Question 1

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 a common reason why companies choose to include a call option in their bond issues. If interest rates decline, the company can save money on interest payments by issuing new low-interest-rate bonds and using the proceeds to pay off the old, higher-interest-rate bonds. However, this can also be disadvantageous for bondholders if they were counting on a steady stream of income from the original bonds, as they may be forced to reinvest their money at lower rates.

Question 2

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 when interest rates increase, the present value of future cash flows decreases, which results in a decrease in bond prices. Conversely, when interest rates decrease, the present value of future cash flows increases, resulting in an increase in bond prices. Bonds with longer maturities have more future cash flows, and thus their prices are more sensitive to changes in interest rates.

Question 3

A bond that has a claim on assets only after the senior debt has been paid off in the event of liquidation is called what?

Accepted Answer

A subordinated debenture is a type of bond that has a lower priority claim on assets in the event of liquidation, meaning it will only receive payment after senior debt holders have been paid.

Question 4

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

This is because a zero-coupon bond does not pay periodic interest payments, so its price is entirely based on its future cash flow (the face value) and the prevailing interest rate. Therefore, changes in interest rates will have a greater impact on the present value of the future cash flow for a zero-coupon bond compared to a bond with a fixed coupon rate.

Question 5

A bond differs from term in loans in that

Accepted Answer

A bond issue is typically advertised and offered to the public, and it is sold to multiple investors, whereas a term loan is typically offered to a single borrower. Therefore, all of the above options apply to how a bond differs from a term loan.

Question 6

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 7

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 higher coupon bond will provide more cash flows in the form of interest payments, reducing the impact of changes in interest rates on the overall return of the investment. The lower coupon bond, on the other hand, relies more heavily on price appreciation to achieve the same level of return, making it more sensitive to changes in interest rates.

Question 8

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

A term loan is 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. Choice A (preferred stock) and choice E (a bond issue) are different types of securities that do not involve a direct contract with a bank. Choice B (commercial paper) is a short-term unsecured promissory note issued by a company, while choice C (convertible debt) is a corporate bond that can be converted into a specified number of shares of the issuing company's common stock.

Question 9

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 allow the issuer to retire the higher-yielding bond and issue a new bond at a lower interest rate, which typically leads to a decline in the market value of the called bond. However, call provisions do not affect the stated maturity date of the bond.

Question 10

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 the bond's fixed interest rate becomes less attractive compared to higher interest rates offered by newer bonds.

Question 11

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 12

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 13

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, meaning the bond is paying a higher interest rate than the current market rate, the bond may actually sell at a premium, meaning the market price is higher than the face value.

Question 14

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 is because as the maturity date approaches, the bond will be closer to paying off its full face value, which is the amount the bondholder will receive at maturity. This makes the bond more valuable, and if interest rates do not change, demand for the bond will increase, driving up its price. This is known as capital appreciation.

Question 15

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

Accepted Answer

Mortgage bonds are backed by specific property such as real estate, whereas debentures and subordinated debt are not.

Question 16

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 17

Bonds issued by BB&C Communications 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,BB&C's bonds must currently be selling at a premium in the financial markets.

Accepted Answer

If the bond's YTM is less than the coupon rate, it is selling at a premium in the market. However, in this scenario, the YTM is less than the coupon rate, which indicates that the bonds are selling at a discount, not at a premium.

Question 18

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 outlined in the bond's indenture, which is a legal agreement between the issuer and the bondholders.

Question 19

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 redeem the bond before maturity, which is beneficial for the issuer but not for the bondholder. As a result, a bond with a call provision is considered less valuable to the bondholder than a bond without a call provision. Therefore, investors require a higher yield to compensate for the risk of having their investment called away early. Thus, the yield to maturity without a call provision will generally be lower than the YTM with it.

Question 20

A bond with a $100 annual interest payment and $1,000 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

This is correct as bond prices have an inverse relationship with interest rates. When interest rates are below the coupon rate (in this case, 9%), the bond becomes more valuable and sells at a premium. However, when interest rates are above the coupon rate (in this case, 11%), the bond becomes less valuable and sells at a discount.

Quiz 6: Bonds Debt-Characteristics and Valuation