 44

How much would you have to pay for a U.S. Government bond ($1,000 maturity value) scheduled to mature in February 2020 and quoted at 118:07 "bid" and 118:15 "asked"?

A) $1,182.19
B) $1,181.50
C) $1,184.69
D) $1,180.70

Question 45

A General Electric 7½ bond closed at 98. What is the current yield?

A) 7.65%
B) 7.81%
C) 7.50%
D) 7.34%

Question 46

The following bond quotation indicates that the holder expects to receive ____ in interest annually: PACEI 11s 09 11.6 20 95 -1

A) $90
B) $116
C) $95
D) $110

Question 47

The State of New York issued $50 million of perpetual bonds in 1990. The bonds were issued in $100 denominations with an annual coupon interest rate of 5%. Determine the value of these bonds today to an investor who requires a 10% return on his investment.

A) $25
B) $5
C) $10
D) $50

Question 48

In reading price quotes on U.S. Treasury bills, you would ____ expect to find the "asked" price higher than the "bid."

A) always
B) never
C) sometimes
D) seldom

Question 49

The State of Adaven issued $50 million of perpetual bonds in 1990. The bonds were issued in $100 denominations with an annual coupon interest rate of 5%. Determine the rate of return or current yield on these bonds if they are purchased at the current price of $40.

A) 12.5%
B) 8.0%
C) 5.0%
D) 1.25%

Question 50

____ bonds normally are denominated in the currency of the country of sale.

A) Eurodollar
B) International
C) Foreign
D) LIBOR

Question 51

Treasury bills _____.

A) have a stated interest rate
B) pay no explicit interest
C) are sold for exactly $10,000
D) are quoted in terms of yield to maturity

Question 52

A Treasury bill with 182 days to maturity is quoted at 5.62 bid, 5.60 asked, and an asked yield of 5.84. How much would you pay for this security?

A) $9,440
B) $9,720
C) $9,708
D) $9,438

Question 53

If an Allied Chemical zero coupon bond due in 12 years is selling for $420, what is its yield to maturity?

A) 7.50%
B) 4.64%
C) 6.51%
D) 5.26%

Question 54

The ____ of a debt issue is equal to the difference between the ____ and the ____.

A) call price; market price; par value
B) call price; market price; call premium
C) call premium; call price; par value
D) call premium; market price; par value

Question 55

What is the yield to maturity for a Poughkeepsie Gypsy Fortune Tellers' zero coupon bond that matures in 14 years if the bond is selling for $530?

A) 5.84%
B) 4.64%
C) 4.28%
D) 5.49%

Question 56

Which of the following features (if any) of debt securities provides the investor with a measure of protection against inflation?

A) sinking fund
B) call feature
C) floating coupon rates
D) poison put covenant

Question 57

In the Treasury bill quote that follows, the price of the bill can be calculated from the ____ price. $\begin{array}{ll}\text { Mat date } & \text { Bid } &\text { Asked }&\text { Yield }\\9-24&8.34&8.29&8.58\end{array}$

A) bid
B) asked
C) yield
D) None of these are correct

Question 58

An AT&T 5½05 bond with a current yield of 6.2% must be selling ____ its face value.

A) above
B) at
C) below
D) All of these are correct

Question 59

Two years ago, Trans-Atlantic Airlines sold a $250 million bond issue to finance the purchase of new jet airliners. These bonds were issued in $1,000 denominations with an original maturity of 12 years and a coupon rate of 12%. Determine the value today of one of these bonds to an investor who requires a 14% rate of return on these securities.

A) $626
B) $463
C) $897
D) $270

Question 60

A zero coupon bond is a bond that ______.

A) originally sells at a discount
B) will sell for a premium
C) is a premium value bond
D) has a high current yield

Question 61

An Allied Northern preferred stock pays a $3.84 annual dividend. What is the value of the stock to an investor who requires a 9.5 percent return?

A) $40.42
B) $42.67
C) $38.40
D) $37.60

Question 62

What is the value of a PacTen bond with a 10 percent coupon that matures in 15 years? Assume the current market rate for this bond is 16 percent and that interest is paid semiannually.

A) $661.90
B) $1,227.78
C) $1,000.00
D) $875.51

Question 63

Determine the yield to maturity to the nearest tenth of 1 percent of a zero coupon bond with 8 years to maturity that is currently selling for $404.

A) 11.3%
B) 12.3%
C) 11.7%
D) 12.0%

Question 64

Up in Smoke Tobacco Shops' bond carries a 9 percent coupon, pays interest semiannually, and has 10 years to maturity. What is the bond's yield to maturity if the bond is selling for $937.75 (rounded to the nearest whole percent)?

A) 8.0%
B) 10.0%
C) 9.0%
D) 7.0%

Question 65

Two years ago, Trans-Atlantic Airlines sold $250 million worth of bonds at $1,000 each. The bonds had a maturity of 12 years and a coupon rate of 12%. Today these bonds are selling for $910. Determine the yield-to-maturity (to the nearest tenth of one percent).

A) 13.2%
B) 5.6%
C) 13.7%
D) 12.0%

Question 66

Marko needs to raise capital through a zero coupon bond debt offering. If the bonds will have 12 years to maturity and the rate of return on a bond in Marko's risk class is 11 percent, what will be the selling price of the bond?

A) $302.50
B) $335.50
C) $269.50
D) $286.00

Question 67

Baywa has an outstanding bond that has a coupon rate of 8.3%. What is the market price of this bond if it pays interest semiannually, has 15 years to maturity, and the current required rate of return is 9% on bonds of similar quality?

A) $943
B) $1059
C) $954
D) $1,000

Question 68

A refrigerator manufacturer, Zero King, issued a zero coupon bond with 10 years to maturity. What is the yield-to-maturity of this bond if it is sold for $352?

A) 12.2%
B) 10%
C) 11%
D) 9%

Question 69

Five years ago, the city of Baltimore sold at par a $1,000 bond with a coupon rate of 8 percent and 20 years to maturity. If this bond pays interest semiannually, what is the value of this bond to an investor who requires an 8 percent rate of return?

A) $607.72
B) $692.00
C) $1,000.00
D) $1,080.00

Question 70

What is the market value of a zero coupon bond with 5 years to maturity? The bond was originally sold with a yield to maturity equal to 11 percent, but the market rate today is 9 percent.

A) $593
B) $650
C) $621
D) $577

Question 71

What is the value of a Northern Pacific bond with an 11 percent coupon, maturing in 15 years? Assume the market rate for this bond is 14 percent and that the interest is paid semiannually.

A) $1,000.00
B) $790.74
C) $813.50
D) $853.30

Question 72

ICX Company has an issue of perpetual bonds (par value to $1,000) that pays 5% annual interest. Determine the yield (to the nearest tenth of 1 percent) if the bonds are currently selling for $625.

A) 5.0%
B) 8.0%
C) 3.1%
D) 6.25%

Question 73

Assume that the dividend on Central Power Company's $3.25 preferred stock issue is paid annually at the end of the year. Determine the value of this preferred stock to an investor who requires a 12 percent rate of return.

A) $3.25
B) $39
C) $12
D) $27.08

Question 74

What is the value of an Orion bond that has a 10 percent coupon, pays interest semiannually, and has 10 years to maturity, if the required rate of return is 12 percent?

A) $1,200.00
B) $885.50
C) $895.27
D) $1,000.00

Question 75

____ occurs when a firm calls a relatively high interest rate issue and replaces it with a lower interest rate issue.

A) A call feature
B) A sinking fund
C) Bond refunding
D) Indenture refinancing

Question 76

Determine the yield-to-call (to the nearest 0.1 of a percent) of an LTV bond with a 14 percent coupon, that pays interest semiannually. The bond can be called in 7 years, has a call premium of $140, and is currently selling for $1,154.

A) 12.0%
B) 16.2%
C) 13.7%
D) 14%

Question 77

Determine the yield to maturity (to the nearest tenth of 1 percent) of an 8-year zero coupon bond ($1,000 par value) that is currently selling for $521.

A) 6.0%
B) 11.5%
C) 7.9%
D) 8.5%

Question 78

What is the required rate of return to the investor who is willing to purchase a Duke Power preferred stock with a $8.70 dividend, a par value of $100, and a current market price of $87?

A) 10.7%
B) 8.7%
C) 9.4%
D) 10.0%

Question 79

What is the rate of return on a preferred stock that has a par value of $50, a market price of $46.50, and a dividend of $4.10?

A) 8.20%
B) 11.34%
C) 8.82%
D) 12.20%

Question 80

What is the value of a $1,000 par value Consul perpetual bond with a 6 percent coupon rate if the required rate of return is 9 percent?

A) $1,000.00
B) $666.67
C) $333.33
D) $540.00