Question 1

Marketability is primarily an advantage to the issuer of new securities.

Accepted Answer

Marketability is primarily an advantage to the investor because it allows them to buy or sell the security easily in the market without significantly affecting its price.

Question 2

There is positive relationship between a security's marketability and its yield.

Accepted Answer

Marketability refers to how easily a security can be bought or sold in the market without affecting its price. Generally, a more marketable (or liquid) security tends to have a lower yield because investors are willing to accept a lower return for the convenience and lower risk of being able to easily sell the security.

Question 3

While an investor in callable bonds does not know exactly when his or her bonds will be called (if ever), he or she does know that the reinvestment rate will be at time of call because this is specified in the bond's indenture.

Accepted Answer

The bond's indenture specifies the call price and conditions under which the bond can be called, but it does not specify future reinvestment rates, which are uncertain and depend on market conditions at the time of the call.

Question 4

Call privileges on bonds are a disadvantage to investors precisely because the price of the callable bonds may decline.

Accepted Answer

Call privileges on bonds are considered a disadvantage to investors primarily because the issuer can redeem the bonds before their maturity when interest rates decline, potentially depriving investors of higher interest income, not because the price of the callable bonds may decline.

Question 5

Callable securities usually sell at lower prices and higher interest rates than non-callable securities.

Accepted Answer

Callable securities provide the issuer the right to redeem the security before its maturity date, which adds an element of risk for the investor. To compensate for this risk, callable securities typically offer higher interest rates and sell at lower prices compared to non-callable securities, making them more attractive to investors seeking higher yields.

Question 6

The yield differential between callable and non-callable securities is normally smallest when interest rates are expected to rise.

Accepted Answer

When interest rates are expected to rise, investors are more likely to call callable securities, which will reduce the yield differential between callable and non-callable securities.

Question 7

The expectation in the financial marketplace of a significant decline in market interest rates should increase the differential between required rates of interest on new callable and non-callable bonds.

Accepted Answer

When the financial marketplace expects a significant decline in market interest rates, investors demand a higher yield on callable bonds to compensate for the risk that the issuer will refinance the bond at lower rates. This increases the yield differential between callable and non-callable bonds, as non-callable bonds do not carry this risk.

Question 8

Junk bonds have been used to finance mergers.

Accepted Answer

Junk bonds, which are high-yield and high-risk bonds, have historically been used as a financing tool for mergers and acquisitions, providing the necessary capital for companies to pursue these transactions.

Question 9

The Tax Reform Act of 1986 eliminated the favorable tax treatment of capital gains. Such gains became taxed at ordinary income tax rates.

Accepted Answer

The Tax Reform Act of 1986 eliminated the preferential tax rate for capital gains, making them subject to the same tax rates as ordinary income.

Question 10

The maximum possible amount of capital loss that can be deducted for tax purposes is $3,000.

Accepted Answer

The IRS allows individuals to deduct up to $3,000 ($1,500 if married filing separately) of net capital losses per year against ordinary income.

Question 11

The floor which, normally, is the lowest value to which a convertible bond can fall is known as the conversion value of that bond.

Accepted Answer

The lowest value to which a convertible bond can fall is known as the bond floor, which is determined by its value as a traditional bond, independent of its conversion feature. The conversion value is the value of the bond if it were converted into the underlying stock, which can vary independently of the bond floor.

Question 12

Moody's Investor Service and Standard and Poor's Corporation are two of the most widely consulted investment rating companies in the U.S.

Accepted Answer

Moody's Investor Service and Standard & Poor's (S&P) are indeed two of the most widely consulted and influential credit rating agencies in the United States, providing assessments of the creditworthiness of borrowers and financial instruments.

Question 13

If we subtract the default-risk premium from the yield on a risky security we derive the promised marginal yield on a risky security.

Accepted Answer

Subtracting the default-risk premium from the yield on a risky security gives us the risk-free rate, not the promised marginal yield on the risky security. The promised marginal yield is the total yield expected from the security, which includes the risk-free rate plus various premiums for taking on additional risks, such as the default-risk premium.

Question 14

Recent studies cited in the textbook suggest that the default rate on junk bonds has averaged just over 15 percent of the greater of par or market value of those bonds.

Accepted Answer

Recent studies have shown that the default rate on junk bonds, while higher than investment-grade bonds, does not typically average as high as 15 percent. The actual average default rate varies but is generally lower, often cited in the range of 2% to 10% depending on the economic cycle and specific time period analyzed.

Question 15

Municipal bonds are a good investment for recent college graduates because the default risk is so low.

Accepted Answer

Municipal bonds, while generally having low default risk, may not be the best investment for recent college graduates due to their typically lower yields and the fact that young investors might be better served by higher-risk, higher-reward investments that can potentially offer greater long-term growth.

Question 16

Investors find convertible bonds less attractive than nonconvertible bonds because the corporation can convert them to stock at any time.

Accepted Answer

Convertible bonds are often found more attractive by investors because they offer the flexibility to convert the bond into a predetermined number of shares of the company's stock, potentially allowing the investor to benefit from an increase in the stock's price.

Question 17

The number of credit-rating agencies worldwide is declining.

Accepted Answer

The number of credit-rating agencies worldwide has been increasing, especially with the growth of financial markets globally and the emergence of new agencies in developing countries.

Question 18

The rise in new junk bond offerings during the 1990s can be traced to more borrowing companies bypassing rigid and expensive bank loans as a source of credit and an upward surge of corporate mergers financed by junk bond issues.

Accepted Answer

The 1990s saw an increase in junk bond offerings as companies sought alternative financing methods to traditional, more costly bank loans. This period also experienced a boom in corporate mergers and acquisitions, many of which were financed through the issuance of high-yield, high-risk junk bonds.

Question 19

Orange County, California in 1994 and 1995 provided an example of marketability risk in its security offerings.

Accepted Answer

The answer of Orange County, California in 1994 and 1995...

Question 20

Orange County's default was most closely associated with trading in risky state and local government bonds.

Accepted Answer

Orange County's default in 1994 was primarily due to speculative investments in derivatives and leveraging positions, not directly from trading in risky state and local government bonds.

Quiz 8: The Risk Structure of Interest Rates: Defaults, Prepayments, Taxes, and Other Rate-Determining Factors