Question 1

A contract negotiated directly with a bank in which the borrower agrees to make a series of interest and principal payments on specific dates to the bank is called

Accepted Answer

A contract in which the borrower agrees to make a series of interest and principal payments on specific dates to a bank is called a term loan. Commercial paper is a short-term debt instrument issued by companies, convertible debt allows the holder to convert the debt into equity, preferred stock is a type of equity security, and a bond issue is a long-term debt instrument sold to investors.

Question 2

If two bonds have the same maturity and the same expected rate of return, but one has a higher coupon, the price of the low coupon bond will be more affected by a given change in interest rates.

Accepted Answer

The lower coupon bond will have a lower yield to maturity, making it more sensitive to changes in interest rates.

Question 3

A bond with a $100 annual interest payment and $1,000 face value with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates were greater than 11%.

Accepted Answer

When interest rates are lower than the bond's coupon rate (the rate at which the bond pays interest), the bond becomes more attractive to investors, leading to an increase in demand for the bond and driving up its price. This results in the bond selling for a premium, which is the price above its face value. Conversely, when interest rates are higher than the bond's coupon rate, the bond becomes less attractive to investors, leading to a decrease in demand and a drop in price. This results in the bond selling for a discount, which is the price below its face value.

Question 4

Call provisions on corporate bonds are generally included to protect the issuer against large declines in interest rates.They affect the actual maturity of the bond but not its price.

Accepted Answer

Call provisions can affect both the maturity and the price of a bond, as they give the issuer the right to redeem the bond before its maturity, often leading to price adjustments based on interest rate changes and the likelihood of the bond being called.

Question 5

The longer the maturity of a bond, the more its price will change in response to a given change in interest rates; this is called interest rate price risk.

Accepted Answer

Interest rate price risk is directly related to the length of time until a bond matures. The longer the time until maturity, the more sensitive the bond's price will be to changes in interest rates. This means that a given change in interest rates will have a greater impact on the price of a long-term bond than on a short-term bond. This is why investors must consider interest rate risk when selecting bonds for their portfolios.

Question 6

Bonds with long maturities expose the investor to high interest rate reinvestment risk, which is the risk that income will differ from what is expected because the cash flows received from bonds will have to be reinvested at different interest rates.

Accepted Answer

Bonds with long maturities expose the investor to high interest rate risk, not reinvestment risk. Reinvestment risk is more significant for short-term bonds or callable bonds, where cash flows need to be reinvested at potentially lower rates.

Question 7

Which of the following types of debt are backed by some form of specific property?

Accepted Answer

Mortgage bonds are backed by specific property, such as real estate. Debentures and subordinated debt are not backed by any specific property.

Question 8

The terms and conditions to which a bond is subject are set forth in its

Accepted Answer

The terms and conditions of a bond are set forth in its indenture, which is a legal document outlining the terms of the bond agreement between the issuer and the bondholders.

Question 9

If a bond is callable, and if interest rates in the economy decline, then the company can sell a new issue of low- interest-rate bonds and use the proceeds to "call" the old bonds in and have effectively refinanced at a lower rate.

Accepted Answer

When a bond is callable, it means that the company has the option to redeem or "call" the bonds in before the maturity date if it is financially advantageous to do so. If interest rates decline, the company can issue new bonds at lower interest rates and use the proceeds to redeem the older, higher yielding bonds. This is effectively refinancing at a lower rate, allowing the company to save money on interest payments.

Question 10

All else equal, a zero-coupon bond's price is more sensitive to changes interest rates than a bond with a 10% annual coupon.

Accepted Answer

A zero-coupon bond has no coupon payments, so its entire value is based on the final payment at maturity. As a result, changes in interest rates will have a larger impact on the bond's price compared to a bond with a 10% annual coupon, which has some value based on the coupon payments.

Question 11

If you buy a bond that is selling for less than its face, or maturity, value then the price (value) of the bond will increase the maturity date nears if market interest rates do not change during the life of the bond.

Accepted Answer

This is because as the maturity date nears, the bond's price will gradually increase towards its face value, making it a profitable investment. This assumes that market interest rates stay the same, which affects the price of the bond inversely.

Question 12

Other things held constant, if a bond indenture contains a call provision, the yield to maturity that would exist without such a call provision will generally be the YTM with it.

Accepted Answer

A call provision gives the issuer the right to redeem the bond before maturity, which reduces the investor's return. Therefore, the yield to maturity is generally lower with a call provision present compared to a bond without a call provision.

Question 13

Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, be subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.

Accepted Answer

Long-term bonds are generally more sensitive to interest rate changes than short-term bonds, meaning that their prices are more volatile in response to interest rate fluctuations.

Question 14

If we have two bonds with a simple interest rate yield of 9% where one bond is compounded quarterly and the other bond is compounded monthly, the bond compounded quarterly will have a higher effective annual yield.

Accepted Answer

The bond compounded monthly will have a higher effective annual yield because it compounds more frequently than the bond compounded quarterly.

Question 15

If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be selling at a discount; i.e., the bond's market price should be less than its face (maturity) value.

Accepted Answer

If the yield to maturity of a bond is less than its coupon rate, it means that investors can obtain a higher rate of return on their money elsewhere. As a result, demand for the bond will decrease, causing the bond's price to fall and its yield to rise. This increase in yield will eventually reach a point where it is equal to the bond's coupon rate, which is when the bond will be selling at its par value (face/maturity value). Therefore, if the yield to maturity is less than the coupon rate, the bond should actually be selling at a premium, not a discount.

Question 16

A bond differs from term in loans in that

Accepted Answer

A bond issue is generally advertised and sold to many investors through an underwriter, whereas a term loan is typically negotiated between a borrower and a single lender. Additionally, bonds are often offered to the public, while term loans are generally not.

Question 17

A bond's value will increase as interest rates rise over time.

Accepted Answer

A bond's value decreases as interest rates rise over time because investors will demand a higher return on their investment, making existing bonds with lower interest rates less attractive.

Question 18

You have just noticed in the financial pages of the local newspaper that you can buy a bond ($1,000 par) for $800.
If the coupon rate is 10 percent, with annual interest payments, and there are 10 years to maturity, should you make the purchase if your required return on investments of this type is 12 percent?

Accepted Answer

The bond is being sold at a discount ($800 instead of the $1,000 par value), which means a higher yield for the investor. The coupon rate of 10% is higher than the required return of 12%, further increasing the attractiveness of the investment. Therefore, it would be beneficial to purchase this bond.

Question 19

Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10 percent currently have a yield to maturity (YTM) equal to 8 percent.Based on this information, BB&C's bonds must currently be selling at a premium in the financial markets.

Accepted Answer

If the coupon rate is higher than the YTM, the bond must be selling at a premium, but in this case, the YTM is higher than the coupon rate, indicating that the bond is selling at a discount.

Question 20

Which of the following are generally considered advantages of term loans over publicly issued bonds?

Accepted Answer

Term loans often have lower flotation costs, can be brought to market more quickly, and offer more flexibility in terms of adjusting terms after issuance compared to publicly issued bonds.

Quiz 6: Bonds Debt Characteristics and Valuation