Question 1

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 the government has the ability to raise funds through taxation and can print money to repay its debts.

Answer: D 
 While bonds issued by individual states may have higher coupons than those issued by the U.S. government, interest paid on U.S. government bonds is exempt from federal income taxes, making them attractive to investors in higher tax brackets.

Therefore, the correct choices are C and D.

Question 2

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 3

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 4

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

Accepted Answer

A "fallen angel" is a bond that was originally rated as investment grade but due to some reason, such as financial difficulties, it has now been downgraded to speculative grade, commonly referred to as "junk" status. This downgrade results in a higher yield to maturity (interest rate) to compensate investors for the increased risk.

Question 5

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 6

Municipal bonds:

Accepted Answer

Municipal bonds often pay interest that is federally tax-free, making them attractive to investors seeking tax advantages. However, they are not considered totally risk-free and do carry default risk. Corporate bonds may have higher coupon rates than municipal bonds, but this can vary depending on many factors such as credit quality and market conditions. Municipal bonds may also be callable, meaning that the issuer can choose to redeem them early, resulting in potential reinvestment risk for investors.

Question 7

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 8

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

The answer of You own a bond that has a...

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

Callable bonds generally:

Accepted Answer

The answer of Callable bonds generally:
...

Question 11

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 break-even tax rate is found by setting the after-tax yield of the corporate bond equal to the yield of the municipal bond: 0.07 × (1 - t) = 0.05. Solving for t gives the break-even tax rate.

Question 12

Treasury bonds are:

Accepted Answer

Treasury bonds are generally issued as semi-annual coupon bonds, meaning they pay interest twice a year. Choice A is incorrect because Treasury bonds are specifically issued by the U.S. Department of Treasury. Choice B is incorrect because Treasury bonds can be issued throughout the year, not just on the first day of the fiscal year. Choice C is misleading because while Treasury bonds may offer tax benefits, they are not necessarily the best compared to other bonds. Choice E is also incorrect because while Treasury bonds are considered very low-risk investments, they are not completely risk-free.

Question 13

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

Accepted Answer

As time to maturity increases, the bond's price becomes more sensitive to changes in interest rates. However, this sensitivity increases at a decreasing rate because as the bond approaches maturity, its price becomes less sensitive to interest rate changes.

Question 14

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 15

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.

Question 16

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

Accepted Answer

Split rated bonds are referred to as crossover bonds because they receive different ratings from different rating agencies, indicating they are on the cusp between investment grade and non-investment grade.

Question 17

Protective covenants:

Accepted Answer

Protective covenants are designed to protect the interests of bondholders, and are commonly included in bond indentures (both publicly and privately issued) to ensure that the issuer fulfills its obligations to bondholders. These covenants may include restrictions on the issuer's ability to take on additional debt, pay dividends, or engage in certain business activities that may negatively impact the issuer's ability to repay bondholders.

Question 18

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 19

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 20

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

Negative covenants restrict certain actions by the borrower. II and III are restrictions: not issuing senior debt and not leasing major assets without approval.

Quiz 7: Interest Rates and Bond Valuation