Question 1

Which one of the following variables has the greatest effect on bond prices?

Accepted Answer

Interest rates have the greatest effect on bond prices. When interest rates go up, bond prices go down and vice versa. This is because investors can earn higher yields on newly issued bonds with higher interest rates, making existing bonds with lower interest rates less attractive and decreasing their demand, which drives down their prices.

Question 2

An increase in the market rate of interest can cause a bondholder to realize a capital loss on the sale of their bonds.

Accepted Answer

When interest rates rise, the value of existing bonds decrease because they were issued at a lower interest rate. This means that if a bondholder sells their bonds in a higher interest rate environment, they will receive less than what they originally paid, resulting in a capital loss.

Question 3

When the economy is moving toward a recession, the yield on riskier bonds will tend to

Accepted Answer

In times of economic uncertainty, investors become more risk-averse and tend to move their money to safer investments. This increased demand for safe investments leads to a decrease in their yields. On the other hand, riskier bonds become less attractive to investors, leading to a decrease in demand and an increase in yields. Therefore, the yield on riskier bonds will tend to rise during a recession.

Question 4

Which of the following bond features is least desirable to investors ?

Accepted Answer

A call provision allows the issuer to redeem the bonds before maturity, which may hurt investors if the interest rates have decreased since the bond was issued. This reduces the potential earnings and makes the investment less attractive. Therefore, a call provision is least desirable to investors.

Question 5

When the market rate of interest drops below a bond's coupon rate, the bond will sell at a premium.

Accepted Answer

When the market rate of interest drops below a bond's coupon rate, the bond becomes more valuable to investors and will sell at a premium. This is because the bond's fixed coupon rate is now higher than the prevailing market rate, making it a more attractive investment.

Question 6

If you want to reduce the price volatility of your bond portfolio, you should shorten the time-to-maturity of your portfolio.

Accepted Answer

Shortening the time-to-maturity of a bond portfolio can reduce price volatility, as it reduces the exposure to interest rate changes over time. Shorter-term bonds are generally less sensitive to interest rate changes than longer-term bonds.

Question 7

Junk bond prices are more sensitive to ratings changes than investment grade bonds.

Accepted Answer

Junk bonds have a lower credit rating and are therefore considered riskier investments. As a result, they are more sensitive to changes in credit ratings than higher-rated investment grade bonds.

Question 8

Solstice Corporation issued a 3% bond four years ago at par value.The market interest rate on comparable bonds today is 4%.

Accepted Answer

The bond sells at a premium because the market interest rate is lower than the coupon rate. The coupon rate is lower than the yield because the bond is selling at a premium.

Question 9

Issuers must redeem outstanding bonds for at least their par value.

Accepted Answer

Issuers are not always required to redeem outstanding bonds for at least their par value; the redemption price can be specified in the bond's terms and could be at, above, or below par value, depending on the bond's call provisions and market conditions.

Question 10

An increase in the market rate of return on an outstanding bond will

Accepted Answer

An increase in the market rate of return on an outstanding bond will cause the bond price to decrease. This is because investors will demand a higher return on their investment, and therefore, will be willing to pay a lower price for the bond. The coupon rate, which is fixed at the time of issuance, will not change.

Question 11

Bonds with one of the top four ratings (Aaa through Baa, or AAA through BBB)are designated as

Accepted Answer

Bonds with one of the top four ratings (Aaa through Baa, or AAA through BBB) are generally considered investment grade bonds, indicating a relatively low risk of default.

Question 12

If you feel interest rates are going to drop significantly, you could potentially realize large capital gains by purchasing long-term zero coupon bonds prior to the rates decreasing.

Accepted Answer

This statement is true. Zero coupon bonds are sold at a discount from their face value and do not pay interest. The investor realizes their return in the form of a capital gain when the bond matures and is paid the full face value. If interest rates decrease significantly after purchasing the bond, the market value of the bond will increase, resulting in a capital gain for the investor.

Question 13

Interest rates and bond prices are positively related.

Accepted Answer

Interest rates and bond prices have an inverse relationship. When interest rates increase, bond prices decrease and vice versa.

Question 14

Bonds are least likely to be called if

Accepted Answer

Bonds are least likely to be called if they are selling at a substantial discount because the issuer would have to pay more than the market value to call them, which is not financially advantageous.

Question 15

When interest rates change, the prices of short-term bonds will change more than those of long-term bonds.

Accepted Answer

Long-term bonds are generally more sensitive to interest rate changes than short-term bonds, meaning their prices will fluctuate more in response to changes in interest rates.

Question 16

The Franklin Company issued a 6% bond three years ago at par value.The market interest rate on comparable bonds today is 5%.The Franklin Company bond currently pays ________ a year in interest and the bond sells at a ________.

Accepted Answer

The bond pays $60 a year in interest (6% of the par value, assuming par value is $1,000). Since the market interest rate is now lower at 5%, the bond sells at a premium.

Question 17

Bond ratings are an important element of the bond market.Explain what bond ratings are, who issues the ratings, and what the ratings mean to the average investor.

Accepted Answer

The answer of Bond ratings are an important element of...

Question 18

If a bond rating moves from a BB to a BBB rating

Accepted Answer

Moving from a BB rating to a BBB rating indicates an improvement in the issuer's creditworthiness, which would lead to an increase in demand for the bond, causing its market price to rise.

Question 19

Every bond is issued with a call feature.Explain what it means for a bond to be "called," then briefly describe the three most common types of call features.Also explain why investors suffer when bonds are called.

Accepted Answer

The answer of Every bond is issued with a call...

Question 20

Which of the following factors are included in the rating analysis of a corporate bond?
I.the issue's indenture provisions
II.the liquidity position of the issuing company
III.the issuing company's relative debt burden
IV.the stability of the company's earnings

Accepted Answer

All four factors are typically included in the rating analysis of a corporate bond. The indenture provisions help assess the creditworthiness of the bond and the likelihood of the issuer defaulting. The liquidity position of the issuing company is important to determine its ability to meet its financial obligations. The relative debt burden is a relevant factor because it affects the company's ability to generate cash flow to pay off the bond. The stability of the company's earnings helps determine the likelihood of the issuer being able to make timely interest payments and repay the principal amount of the bond.

Quiz 10: Fixed-Income Securities