Business Finance Chapter 6 Interest Rates and Bond Valuation

What is the definition of a bond’s time to maturity? It is the number of years until the face value is paid off
A firm decides to raise money by issuing 5 million bonds with a per 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 $5,000 each. What will the per value of the bonds be in year 5? $5,000 per bond
The sensitivity of a bond’s price to interest rate changes is dependent on which of the following two variables? Time to maturity, coupon rate
Which three of the following common shapes for the term structure of interest rates? Downward sloping, upward sloping, and humped.
What is the price of a U.S. Treasury bond that is listed at 90 if the per value is $1,000? $1,000 x 90% = $900
A corporate bond’s yield to maturity is usually not the same as a bond’s coupon rate; changes over time
What does the dirty price represent? It includes the quoted price and accrued interest
What does a bond’s rating reflect? The ability of the firm to repay its debt and interest on time
The term structure of interest rates describes ______. The relationship between nominal rates and time to maturity; the pure time value of money
What is a real rate of return? It is a rate of return that has been adjusted to remove inflation; it is a percentage change in buying power.
What will your aftertax yield be on a corporate bond that is currently priced to yield 7% percent if you are in the 25 percent tax bracket? (yield) X (1 – tax rate).07 X (1 – .25).07 X .75= 5.25
If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond’s price will be more sensitive to interest rate risk? The 10- year bond
What does the AAA rating assigned by S&P mean? The firm is in a strong position to meet its debt obligations
What are some features of the OTC market for bonds? The OTC has no designated physical location. OTC dealers are connected electronically
Which of the following are features of municipal bonds? They are issued by state and local governments. The interest on municipal bonds is exempt from federal taxes. The interest on municipal bonds is, in some cases exempt from state taxes in the state of issue.
The term structure of interest rates examines the ______. relationship between short-term and long-term interest rates
The US government borrows money by issuing: Treasury bonds; Treasury notes
As an investor in the bond market, why should you be concerned about changes in interest rates? Changes in interest rates cause changes in bond prices.
Which of the following are true of 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 rater = the real rateh = the rate of inflation (1 + R) = (1 + r) x (1 +h)
What is the nominal rate of return on an investment? It is the actual percentage in the dollar value of an investment adjusted for inflation.
Assume a bond has $1,000 per value, a coupon rate of 6 percent, annual interest payments, and 7 years to maturity, if the yield on similar bonds is 8 percent, what is the current market value of this bond? $895.87
The degree of inters rate risk depends on _____. the sensitivity of the bond’s price to interest rate changes
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 per value.
The relationship between nominal rates, real rates and inflation is called ______. The Fisher Effect
What four variables are required to calculate the value of a bond? Coupon rate, per value, yield to maturity, time remaining to maturity
What is the current yield on a $1,000 per value bond that sells for $900 if the coupon rate is 10 percent? 11.11%
As a general rule, which of the following are true of debt and equity? The maximum reward for owning debt is fixed. Equity represents an ownership interest.
A bond with a BBB rating has _____ than a bond with an A rating. higher risk of default
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.
When interest rates in the market rise, we can expect the price of bonds to ___. decrease
A bond’s coupon payment is: a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders.
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.
If the rate of inflation is 3 percent and the real rate of return is 9 percent, the nominal rate is approximately ____ percent 12
What is the bid price? It is the price at an investor will receive if he sells a bond to a dealer. It is the price at which the dealer is willing to buy securities.
Which of these correctly identify differences between Treasury bonds and corporate bonds? Treasury bonds are issued by the US government will corporate bonds are issued by corporations. Treasury bonds offered to certain tax benefits to investors the corporate bonds cannot offer.Treasury bonds are free of default risk while corporate bonds are exposed to default risk.
Which of the following variables is NOT required to calculate the value of a bond? Original issue price of bond
What are the cash flows involved in the purchase of a 5-year zero-coupon bond that has a per value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent. Pay $800 today and receive $1,000 at the end of 5 years
If you are holding a municipal bond that is trading at par to yield 6%, by how much will your after-tax yield change if your federal income tax bracket increases from 15% to 20%. Assume there are no state or local taxes 0%
What does the clean price for a bond represent? The quoted price excluding accrued interest
Bonds are classified based on the collateral provided to protect bondholders in case of default. Which of the following are unsecured forms of debt? Debentures (in the U.S.) Notes
What is a bond’s current yield? Current yield = Annual coupon payment/Current Price
The bid-ask spread represents the ____. dealer’s profit
What are the three components that influence the Treasury yield curve? The interest rate risk premium, expected inflation, the real rate of return
Which of the following are bonds that have actually been issued? a put bond, a CoCo bond, a convertible bond
Junk bonds have the following features They pay a high rate of interest, they are rated below investment grade bonds, they have a high probability of default
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
A corporation issues 50,000 bonds at $1,000 each. The bonds mature in 5 years and have a coupon rate of 7 percent. What will the total annual interest expense be for the corporation? 50,000 x $1,000 x 0.7+ $3,500,0003.5 Million
A zero-coupon bond is a bond that ____. makes no interest payments
What will happen to a bond’s time to maturity as the years go by? It will decline
If bonds for AT&T are quoted at 115, they can be purchased: at 115% of par value plus accrued interest
What is a bond’s accrued interest It is interest that has been earned but not yet received by the current bondholder
Which of the following are usually included in a bonds indenture? The total amount of bonds issued, the repayment arrangements
Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact Treasury bond yields? Liquidity premium, Default risk premium
Why is the bond market less transparent than the stock market? Many bond transactions are negotiated privately.
If a $1,000 par value is trading at a discount, it means that the market value of the bond is ______ $1,000. less than
What does a Treasury yield curve show? It shows the yield for different maturities of Treasury notes and bonds
A limitation of bond ratings is that they ____. focus exclusively on default risk
The interest rate risk premium is the additional compensation demanded by investors for holding ____ bonds long-term
What are the two major forms of long-term debt? Public issue and privately placed
What are crossover bonds? Bonds that have both an investment grade and a junk bond rating
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
If you are holding two bonds – one with a 5% coupon rate and other with a 8% coupon rate – which one is more sensitive to interest rate risk, all other things being equal? The bond with a 5% coupon rate
Most of the time, a floating-rate bond’s coupon adjusts ___. with a lag to some base rate
What is a discount bond? Discount bonds are bonds that sell for less than the face value.
What are “fallen angel” bonds? Bonds that have dropped from investment grade to junk bond status
As the maturity of a bond increases, interest rate risk ____. increases at a decreasing rate
When using trial and error to compute the yield to maturity (YTM) for a 6 percent coupon bond that trades a premium, the process can be shortened if the initial guess is ____6 percent lower than
What is a premium bond A bond that sells for more than face value
Suppose a bond’s clean price is $1,050, and the bond currently has accrued interest of $30. What is the dirty price? $1,080
Most of the time, a floating-rate bond’s coupon adjusts ____. with a lag to some base rate

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