Question 1

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 interest payments and therefore relies entirely on changes in interest rates for its return. A bond with a 10% annual coupon, however, still provides a significant portion of its return through its coupon payments, so its price will be less sensitive to changes in interest rates.

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

This is because the low coupon bond has less interest income to offset the impact of a change in interest rates, making it more sensitive to changes in the market. The higher coupon bond has more interest income, so it is less sensitive to changes in interest rates.

Question 3

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

The answer of Bonds with long maturities expose the investor...

Question 4

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

This is correct. When a company issues callable bonds, they have the option to "call" or buy back the bonds before maturity. If interest rates in the economy decline, the company may choose to sell a new issue of low-interest-rate bonds and then use the proceeds to call in the old, higher-interest-rate bonds. This effectively allows the company to refinance their debt at a lower interest rate. However, it is important to note that the company typically must pay a premium to call in the old bonds, which can offset some of the cost savings from refinancing.

Question 5

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

Accepted Answer

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

Question 6

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 statement is true because as the bond approaches its maturity date, the investor will receive the full face value of the bond. Therefore, the value of the bond will increase as it gets closer to maturity. This is because the investor will receive the full face value regardless of the price they paid for the bond, so investors are willing to pay more for a bond that is selling for less than its face value. Additionally, if market interest rates remain the same, the bond will become more valuable because its fixed interest rate will be more attractive compared to the current market rates.

Question 7

Bonds issued by Telsa 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, Telsa's bonds must currently be selling at a premium in the financial markets.

Accepted Answer

A bond selling at a premium has a YTM lower than its coupon rate. In this case, the YTM is lower than the coupon rate, but not by enough to make the bond sell at a premium. Therefore, the bond must be selling at a discount.

Question 8

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 answer of If we have two bonds with a...

Question 9

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 10

A bond differs from term in loans in that

Accepted Answer

A bond issue is generally advertised and offered to the public, and is sold to many investors, whereas term loans are generally negotiated between a borrower and a lender. Therefore, all of the above options are correct.

Question 11

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 on corporate bonds do affect the price of the bond, as they give the issuer the option to call back the bond before its scheduled maturity date, which can cause the bond's price to decrease. However, call provisions are often included to protect the issuer against rising interest rates, not declining interest rates.

Question 12

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 is less than the coupon rate, it means the bond is desirable to investors and they are willing to pay more for it than the face value, which results in the bond selling at a premium, not a discount.

Question 13

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

The contract described is most commonly known as a term loan.

Question 14

You have just noticed in the financial pages of the local newspaper that you can buy a bond (R1,000 par) for R800.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

To determine whether or not to make the purchase, we need to calculate the bond's yield to maturity (YTM) and compare it to our required return.

To calculate YTM, we can use a financial calculator or Excel's RATE function:

N = 10 (years to maturity)
PV = -800 (price of the bond, negative because it's a cash outflow)
PMT = 100 (annual coupon payment, 10% of R1,000 par value)
FV = 1000 (par value)
Solve for i, the YTM:

i = 15.33%

Since the YTM of 15.33% is higher than our required return of 12%, we should make the purchase. This is because we are buying the bond at a discount (R800 instead of R1,000), which means we will earn both interest income and capital gains when we receive the par value at maturity. Even though the coupon rate is lower than our required return, the discounted price of the bond provides a higher yield to maturity.

Question 15

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

Accepted Answer

A bond's value will decrease as interest rates rise over time. This is because newer bonds will offer higher yields due to the increased interest rates, making older bonds with fixed yields less attractive to investors.

Question 16

A bond with a R100 annual interest payment and R1,000 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 below the bond's coupon rate (9% in this case), investors are willing to pay more than the face value for the bond because it provides a higher yield than what is available in the market. This results in the bond being sold at a premium. Conversely, when interest rates are above the bond's coupon rate (11% in this case), investors can find higher yields elsewhere and are not willing to pay the full face value for the bond. This results in the bond being sold at a discount.

Question 17

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.

Question 18

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

This is because as the maturity of a bond increases, there are more coupon payments that are affected by changes in interest rates, which can lead to a greater overall impact on the bond's price.

Question 19

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 typically set forth in an indenture, which is a legally binding document that outlines the rights and obligations of both the issuer and the bondholders. Debentures are a type of bond, but they are not typically used to specify the terms and conditions of a bond. Underwriting agreements are contracts between the issuer of a security and an underwriter that outlines the terms of the offering, but they do not typically address the terms and conditions of the bond once it is issued. Restrictive covenants and call provisions may be included in the indenture, but they are not the document that sets forth the terms and conditions of the bond in its entirety.

Question 20

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 call (or redeem) the bond before its maturity date. This reduces the risk for the issuer and thus lowers the yield required by investors. Therefore, the YTM with a call provision will generally be lower than the YTM without it.

Quiz 6: Bonds Debt-Characteristics and Valuation