# Business Finance Chapter 6 Learnsmart

 The degree of interest rate risk depends on the sensitivity of the bond’s price to interest rate changes The US government borrows money by issuing Treasury bonds and treasury notes A corporate bond’s yield to maturity is usually not the same as a bond’s coupon rate; changes over time What is the nominal rate of return on an investment? It is the actual percentage change in the dollar value of an investment unadjusted for inflation The term structure of interest rates examines the relationship between short-term and long-term interest rates Which of the following are true bonds? They are issued by both corporations and governments; they are interest-only loans The model that correctly specifies the relationship between the nominal rate and the real rate is: R= the nominal rate; r= the real rate; h= the rate of inflation 1+R=(1+r) x (1+h) What are the three components that influence the Treasury yield curve? the real rate, expected future inflation, and the interest rate risk premium Which of the following are usually included in a bond’s indenture? 1. the basic terms of the bonds2. the total amount of bonds issued3. a description of property used as security4. the repayment arrangements5. the call provisions6. details of the protective covenants What will your aftertax yield be on a corporate bond that is currently priced to yield 7% if you are in the 25% tax bracket? 5.25% A firm decides to raise money by issuing 5 million bonds with a par value of \$5,000 each for 10 years at a coupon rate of 7 percent. At the time of issue, the bonds were sold for \$5,500 each. What will the par value be in year 5? … If a \$1,000 face value U.S. Treasury bond is quoted at 99.5, then the bond can be purchased at 99.5 percent of face value plus any accrued interest What is the asked price? It is the price at which an investor can buy a particular security from a dealer; it is the price at which a dealer is willing to sell a particular security What does the dirty price represent? It includes the quoted price and accrued interest What four variables are required to calculate the value of a bond? 1. the number of periods remaining until maturity2. the face value3. the coupon4. the market interest rate for bonds with similar features If the present value of the interest payments on a bond is \$320 and the present value of the par value to be paid at maturity is \$900, the total value of the bond must be \$1220 As a general rule, which of the following are true of debt and equity? equity represents an ownership interest; the maximum reward for owning debt is fixed Which of the following are features of municipal bonds? They are issued by state and local governments, the interest on municipal bonds is, in some cases, exempt from state taxes in the state of issue, the interest on municipal bonds is exempt from federal taxes The bid-ask spread represents the dealer’s profit The sensitivity of a bond’s price to interest rate changes is dependent on which o the following two variables? 1. All other things being equal, the longer the time to maturity, the greater the interest rate risk2. All other things being equal, the lower the coupon rate, the greater the interest rate risk What does the AAA rating assigned by S&P mean? The firm is in a strong position to meet its debt obligations What is the current yield on a \$1,000 par value bond that sells for \$900 if the coupon rate is 10 percent? 11.11% True or false: The price you actually pay to purchase a bond will generally exceed the clean price. true Which of the following are true about a bond’s face value? It is the principal amount repaid at maturity, it is also known as the par value What are municipal bonds? bonds that have been issued by state or local governments Which three of the following are common shapes for the term structure of interest rates? upward sloping, downward sloping, humped What is the equation for approximating the nominal rate of return? R = the nominal rate of interest; r = the real rate of interest; h = the inflation rate R = r+h A zero-coupon bond is a bond that makes no interest payments Which three components determine the shape of the term structure of interest rates? 1. the real rate of interest2. inflation premium3. interest rate risk premium Which of the following variables is NOT required to calculate the value of a bond? original issue price of bond Which of these correctly identify differences between Treasury bonds and corporate bonds? treasury bonds are free of default risk while corporate bonds are exposed to default risk, treasury bonds are issued by the US government while corproate bonds are issued by corporations; treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer What is the coupon rate on a bond that has a par value of \$1,000, a market value of \$1,100, and a coupon interest payment of \$100 per year? 10% ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is \$1,000 per bond. What are the expected cash flows from one of these bonds? \$60 in interest at the end of each year for 10 years and a \$1,000 repayment of principal at the end of 10 years When interest rates in the market fall, bond values are likely to increase because the present value of the bond’s remaining cash flows increases What are some features of the OTC market for bonds? OTC dealers are connected electronically, the OTC has no designated physical location Which of the following are bonds that have actually been issued? a convertible bond, a put bond, a CoCo bond Junk bonds have the following features 1. they pay a high rate of interest, they are rated below investment grade bonds, they have a high probability of default Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact treasury bond yields? default risk premium, liquidity premium If a bond is selling at a discount from its par value, the YTM must be _____ the coupon rate greater than What is a premium bond? A bond that sells for more than face value As the maturity of a bond increases, interest rate risk increases at a decreasing rate
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