Exam 5: Bonds, bond valuation, and interest rates

A) A 1-year bond with an 8% coupon.
B) A 10-year bond with an 8% coupon.
C) A 10-year bond with a 12% coupon.
D) A 10-year zero coupon bond.
E) A 1-year zero coupon bond.

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A) The economy is not in a recession.
B) Long-term bonds are a better buy than short-term bonds.
C) Maturity risk premiums could help to explain the yield curve's upward slope.
D) Long-term interest rates are more volatile than short-term rates.
E) Inflation is expected to decline in the future.

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A) On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.
B) On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest.
C) If a coupon bond is selling at par, its current yield equals its yield to maturity.
D) The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B.
E) If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity.

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A) $891.00
B) $913.27
C) $936.10
D) $959.51
E) $983.49

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A) A 1-year bond with a 15% coupon.
B) A 3-year bond with a 10% coupon.
C) A 10-year zero coupon bond.
D) A 10-year bond with a 10% coupon.
E) An 8-year bond with a 9% coupon.

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A) If a 10-year, $1, 000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1, 000 par value.
B) Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.
C) Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.
D) Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon.
E) If a 10-year, $1, 000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1, 000 par value.

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A) An indenture is a bond that is less risky than a mortgage bond.
B) The expected return on a corporate bond will generally exceed the bond's yield to maturity.
C) If a bond's coupon rate exceeds its yield to maturity, then its expected return to investors exceeds the yield to maturity.
D) Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated.
E) All else equal, senior debt generally has a lower yield to maturity than subordinated debt.

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A) 2.11%
B) 2.32%
C) 2.55%
D) 2.80%
E) 3.09%

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A) The bond has a current yield greater than 8%.
B) The bond sells at a discount.
C) The bond's required rate of return is less than 7.5%.
D) If the yield to maturity remains constant, the price of the bond will decline over time.
E) The bond sells at a price below par.

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A) The bond's current yield exceeds its yield to maturity.
B) The bond's yield to maturity is greater than its coupon rate.
C) The bond's current yield is equal to its coupon rate.
D) If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850.
E) The bond's coupon rate exceeds its current yield.

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A) Subordinated debt has less default risk than senior debt.
B) Convertible bonds have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.
C) Junk bonds typically provide a lower yield to maturity than investment-grade bonds.
D) A debenture is a secured bond that is backed by some or all of the firm's fixed assets.
E) Junior debt is debt that has been more recently issued, and in bankruptcy it is paid off after senior debt because the senior debt was issued first.

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A) If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of debentures.
B) In this situation, we cannot tell for sure how, or whether, the firm's total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds.The interest rate on each of the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result might well be such that the firm's total interest charges would not be affected materially by the mix between the two.
C) The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures.
D) If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds.
E) The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm's total dollar interest charges will be.

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A) The expected return on a corporate bond must be less than its promised return if the probability of default is greater than zero.
B) All else equal, senior debt has less default risk than subordinated debt.
C) A company's bond rating is affected by its financial ratios and provisions in its indenture.
D) Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off its debt according to the seniority of the debt as spelled out in the Act.
E) All else equal, secured debt is less risky than unsecured debt.

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A) 3.92%
B) 4.12%
C) 4.34%
D) 4.57%
E) 4.81%

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A) Most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature.
B) A sinking fund provision makes a bond more risky to investors at the time of issuance.
C) Sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time.
D) If interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.
E) Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued.

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A) Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.
B) The prices of both bonds would increase by the same amount.
C) One bond's price would increase, while the other bond's price would decrease.
D) The prices of the two bonds would remain constant.
E) The prices of both bonds will decrease by the same amount.

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