Fixed-Income Securities Overview

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Questions and Answers

Which of the following types of debt securities protect investors against interest rate risk?

floating rate bonds and extendible notes (correct)

extendible notes

floating rate bonds

original issue deep discount bonds

Zero coupon bonds are an example of

convertible bonds

extendible notes

original issue deep discount bonds (correct)

floating rate notes

Original issue deep discount bonds have decreased in popularity over the last several years due to:

issuance by brokerage firms of lower risk substitutes

changes in tax laws

increased interest in equity securities

changes in tax laws and issuance by brokerage firms of lower risk substitutes (correct)

Extendable notes are redeemable at par at the option of the

holder Signup and view all the answers

If a firm could sell a mortgage bond at an 8% interest rate, it could sell an otherwise identical debenture at

a rate greater than 8% Signup and view all the answers

When the market for an asset is in equilibrium, the expected rate of return on the asset is equal to the:

marginal investor's required rate of return Signup and view all the answers

The the investor's required rate of return on a bond, the will be the value of the bond to the investor.

lower, higher Signup and view all the answers

The yield-to-maturity of a bond with a finite maturity date is a function of all of the following variables except:

the required rate of return on the bond Signup and view all the answers

The value of a perpetual bond is equal to the annual interest payment divided by the:

required rate of return Signup and view all the answers

Which of the following statements concerning preferred stocks is true?

Preferred dividends per share are usually not cut or suspended unless the firm is faced with serious financial problems. Signup and view all the answers

Rank in ascending order (lowest to highest) the relative risk associated with holding the preferred stock, common stock and bonds of a firm:

bonds, preferred stock, common stock Signup and view all the answers

By the capitalization-of-cash flows method, the value of an asset is a function of

the risk of the asset's cash flows Signup and view all the answers

Which of the following is not a characteristic of long-term debt?

firm is not legally required to pay interest to bond-holders Signup and view all the answers

The quality of a debenture depends on the

general credit-worthiness of the issuing company Signup and view all the answers

The indenture is a contract between the issuer and lenders that does all the following except:

gives management's expectations about return of the proceeds Signup and view all the answers

The call feature of a long-term bond

all these are correct Signup and view all the answers

A sinking fund allows the issuer to

purchase a portion of the debt each year in the open market or call a portion of the debt for mandatory redemption Signup and view all the answers

Normally the coupon rates on new bonds

do not change over the life of the issue Signup and view all the answers

Junk bonds are

are issued by firms with a high debt ratio Signup and view all the answers

Large companies build up short-term debt over the period of 1 to 2 years, then sell long-term debt using a portion of the proceeds to repay the short-term borrowings. This procedure is called:

funding short-term debt Signup and view all the answers

The major advantages of long-term debt include all the following except:

decrease in financial risk Signup and view all the answers

The value of a 15-year bond will change ______ for a given change in the required rate of return than the value of a 5 year bond.

more Signup and view all the answers

When the required rate of return is ______ the coupon rate, the bond will sell at a discount.

greater than Signup and view all the answers

Equipment trust certificates are used mainly by

trucking companies Signup and view all the answers

All of the following types of bonds are secured except

debentures Signup and view all the answers

The call feature is an advantage to the issuing firm

if interest rates decline Signup and view all the answers

Which of the following is the highest risk debt issue?

debenture Signup and view all the answers

The ______ represents the debtholders in dealings with the issuing company.

trustee Signup and view all the answers

If an American Water Company bond has a coupon rate of 9.0 percent and is selling for $920, then the yield to maturity must be:

greater than 9% Signup and view all the answers

“Junk bond” is a term used to describe a bond that

is rated Ba or lower Signup and view all the answers

The basic relationship in bond valuation is for a given percentage point change in the required rate of return, the the time to maturity, the the change in value.

longer, greater Signup and view all the answers

Preferred stock has a priority over common stock with regard to the company's

assets and dividends Signup and view all the answers

The principal disadvantage of preferred stock financing is

its high after-tax cost as compared with long-term debt Signup and view all the answers

______ are not secured by specific assets.

Debentures Signup and view all the answers

Bonds normally are denominated in the currency of the country of sale.

Foreign Signup and view all the answers

A zero coupon bond is a bond that

originally sold at a discount Signup and view all the answers

The following bond quotation indicates that the holder expects to receive ______ in interest annually: PACEI 11s 09 11.6 20 95 -1

$110 Signup and view all the answers

In the Treasury bill quote that follows, the price of the bill can be calculated from the ______ price. Mat. date Bid Asked Yield 9-24 8.34 8.29 8.58

asked Signup and view all the answers

Treasury bills

pay no explicit interest Signup and view all the answers

Treasury notes typically have initial maturities ranging from

1 to 10 years Signup and view all the answers

Users of preferred stock include:

All listed answers are users Signup and view all the answers

Which of the following is NOT one of the many differences between long-term debt and preferred stock?

Preferred stockholders are paid before bondholders if the company bankrupts. Signup and view all the answers

Which of the following is/are correct regarding the maturity date on securities? I. Long-term debt has a shorter maturity date than preferred stock. II. Preferred stock can have no specific maturity date, so can be perpetual.

Both I and II Signup and view all the answers

Debt is usually issued with a par value of

$1000 Signup and view all the answers

Which of the following is NOT one of the various types of long-term debt?

Preferred stock Signup and view all the answers

The largest user of mortgage bonds is

credit unions Signup and view all the answers

An indenture on long-term debt does all of the following EXCEPT:

It allows the borrower to borrow extensively so that the interest may be regularly paid. Signup and view all the answers

Which of the following statements is/are correct about long-term loans? I. Debentures are generally sold with a lower interest rate than mortgage bonds or secured bonds. II. The quality of a debenture depends on the general creditworthiness of the issuing company.

Only statement II is correct Signup and view all the answers

An advantage of preferred stock financing is:

Preferred stock dividends are flexible. The penalties for not paying a dividend are not severe. Signup and view all the answers

Unsecured income bonds are considered_____ securities.

weak Signup and view all the answers

When an investor is trying to find the market value of an asset, he/she is trying to determine:

the market price Signup and view all the answers

Junk bonds (i.e., bonds issued by companies with weak financial positions) are rated or lower by Moody's.

Ba Signup and view all the answers

The required rate of return on an asset is a function of the____ .

risk associated with the asset and the risk-free interest rate Signup and view all the answers

The__ of a debt issue is equal to the difference between the and the_

call premium; call price; par value Signup and view all the answers

A zero coupon bond is an example of a(n)____ .

fixed income security and an original issue deep discount bond Signup and view all the answers

There is a(n)____ relationship between the value of a bond and its required rate of return.

inverse Signup and view all the answers

Study Notes

Fixed-Income Securities: Characteristics and Valuation

Interest Rate Risk Protection: Floating rate bonds and extendible notes protect investors against interest rate risk.
Zero Coupon Bonds: An example of original issue deep discount bonds.
Original Issue Deep Discount Bonds: Have decreased in popularity due to changes in tax laws and issuance of lower risk substitutes by brokerage firms.
Extendable Notes: Redeemable at par value at the option of the holder or trustee .
Mortgage Bond vs. Debenture: Debentures are unsecured, while mortgage bonds are secured.
Junk Bonds: Bonds issued by firms with weak financial positions, rated Ba or lower by Moody's.
Bond Valuation Relationship: The value of a bond is inversely related to the required rate of return. A higher required rate of return leads to a lower bond value, and vice versa.
Bond Yield-to-Maturity: A function of current bond price, required rate of return, uniform annual interest payments and maturity value.
Perpetual Bond Value: Equal to the annual interest payment divided by the required rate of return.
Preferred Stock: Preferred stockholders have a prior claim on the company's income and assets compared to lenders. Preferred stock dividends are usually not cut or suspended unless the company is facing significant financial problems. They typically do not have voting rights.
Bond Indenture: Contains provisions regarding the principal repayment, details on the debt issue, and any restrictive covenants.
Sinking Fund: Allows the bond issuer to buy back a portion of the debt every year in the open market or call a portion of the debt for mandatory redemption.
Coupon Rates on New Bonds: Are generally set equal to the prevailing prime rate or slightly above.
Bond Ratings (Junk Bonds): Commonly Rated Ba or lower.
Bond Value and Required Rate of Return: Inverse relationship. As one increases, the other decreases.
Maturity and Bond Value: Longer-term bonds are more sensitive to changes in required rates of return compared to shorter-term bonds.
Characteristics of Long-Term Debt: Interest paid is often tax-deductible, usually has a specific maturity, and the firm is not legally required to pay immediately.
Debentures: Unsecured debt; higher risk compared to secured debt.
Equipment Trust Certificates: Typically used by equipment manufacturers.
Bond and Its Characteristics: Various bonds differ in their security provisions, payment schedules, and potential for early repayment (e.g., callable bonds).

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Description

Explore the key characteristics and valuation methods for fixed-income securities in this quiz. Understand concepts like interest rate risk, zero coupon bonds, and the differences between mortgage bonds and debentures. Test your knowledge on junk bonds and bond valuation relationships to enhance your investment insights.