Finance Exam Flashcards

Questions and Answers

The current yield on a bond is equal to the annual interest divided by the:

Current par value

Current market price (correct)

Face amount

Maturity value

Issue price

Which statement is true?

Bonds are generally called at par value.

A current list of all bondholders is maintained whenever a firm issues bearer bonds.

Collateralized bonds are called debentures.

An indenture is a contract between a bond's issuer and its holders. (correct)

A bondholder has the right to determine when his or her bond is called.

If inflation is expected to steadily decrease in the future, the term structure of interest rates will most likely be:

Double-humped

Flat

Humped

Downward sloping (correct)

Upward sloping

A semiannual 5.4 percent coupon bond currently sells for par value. What is the maturity on this bond?

The bond could have any maturity date. Signup and view all the answers

Bond ratings classify bonds based on:

Default risk only. Signup and view all the answers

An agent who buys and sells securities from inventory is called a:

Dealer Signup and view all the answers

Which one of the following must equal zero if a firm pays a constant annual dividend?

Capital gains yield Signup and view all the answers

Dividends are:

Paid out of aftertax profits. Signup and view all the answers

Which one of the following statements is correct?

The payback period ignores the time value of money. Signup and view all the answers

The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to:

Recoup its initial cost. Signup and view all the answers

The internal rate of return is the:

Discount rate that results in a zero net present value for the project. Signup and view all the answers

What condition must exist if a bond's coupon rate is to equal both the bond's current yield and its yield to maturity? Assume the market rate of interest for this bond is positive.

The bond must be priced at par. Signup and view all the answers

Which one of the following terms applies to a bond that initially sells at a deep discount and only makes one payment to bondholders?

Zero coupon Signup and view all the answers

The term structure of interest rates represents the relationship between which of the following?

Nominal rates on default-free, pure discount bonds and time to maturity Signup and view all the answers

Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected?

Default risk premium Signup and view all the answers

When a bond's yield to maturity is less than the bond's coupon rate, the bond:

Is selling at a premium. Signup and view all the answers

Which one of the following statements is true?

A discount bond has a coupon rate that is less than the bond's yield to maturity. Signup and view all the answers

All else held constant, the price of a bond increases when the:

Yield to maturity decreases. Signup and view all the answers

Which one of the following bonds is the most sensitive to changes in market interest rates?

10-year, zero coupon Signup and view all the answers

An unexpected decrease in market interest rates will cause a:

Coupon bond's yield to maturity to decrease. Signup and view all the answers

Study Notes

Bond Fundamentals

Current yield on a bond is calculated using annual interest divided by current market price.
True statement regarding bonds: An indenture is a formal agreement between the bond issuer and bondholders.
If inflation decreases, the term structure of interest rates is likely to be downward sloping.

Bond Characteristics

A semiannual 5.4% coupon bond can have any maturity date if currently selling at par value.
Bond ratings primarily assess default risk among various categories.
A dealer is an agent who actively buys and sells securities from inventory.

Dividends and Returns

If a firm pays a constant annual dividend, the capital gains yield must equal zero.
Dividends paid by firms come from after-tax profits, not tax-deductible expenses.
Payback period ignores time value of money, evaluating projects primarily on cash flow recovery time.

Financial Metrics

Internal rate of return (IRR) is defined as the discount rate that makes the net present value (NPV) of a project equal to zero.
For coupon bonds, when the market price equals par, the coupon rate matches both current yield and yield to maturity.

Bond Types

A zero coupon bond sells at a deep discount, providing a single payment at maturity.
The term structure of interest rates relates nominal rates on default-free bonds to their time to maturity.
Additional compensation to bondholders to mitigate default risks is known as the default risk premium.

Market Sensitivity

Bonds with coupon rates lower than the current yield are selling at a premium.
A bond’s price increases when the yield to maturity decreases, indicating inverse relationship dynamics.
10-year zero coupon bonds are most sensitive to changes in market interest rates due to longer duration without cash flows.

Interest Rate Impact

An unexpected drop in market interest rates will decrease yields to maturity for coupon bonds and impact zero coupon bond prices.

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Test your knowledge with these finance flashcards focused on bond yields and related concepts. Each card presents a question and multiple-choice answers to gauge your understanding of key finance principles. Perfect for exam preparation!