Question 1

Last year, Lexington Homes issued $1 million in unsecured, non-callable debt.This debt pays an annual interest payment of $55 and matures 6 years from now.The face value is $1,000 and the market price is $1,020.Which one of these terms correctly describes a feature of this debt?

Accepted Answer

The fact that the debt pays an annual interest payment and matures 6 years from now indicates that it is a note. The other choices do not apply to this particular debt.

Question 2

You own a bond that has a 6 percent annual coupon and matures 5 years from now.You purchased this 10-year bond at par value when it was originally issued.Which one of the following statements applies to this bond if the relevant market interest rate is now 5.8 percent?

Accepted Answer

When the relevant market interest rate decreases, the value of the bond increases because its fixed coupon rate becomes more attractive. So, the bond is currently valued above par value. If it is sold today, it will result in a capital gain for the investor. Therefore, option E is correct. The current yield-to-maturity and the next interest payment are not relevant to the question. The bond is not currently valued at one-half of its issue price as the coupon rate is greater than the current market interest rate.

Question 3

Treasury bonds are:

Accepted Answer

Treasury bonds are typically issued as semi-annual coupon bonds, meaning that they pay interest twice a year. They are considered to be relatively safe investments, but they are not completely risk-free.

Question 4

Which one of the following statements concerning bond ratings is correct?

Accepted Answer

The answer of Which one of the following statements concerning...

Question 5

A newly issued bond has a 7 percent coupon with semiannual interest payments.The bonds are currently priced at par value.The effective annual rate provided by these bonds must be:

Accepted Answer

The answer of A newly issued bond has a 7...

Question 6

Which of the following increase the price sensitivity of a bond to changes in interest rates?
I.increase in time to maturity
II.decrease in time to maturity
III.increase in coupon rate
IV.decrease in coupon rate

Accepted Answer

I and IV only - An increase in time to maturity and a decrease in coupon rate both increase a bond's sensitivity to changes in interest rates. Longer maturity bonds have more future payments affected by rate changes, and lower coupon rates mean less income before maturity, making the bond's price more sensitive to rate changes.

Question 7

Protective covenants:

Accepted Answer

Protective covenants are designed to protect bondholders by establishing certain obligations and restrictions for issuers. These covenants can apply to both short-term and long-term debt issues, privately and publicly issued bonds, and bonds with or without a deferred call provision.

Question 8

The break-even tax rate between a taxable corporate bond yielding 7 percent and a comparable nontaxable municipal bond yielding 5 percent can be expressed as:

Accepted Answer

The answer of The break-even tax rate between a taxable...

Question 9

You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change.Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur?

Accepted Answer

Zero coupon bonds have the longest duration and are most sensitive to changes in interest rates. If interest rates decline, the value of these bonds will increase the most compared to other types of bonds. As the bond market is not indicating any sign of a rate decline, it is best to choose a long-term bond to maximize gains in case the rate decline occurs in the future. Additionally, a zero coupon bond does not have interest payments, so it will not be affected by changes in interest rates in the same way as bonds with coupon payments.

Question 10

Which one of the following bonds is the least sensitive to interest rate risk?

Accepted Answer

Bonds with shorter maturities and higher coupon rates are generally less sensitive to interest rate changes. Among the options, the 3-year bond with a 6 percent coupon (Option B) has the shortest maturity and the highest coupon rate, making it the least sensitive to interest rate risk.

Question 11

Which of the following statements concerning bonds are correct?
I.Bonds provide tax benefits to issuers.
II.The risk of a firm financially failing increases when the firm issues bonds.
III.Most long-term bond issues are referred to as unfunded debt.
IV.All bonds are treated equally in a bankruptcy proceeding.

Accepted Answer

I. Bonds often provide tax benefits to issuers because the interest payments on bonds are tax-deductible.II. Issuing bonds increases a firm's financial obligations due to the required interest payments, thus potentially increasing the risk of financial failure if the firm cannot meet these obligations.

Question 12

Callable bonds generally:

Accepted Answer

The answer of Callable bonds generally:
...

Question 13

Bonds issued by the U.S.government:

Accepted Answer

Bonds issued by the U.S. government are considered to be free of default risk as they are backed by the U.S. government.

Question 14

A "fallen angel" is a bond that has moved from:

Accepted Answer

A "fallen angel" is a bond that was previously rated as investment grade but has since been downgraded to speculative grade. This can happen for a variety of reasons such as deteriorating financials or changes in the industry.

Question 15

Green Roof Inns is preparing a bond offering with a 6 percent, semiannual coupon and a face value of $1,000.The bonds will be repaid in 10 years and will be sold at par.Given this, which one of the following statements is correct?

Accepted Answer

The bonds will sell at a premium if the market rate is 5.5 percent because the coupon rate (6 percent) is higher than the market rate, making the bonds more valuable than similar bonds issued at the current market rate.

Question 16

Texas Foods has a 6 percent bond issue outstanding that pays $30 in interest every March and September.The bonds are investment grade and sell at par.The bonds are callable at a price equal to the present value of all future interest and principal payments discounted at a rate equal to the comparable Treasury rate plus 0.50 percent.Which of the following correctly describe the features of this bond?
I.bond rating of B
II."make whole" call price
III.$1,000 face value
IV.offer price of $1,000

Accepted Answer

The bond is described as investment grade, which contradicts a rating of B (choice I), typically considered below investment grade. The call price is based on the present value of future cash flows discounted at a specific rate (choice II), indicating a "make whole" call provision. The bond pays $30 in interest semi-annually, which suggests a $1,000 face value assuming a 6 percent annual interest rate (choice III). It sells at par, meaning the offer price is equal to its face value of $1,000 (choice IV).

Question 17

As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:

Accepted Answer

As time to maturity increases, the price of the bond becomes more sensitive to changes in interest rates. However, this increase in sensitivity slows down as time to maturity gets longer, leading to an increasing rate of decrease in the bond's sensitivity to interest rate risk. Therefore, the bond's sensitivity to interest rate risk increases at a decreasing rate as time to maturity increases.

Question 18

Which of the following are negative covenants that might be found in a bond indenture?
I.The company shall maintain a current ratio of 1.10 or better.
II.No debt senior to this issue can be issued.
III.The company cannot lease any major assets without approval by the lender.
IV.The company must maintain the loan collateral in good working order.

Accepted Answer

The answer of Which of the following are negative covenants...

Question 19

Municipal bonds:

Accepted Answer

Municipal bonds pay interest that is federally tax-free, which can make them attractive to investors in higher tax brackets. However, they do involve some level of risk, including default risk, and may not always have higher coupon rates than corporate bonds.

Question 20

A 6 percent, annual coupon bond is currently selling at a premium and matures in 7 years.The bond was originally issued 3 years ago at par.Which one of the following statements is accurate in respect to this bond today?

Accepted Answer

The yield-to-maturity (YTM) is less than the coupon rate when a bond is selling at a premium. This is because the bond's price is above its face value due to the higher interest payments compared to current market rates, leading to a lower yield to maturity compared to the original coupon rate.

Quiz 7: Equity Valuation