Question 1

Since the issuer of zero (or low) coupon bonds can annually deduct the current year's interest accrual without having to actually pay the interest until the bond matures (or is called), its cash flow each year is increased by the amount of the tax shield provided by the interest deduction.

Accepted Answer

Zero coupon bonds do not pay interest regularly but accrue interest until maturity or call. The issuer can deduct the annual interest accrual for tax purposes, which reduces their tax liability and increases their cash flow. This is known as the tax shield provided by the interest deduction.

Question 2

With subordinated debentures, payment of interest by a firm is required only when earnings are available.

Accepted Answer

Subordinated debentures are a type of debt that ranks below other debts with respect to claims on assets or earnings in the event of a liquidation, but interest payments are typically required at fixed intervals, not contingent on the firm's earnings.

Question 3

A Eurobond is a bond issued by an international borrower and sold to investors in countries with currencies other than the country in which the bond is denominated.

Accepted Answer

A Eurobond is issued by an international borrower and can be denominated in any currency, typically the currency of the investor's country. It is sold to investors in countries with currencies other than the country where the bond is issued.

Question 4

A foreign bond is a bond issued by a foreign corporation or government and is denominated in the investor's home currency and sold in the investor's home market.

Accepted Answer

A foreign bond is issued by a foreign entity in the investor's domestic market and is denominated in the investor's home currency, making it accessible and familiar to local investors.

Question 5

Since a putable bond gives its holder the right to "put the bond" at specified times or because of specified actions by the issuing firm, the bond's yield would be lower than that of an otherwise equivalent non-putable bond.

Accepted Answer

The fact that the bond is putable provides more flexibility and protection to the bondholder, which leads to a lower yield. Therefore, a putable bond typically has a lower yield than a non-putable bond.

Question 6

Debentures such as convertible bonds are unsecured bonds that only the most creditworthy firms can issue.

Accepted Answer

Convertible bonds are secured bonds, not unsecured bonds.

Question 7

High-quality (high-rated) bonds provide lower returns than lower-quality (low-rated) bonds.

Accepted Answer

This statement is true. High-quality bonds, also known as investment-grade bonds, are issued by financially stable companies or governments with a low risk of default. As a result, they offer lower returns. On the other hand, lower-quality (low-rated) bonds, also known as high-yield bonds or junk bonds, are issued by companies with higher credit risks and therefore offer higher returns to compensate for the increased risk.

Question 8

Floating-rate bonds are bonds that can be redeemed at par at the option of their holder either at specific date after the date of issue and every 1 to 5 years thereafter or when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt.

Accepted Answer

Floating-rate bonds have interest rates that reset periodically, typically based on a reference rate plus a spread, rather than offering options for redemption at par based on specific actions or timeframes.

Question 9

________ allow bondholders to purchase a certain number of shares of the firm's common stock at a specified price over a certain period of time.

Accepted Answer

Stock purchase warrants allow bondholders to purchase a certain number of shares of the firm's common stock at a specified price over a certain period of time. Call options and put options are types of financial derivatives, and debentures are a type of long-term debt instrument often used by corporations.

Question 10

Putable bonds give the bondholders an option to sell the bond at a price higher than par value by the amount of one year interest payment when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt.

Accepted Answer

Putable bonds give the bondholders the option to sell the bond back to the issuer at a predetermined price before maturity, but this feature is not specifically tied to actions such as acquisitions or issuing additional debt, nor is it typically described as being at a price higher than par value by the amount of one year's interest payment.

Question 11

As a bond approaches maturity, the price of the bond will approach its par value until, the bond is worth its face value at maturity.

Accepted Answer

This statement is true. When a bond approaches maturity, the price of the bond will gradually increase and approach its par value, which is the bond's face value. At maturity, the bond will be worth its full face value.

Question 12

A Eurobond bond is a bond denominated in Euros.

Accepted Answer

A Eurobond is a bond issued in a currency other than the currency of the country or market in which it is issued. It does not specifically refer to bonds denominated in Euros.

Question 13

A bond issued by an American company that is denominated in Swiss Francs and sold in Switzerland would be an example of a foreign bond.

Accepted Answer

This is an example of a foreign bond because it is issued by a company based in the United States, but is denominated in a foreign currency (Swiss Francs) and sold in a foreign market (Switzerland).

Question 14

The ________ feature permits the issuer to repurchase bonds at a stated price prior to maturity.

Accepted Answer

The call feature allows the issuer to buy back or "call" the bonds from bondholders before their maturity date at a specified price. This gives the issuer flexibility if interest rates decline or if the issuer's financial situation improves, allowing them to refinance the debt at a cheaper cost.

Question 15

Any bond rated Aaa through Caa according to Moody's, would be considered investment grade debt.

Accepted Answer

Moody's ratings from Aaa to Baa3 are considered investment grade, while ratings from Ba1 to Caa and lower are considered non-investment grade or "junk" bonds.

Question 16

There is an inverse relationship between the quality or rating of a bond and the rate of return it must provide bondholders.

Accepted Answer

This is because higher quality/rating bonds are considered less risky, so they offer a lower rate of return to bondholders, while lower quality/rating bonds are riskier and thus offer a higher rate of return to compensate for that risk.

Question 17

The market price of a callable bond will not generally exceed its call price, except in the case of a convertible bond.

Accepted Answer

The market price of a callable bond typically does not exceed its call price significantly because investors anticipate that the issuer will likely call the bond if interest rates drop and the bond's price rises too much above the call price. However, a convertible bond can exceed its call price due to the added value of the conversion option into equity, which may appreciate independently of interest rate movements.

Question 18

An A rated bond should provide investors with a higher yield than an otherwise identical B rated bond.

Accepted Answer

This statement is false. A higher credit rating typically results in a lower yield because the issuer is considered to be less risky. So, an A rated bond would generally provide investors with a lower yield than a B rated bond.

Question 19

The ________ feature allows bondholders to change each bond into stated number of shares of stock.

Accepted Answer

The feature described is known as conversion, which allows bondholders to convert their bonds into a stated number of shares of stock. Choices A, C, and D are incorrect because they do not describe this specific feature. A call feature allows the issuer to redeem or buy back the bonds before maturity. A put feature allows the bondholder to sell back their bonds before maturity. A swap feature allows two parties to exchange cash flows or assets.

Question 20

Any Ba rated bond or lower would be considered speculative or "junk."

Accepted Answer

Ba rated bonds are classified as "speculative" or "junk" by credit rating agencies.  Any bond with a credit rating lower than Ba would also be considered speculative or "junk."

Quiz 6: Interest Rates and Bond Valuation