Question 1

When interest rates rise, bond refunding becomes quite popular.
If interest rates are rising, issuers would naturally resist refunding at higher rates when they already have a lower rate locked in for existing bonds.

Accepted Answer

When interest rates rise, bond refunding becomes less popular since it would mean issuing new bonds at a higher interest rate than existing bonds. Issuers would therefore resist refunding at higher rates and instead hold onto their existing bonds with lower rates.

Question 2

The "yield to maturity" is the internal rate of return on a bond.

Accepted Answer

The yield to maturity is the discount rate that makes the present value of a bond’s cash flows equal to its price. It is commonly referred to as the internal rate of return on a bond.

Question 3

The coupon rate is the actual interest that the seller pays, which may not equal the amount that the seller incurs for an expense.

Accepted Answer

The coupon rate is the annual interest rate that the issuer promises to pay to the bondholder. It is a fixed rate and does not change over the life of the bond. The seller (issuer) pays this coupon rate to the bondholder. However, the amount that the seller incurs for an expense can be higher or lower than the coupon rate. For example, if the seller issues a bond at a premium, it means that the seller receives more money than the face value of the bond. In such a case, the seller incurs a higher expense than the coupon rate. Similarly, if the seller issues a bond at a discount, it means that the seller receives less money than the face value of the bond. In such a case, the seller incurs a lower expense than the coupon rate.

Question 4

Zero-coupon bonds are sold at face value because no interest is paid.
They are sold at a deep discount and grow to maturity value.

Accepted Answer

Zero-coupon bonds are sold at a deep discount below face value because no interest is paid. They do not grow to maturity value, but instead provide a return on investment based on the difference between purchase price and face value at maturity.

Question 5

The prices of zero-coupon bonds tend to react violently to large swings in interest rates.

Accepted Answer

Zero-coupon bonds, which do not pay periodic interest payments, are highly sensitive to changes in interest rates because their entire return is earned through capital appreciation, which is closely tied to interest rates. As interest rates rise, the price of a zero-coupon bond will fall and vice versa, leading to volatile price movements.

Question 6

A bond can only be easily refunded if it has a call feature.

Accepted Answer

A call feature allows the issuer to redeem or "call back" the bond before its maturity date, which makes it easier to refund. Without a call feature, the bondholder would have to wait until the maturity date to receive the principal repayment.

Question 7

An advantage of the zero coupon bond is that there is no coupon, so the yield to maturity is locked in for the life of the bond.

Accepted Answer

Zero coupon bonds do not pay any coupons, so investors know the exact amount they will receive at maturity. Since there are no coupon payments, the yield to maturity is locked in for the life of the bond.

Question 8

The costs of bond refunding are the call premium and the underwriting cost on the new bond issue.

Accepted Answer

Bond refunding involves calling in the existing bonds and issuing new bonds. The call premium is the amount paid to bondholders to compensate for calling in their existing bonds before maturity. The underwriting cost refers to the fees paid to underwriters who help with the process of issuing new bonds. Therefore, the statement is true.

Question 9

Zero-coupon bonds are more risky then other bonds because there is no interest payments involved during the life of the bond.

Accepted Answer

Zero-coupon bonds do not pay any interest during their life, making them more risky than other bonds as investors do not receive any periodic cash flow. The only return on investment comes from the difference between the purchase price and the face value of the bond at maturity.

Question 10

Zero-coupon bonds are sold at a deep discount primarily because investors are not interested in owning them.
"Zeroes" are sold at a deep discount with the strategy in mind that they will grow to maturity, providing the investor with income equal to the spread.

Accepted Answer

Zero-coupon bonds are sold at a deep discount because they do not pay interest periodically, unlike traditional bonds. Instead, they are sold at a discount and then redeemed at face value at maturity, providing the investor with a return on investment. This is the reason for the deep discount, not because investors are not interested in owning them.

Question 11

The costs of bond refunding are the call premium and the underwriting costs on the old and new bond issue.
The underwriting cost on the OLD issue is not a cost of bond refunding.

Accepted Answer

The underwriting cost on the old issue is still a cost associated with the bond refunding process, as it is a cost incurred in the process of issuing the original bonds that are now being refunded.

Question 12

During economic upswings, spreads between bonds of different ratings tend to widen.

Accepted Answer

During economic upswings, spreads between bonds of different ratings tend to narrow. This is because investors have more confidence in the economy and are willing to take on riskier investments, driving up demand for lower-rated bonds and pushing their yields closer to those of higher-rated bonds.

Question 13

Refunding a bond occurs when the company sells more bonds of the same series with maturity and a coupon equal to the bonds sold earlier.
Refunding is the calling and elimination of the old bond by the issuing company.

Accepted Answer

The answer of Refunding a bond occurs when the company...

Question 14

The payment of a call premium may generally be taken as an immediate tax write-off.

Accepted Answer

Payment of call premium is considered as an expense and can be deducted for tax purposes in the year in which it is paid. Hence, it can be taken as an immediate tax write-off.

Question 15

As interest rates decline, bond refunding should become more common.
Bond issuers will seek to call bonds early and refinance them at declining lower rates in the same fashion that homeowners might refinance the mortgage on their home.

Accepted Answer

This statement is true. When interest rates decline, it becomes more advantageous for bond issuers to refinance their existing bonds at lower rates, much like how homeowners may refinance their mortgages when rates drop. This is known as bond refunding.

Question 16

The difference between the initial bond price and the maturity value is amortized for tax purposes over the life of a zero-coupon bond.

Accepted Answer

This is correct, as the difference between the initial bond price (purchase price) and the maturity value (face value) is treated as interest income for tax purposes, and is therefore amortized (spread out) over the life of the bond.

Question 17

If you expect interest rates to go up, you should buy a long-term bond now.
Since bonds competing in the market are at fixed interest rates, you are better advised to lock in your money later when rates are higher.

Accepted Answer

If you expect interest rates to go up, it is not advisable to buy a long-term bond now because its value will decrease when interest rates rise. It is better to wait for rates to go up and then invest in a higher yielding bond.

Question 18

The weighted average cost of capital is generally used as the discount rate in a bond-refunding decision.
The after-tax cost of new debt is used as the discount rate since the savings are certain, unlike in a capital budgeting situation.

Accepted Answer

The answer of The weighted average cost of capital is...

Question 19

The value of bonds will move in the opposite direction from the market interest rates.

Accepted Answer

When market interest rates go up, the value of bonds decreases because the interest rate on the bond becomes less attractive compared to other investments with higher rates. On the other hand, when market interest rates go down, the value of bonds increases because the interest rate on the bond becomes more attractive compared to other investments with lower rates.

Question 20

If you expect interest rates to go up, you should sell a long-term bond now.
Selling means you are the one paying the interest, so locking in on a lower interest rate now would be best.

Accepted Answer

The answer of If you expect interest rates to go...

Quiz 16: Long-Term Debt and Lease Financing

When interest rates rise, bond refunding becomes quite popular. If interest rates are rising, issuers would naturally resist refunding at higher rates when they already have a lower rate locked in for existing bonds.

The "yield to maturity" is the internal rate of return on a bond.

The coupon rate is the actual interest that the seller pays, which may not equal the amount that the seller incurs for an expense.

Zero-coupon bonds are sold at face value because no interest is paid. They are sold at a deep discount and grow to maturity value.

The prices of zero-coupon bonds tend to react violently to large swings in interest rates.

A bond can only be easily refunded if it has a call feature.

An advantage of the zero coupon bond is that there is no coupon, so the yield to maturity is locked in for the life of the bond.

The costs of bond refunding are the call premium and the underwriting cost on the new bond issue.

Zero-coupon bonds are more risky then other bonds because there is no interest payments involved during the life of the bond.

Zero-coupon bonds are sold at a deep discount primarily because investors are not interested in owning them. "Zeroes" are sold at a deep discount with the strategy in mind that they will grow to maturity, providing the investor with income equal to the spread.

The costs of bond refunding are the call premium and the underwriting costs on the old and new bond issue. The underwriting cost on the OLD issue is not a cost of bond refunding.

During economic upswings, spreads between bonds of different ratings tend to widen.

Refunding a bond occurs when the company sells more bonds of the same series with maturity and a coupon equal to the bonds sold earlier. Refunding is the calling and elimination of the old bond by the issuing company.

The payment of a call premium may generally be taken as an immediate tax write-off.

As interest rates decline, bond refunding should become more common. Bond issuers will seek to call bonds early and refinance them at declining lower rates in the same fashion that homeowners might refinance the mortgage on their home.

The difference between the initial bond price and the maturity value is amortized for tax purposes over the life of a zero-coupon bond.

If you expect interest rates to go up, you should buy a long-term bond now. Since bonds competing in the market are at fixed interest rates, you are better advised to lock in your money later when rates are higher.

The weighted average cost of capital is generally used as the discount rate in a bond-refunding decision. The after-tax cost of new debt is used as the discount rate since the savings are certain, unlike in a capital budgeting situation.

The value of bonds will move in the opposite direction from the market interest rates.

If you expect interest rates to go up, you should sell a long-term bond now. Selling means you are the one paying the interest, so locking in on a lower interest rate now would be best.