Chapter 6: Fixed-Income Securities PDF

CHAPTER 6: FIXED-INCOME SECURITIES: CHARACTERISTICS AND VALUATION 1.​ Which of the following types of debt securities protect investors against interest rate risk? a.​floating rate bonds b.​extendible notes c.​original issue deep discount bonds d.​floating rate bonds and extendible...

CHAPTER 6: FIXED-INCOME SECURITIES: CHARACTERISTICS AND VALUATION 1.​ Which of the following types of debt securities protect investors against interest rate risk? a.​floating rate bonds b.​extendible notes c.​original issue deep discount bonds d.​floating rate bonds and extendible notes ANSWER: d 2.​Zero coupon bonds are an example of a.​original issue deep discount bonds b.​extendible notes c.​convertible bonds d.​floating rate notes ANSWER: a 3.​Original issue deep discount bonds have decreased in popularity over the last several years due to: a.​changes in tax laws b.​issuance by brokerage firms of lower risk substitutes c.​increased interest in equity securities d.​changes in tax laws and issuance by brokerage firms of lower risk substitutes ANSWER: d 4.​Extendable notes are redeemable at par at the option of the a.​holder b.​company c.​trustee d.​holder and trustee ANSWER: a 5.​If a firm could sell a mortgage bond at an 8% interest rate, it could sell an otherwise identical debenture at a.​a rate less than 8% b.​8% c.​a rate greater than 8% d.​cannot be determined ANSWER: c © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 6.​When the market for an asset is in equilibrium, the expected rate of return on the asset is equal to the: a.​risk-free rate b.​marginal investor's required rate of return c.​historical cost of capital d.​perpetual capitalization rate ANSWER: b 7.​The​ the investor's required rate of return on a bond, the​ will be the value of the bond to the investor. a.​lower, higher b.​higher, higher c.​lower, lower d.​higher, lower ANSWER: a 8.​The yield-to-maturity of a bond with a finite maturity date is a function of all of the following variables except: a.​the current price b.​the required rate of return on the bond c.​the uniform annual interest payments d.​the maturity value ANSWER: b 9.​The value of a perpetual bond is equal to the annual interest payment divided by the: a.​risk-free rate b.​required rate of return c.​bank interest rate d.​after-tax historical cost of capital ANSWER: b 10.​Which of the following statements concerning preferred stocks is true? a.​Preferred stockholders have a prior claim on the income and assets of the firm as compared to the claims of lenders. b.​Preferred stock dividends per share are normally increased as the earnings of the firm increase. c.​Preferred dividends per share are usually not cut or suspended unless the firm is faced with serious financial problems. d.​The par value of a stock is always the same as the initial selling price. ANSWER: c © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 11.​Rank in ascending order (lowest to highest) the relative risk associated with holding the preferred stock, common stock and bonds of a firm: a.​preferred stock, bonds, common stock b.​bonds, common stock, preferred stock c.​common stock, preferred stock, bonds d.​bonds, preferred stock, common stock ANSWER: d 12.​Potential sellers of an asset can be represented as a​ schedule showing the​ prices at which they are willing to sell given quantities of the asset. a.​supply, maximum b.​demand, maximum c.​supply, minimum d.​supply, average ANSWER: c 13.​By the capitalization-of-cash flows method, the value of an asset is a function of a.​the book value of the asset b.​the risk of the asset's cash flows c.​the age of the asset d.​both the book value and the age of the asset ANSWER: b 14.​Which of the following is not a characteristic of long-term debt? a.​interest paid to bond holders is a tax-deductible expense to the firm b.​firm is not legally required to pay interest to bond-holders c.​usually has a specific maturity d.​all of these are characteristics of long-term debt ANSWER: b 15.​The quality of a debenture depends on the a.​general credit-worthiness of the issuing company b.​value of the assets used as collateral c.​the coupon rate of the debenture d.​length of time to maturity ANSWER: a © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 16.​The indenture is a contract between the issuer and lenders that does all the following except: a.​specifies the manner in which the principal must be repaid b.​details the nature of the debt issue c.​gives management's expectations about return of the proceeds d.​lists any restrictive covenants ANSWER: c 17.​The call feature of a long-term bond a.​is an optional retirement provision b.​states the call price c.​allows the issuer to replace a high coupon bond with one with a lower coupon bond d.​all these are correct ANSWER: d 18.​A sinking fund allows the issuer to a.​redeem an entire debt issue prior to maturity b.​purchase a portion of the debt each year in the open market or call a portion of the debt for mandatory redemption c.​call the entire debt issue d.​accumulate interest expenses into a sinking fund account ANSWER: b 19.​Normally the coupon rates on new bonds a.​do not change over the life of the issue b.​are set equal to the market rate plus an inflation premium c.​float with changes in the prime rate d.​are set just over the prevailing prime rate ANSWER: a 20.​Junk bonds are a.​usually rated Ba or higher b.​are issued by firms with a high debt ratio c.​issued with coupon rates at least 8 percentage points or more above the highest quality issues d.​issued by firms with a low debt ratio ANSWER: b © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 21.​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: a.​“drawing down” long-term credit b.​funding short-term debt c.​reducing the tax bite d.​extending the rates ANSWER: b 22.​The major advantages of long-term debt include all the following except: a.​decrease in financial risk b.​relatively low, explicit after-tax cost c.​owners are able to maintain control d.​increased earnings per share through using financial leverage ANSWER: a 23.​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. a.​more b.​less c.​the same percentage d.​exactly the same ANSWER: a 24.​When the required rate of return is​ the coupon rate, the bond will sell at a discount. a.​less than b.​greater than c.​the same as d.​equal to ANSWER: b 25.​Equipment trust certificates are used mainly by a.​equipment manufacturers b.​oil drilling companies c.​state governments d.​trucking companies ANSWER: d © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 26.​All of the following types of bonds are secured except a.​collateral trust b.​mortgage c.​debentures d.​equipment trust certificates ANSWER: c 27.​The call feature is an advantage to the issuing firm a.​if the bond has a floating rate b.​if interest rates decline c.​if the bond has a low par value d.​if interest rates increase ANSWER: b 28.​Which of the following is the highest risk debt issue? a.​senior debt b.​mortgage bond c.​equipment trust certificate d.​debenture ANSWER: d 29.​There is a(n)​ relationship between the value of a bond and its required rate of return. a.​direct b.​distant c.​inverse d.​turgid ANSWER: c 30.​The​ represents the debtholders in dealings with the issuing company. a.​trustee b.​stakeholders c.​broker d.​investment banker ANSWER: a 31.​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: a.​greater than 9% b.​equal to 9% c.​less than 9% d.​cannot be determined ANSWER: a © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 32.​“Junk bond” is a term used to describe a bond that a.​is in default b.​is rated Ba or lower c.​is currently paying interest d.​has been downgraded by Moody’s ANSWER: b 33.​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. a.​shorter, greater b.​longer, smaller c.​longer, greater d.​shorter, smaller ANSWER: c 34.​ Preferred stock has a priority over common stock with regard to the company's a.​assets b.​voting rights c.​dividends d.​assets and dividends ANSWER: d 35.​ The principal disadvantage of preferred stock financing is a.​its high after-tax cost as compared with long-term debt b.​the decrease in the firm's degree of financial leverage c.​the required payment of dividends d.​the reduction in control ANSWER: a 36.​ ____ are not secured by specific assets. a.​Equipment trust certificates b.​Mortgage bonds c.​Debentures d.​Collateral trust bonds ANSWER: c 37.​ A zero coupon bond is an example of a(n)​. a.​fixed income security b.​original issue deep discount bond c.​tax-exempt bond d.​fixed income security and an original issue deep discount bond © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation ANSWER: d © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 38.​ Junk bonds (i.e., bonds issued by companies with weak financial positions) are rated​ or lower by Moody's. a.​Baa b.​BBB c.​Ba d.​CCC ANSWER: c 39.​ The required rate of return on an asset is a function of the​. a.​risk associated with the asset b.​risk-free interest rate c.​age of the asset d.​risk associated with the asset and the risk-free interest rate ANSWER: d 40.​ Which of the following features (if any) of preferred stock provides the investor with a measure of protection against inflation? a.​adjustable dividend rate b.​cumulative feature c.​call feature d.​after-tax cost ANSWER: a 41.​ Which of the following features (if any) of debt securities provides the investor with a measure of protection against inflation? a.​sinking fund b.​call feature c.​floating coupon rates d.​poison put covenant ANSWER: c 42.​ The​ of a debt issue is equal to the difference between the​ and the​. a.​call price; market price; par value b.​call price; market price; call premium c.​call premium; call price; par value d.​call premium; market price; par value ANSWER: c © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 43.​ bonds normally are denominated in the currency of the country of sale. a.​Eurodollar b.​International c.​Foreign d.​LIBOR ANSWER: c 44.​ A zero coupon bond is a bond that a.​originally sold at a discount b.​will sell for a premium c.​is a premium value bond d.​has a high current yield ANSWER: a 45.​ The following bond quotation indicates that the holder expects to receive​ in interest annually: PACEI 11s 09 11.6 20 95 -1 a. $90 b. $116 c. $95 d. $110 ANSWER: d 46.​ 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 a. bid b. asked c. yield d. none of these ANSWER: b 47.​ Treasury bills a.​have a stated interest rate b.​pay no explicit interest c.​are sold for exactly $10,000 d.​are quoted in terms of yield to maturity ANSWER: b © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 48.​ Treasury notes typically have initial maturities ranging from a.​1 to 3 years b.​1 to 5 years c.​1 to 10 years d.​10 to 30 years ANSWER: c 49.​ An AT&T 5½05 bond with a current yield of 6.2% must be selling​ its face value. a.​above b.​at c.​below d.​any of these could be correct ANSWER: c 50.​ In reading price quotes on U.S. Treasury bills, you would​ expect to find the "asked" price higher than the “bid”. a.​always b.​never c.​sometimes d.​seldom ANSWER: b 51.​Users of preferred stock include: a.​Utility companies b.​Acquiring firm in mergers and acquisitions c.​Large commercial banks d.​All listed answers are users ANSWER: d 52.​What is the yield to maturity for a Poughkeepsie Gypsy Fortune Tellers’ zero coupon bond that matures in 14 years if the bond is selling for $530.00? a.​5.84% b.​4.64% c.​4.28% d.​5.49% ANSWER:​ b RATIONALE: Solution: N = 14 PV = –530 PMT = 0 FV = 1000 Solve for I 4.64% by calculator © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 53.​If an Allied Chemical zero coupon bond due in 12 years is selling for $420.00, what is its yield to maturity? a.​7.50% b.​4.64% c.​6.51% d.​5.26% ANSWER:​ a RATIONALE: Solution: N = 12 PV = –420 PMT = 0 FV = 1000 Solve for I 7.50% by calculator 54.​The State of Adaven issued $50 million of perpetual bonds in 1990. The bonds were issued in $100 denominations with an annual coupon interest rate of 5%. Determine the value of these bonds today to an investor who requires a 10% return on his investment. a.​$25 b.​$5 c.​$10 d.​$50 ANSWER:​ d RATIONALE: Solution: P0 = $5/0.10 = $50 55.​A General Electric 7½25 bond closed at 98. What is the current yield? a.​7.65% b.​7.81% c.​7.50% d.​7.34% ANSWER:​ a RATIONALE: Solution: 75/980 =.0765 or 7.65% 56.​The State of Adaven issued $50 million of perpetual bonds in 1990. The bonds were issued in $100 denominations with an annual coupon interest rate of 5%. Determine the rate of return or current yield on these bonds if they are purchased at the current price of $40. a.​12.5% b.​8.0% c.​5.0% d.​1.25% ANSWER: a RATIONALE: Solution: kd = $5/$40 = 0.125 or 12.5% © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 57.​A Treasury bill with 182 days to maturity is quoted at 5.62 bid, 5.60 asked, and an asked yield of 5.84. How much would you pay for this security? a.​$9,440 b.​$9,720 c.​$9,708 d.​$9,438 ANSWER: b RATIONALE: Solution: $10,000 – $10,000(0.056/2) = $9,720 58.​How much would you have to pay for a U.S. Government bond ($1,000 maturity value) scheduled to mature in February, 2020 and quoted at 118:07 “bid” and 118:15 “asked”? a.​$1,182.19 b.​$1,181.50 c.​$1,184.69 d.​$1,180.70 ANSWER: c RATIONALE: Solution: 118.46875% of $1,000 or $1,184.69 59.​A Treasury bill with a July 11th maturity date is quoted today at 8.46 bid and 8.40 asked. How much would you pay today (January 11th) for one bill? a.​$9,577 b.​$9,580 c.​$9,588 d.​$8,400 ANSWER: b RATIONALE: Solution: 10,000 – 10,000(0.084/2) = $9,580 60.​Two-years ago, Trans-Atlantic Airlines sold a $250 million bond issue to finance the purchase of new jet airliners. These bonds were issued in $1000 denominations with an original maturity of 12 years and a coupon rate of 12%. Determine the value today of one of these bonds to an investor who requires a 14% rate of return on these securities. a.​$626 b.​$463 c.​$897 d.​$270 ANSWER:​ c RATIONALE: Solution using a calculator: N = (12 – 2) = 10 I = 14 PMT = 120 FV = 1000 Solve for PV = $896.68 © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 61.​Two years ago, Trans-Atlantic Airlines sold $250 million worth of bonds at $1,000 each. The bonds had a maturity of 12 years and a coupon rate of 12%. Today these bonds are selling for $910. Determine the yield-to-maturity (to the nearest tenth of one percent). a.​13.2% b.​5.6% c.​13.7% d.​12.0% ANSWER:​ c RATIONALE: Solution using a calculator: N = (12 – 2) = 10 PV = –910 PMT = 120 FV = 1000 Solve for I = 13.71% 62.​Assume that the dividend on Central Power Company's $3.25 preferred stock issue is paid annually at the end of the year. Determine the value of this preferred stock to an investor who requires a 12 percent rate of return. a.​$3.25 b.​$39 c.​$12 d.​$27.08 ANSWER:​ d RATIONALE: Solution: P0 = $3.25/0.12 = $27.08 63.​An Allied Northern preferred stock pays a $3.84 annual dividend. What is the value of the stock to an investor who requires a 9.5 percent return? a.​$40.42 b.​$42.67 c.​$38.40 d.​$37.60 ANSWER:​ a RATIONALE: Solution: P0 = $3.84/0.095 = $40.42 64.​What is the rate of return on a preferred stock that has a par value of $50, a market price of $46.50, and a dividend of $4.10? a.​8.20% b.​11.34% c.​8.82% d.​12.20% ANSWER:​ c RATIONALE: Solution: kp = Dp/P = $4.10/$46.50 = 0.0882 or 8.82% © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 65.​A refrigerator manufacturer, Zero King, issued a zero coupon bond with 10 years to maturity. What is the yield-to- maturity of this bond if it is sold for $352? a.​12.2% b.​10% c.​11% d.​9% ANSWER:​ c RATIONALE: Solution using a calculator: N = 10 PV = –352 PMT = 0 FV = 1000 Solve for I = 11% 66.​What is the value of a $1000 par value Consul perpetual bond with a 6 percent coupon rate if the required rate of return is 9 percent? a.​$1,000 b.​$666.67 c.​$333.33 d.​$540 ANSWER:​ b RATIONALE: Solution: P = $60/0.09 = $666.67 67.​Marko needs to raise capital through a zero-coupon bond debt offering. If the bonds will have 12 years to maturity and the rate of return on a bond in Marko's risk class is 11 percent, what will be the selling price of the bond? a.​$302.50 b.​$335.50 c.​$269.50 d.​$286.00 ANSWER:​ d RATIONALE: Solution: PVIF0.11,12 = 0.286 P = $1,000(0.286) = $286 68.​Five years ago, the City of Baltimore sold at par a $1,000 bond with a coupon rate of 8 percent and 20 years to maturity. If this bond pays interest semiannually, what is the value of this bond to an investor who requires an 8 percent rate of return? a.​$607.72 b.​$692.00 c.​$1,000 d.​$1,080 ANSWER:​ c RATIONALE: Solution: No calculation needed because yield to maturity equals the coupon rate © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 69.​Up in Smoke Tobacco Shops’ bond carries a 9 percent coupon, pays interest semiannually, and has 10 years to maturity. What is the bond's yield to maturity if the bond is selling for $937.75 (rounded to the nearest whole percent)? a.​8.0% b.​10.0% c.​9.0% d.​7.0% ANSWER:​ b RATIONALE: Solution: Because the bond is selling at a discount, the YTM must be greater than the coupon of 9%. Therefore, try 10% (5% semiannually). $937.75 = $45(12.462) + $1000(0.377) $937.75 ≈ $937.79 therefore YTM = 10% Solution using a financial calculator: N = 10 × 2 = 20 PV = –937.75 PMT =.09 × 1000 = 90/2 = 45 FV = 1000 Solve for I = 4.99% × 2 = 10% 70.​Determine the yield to maturity to the nearest tenth of 1 percent of a zero coupon bond with 8 years to maturity that is currently selling for $404. a.​11.3% b.​12.3% c.​11.7% d.​12.0% ANSWER:​ d RATIONALE: Solution: $404 = $1000(PVIFkd,8) kd = 12% 71.​What is the value of an Orion bond that has a 10 percent coupon, pays interest semiannually, and has 10 years to maturity, if the required rate of return is 12 percent? a.​$1,200 b.​$885.50 c.​$895.27 d.​$1,000 ANSWER:​ b RATIONALE: Solution: P = $50(11.470) + 1000(0.312) = 885.50 © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 72.​Determine the yield-to-call (to nearest 0.1 of a percent) of an LTV bond with a 14 percent coupon, that pays interest semiannually. The bond can be called in 7 years, has a call premium of $140, and is currently selling for $1154. a.​12.0% b.​16.2% c.​13.7% d.​14% ANSWER:​ a RATIONALE: Solution: Because the bond is selling for a premium, the YTC must be less than 14 percent. Try 12 percent: P = $70(9.295) + $1140(0.442) = $1,154.53 or using a calculator: N=7 PV = –1154 PMT = 140 FV = 1140 Solve for I = 12.01% 73.​What is the value of a Northern Pacific bond with an 11 percent coupon, maturing in 15 years? Assume the market rate for this bond is 14 percent and that the interest is paid semiannually. a.​$1,000 b.​$790.74 c.​$813.50 d.​$853.30 ANSWER:​ c RATIONALE: Solution: P = $55(12.409) + 1000(.131) = $813.50 74.​What is the market value of a zero coupon bond with 5 years to maturity? The bond was originally sold with a yield to maturity equal to 11 percent, but the market rate today is 9 percent. a.​$593 b.​$650 c.​$621 d.​$577 ANSWER:​ b RATIONALE: Solution: P = $1000(0.650) = $650 © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 75.​What is the value of a PacTen bond with a 10 percent coupon that matures in 15 years? Assume the current market rate for this bond is 16 percent and that interest is paid semiannually. a.​$661.90 b.​$1,227.78 c.​$1,000 d.​$875.51 ANSWER:​ a RATIONALE: Solution: P = $50(11.258) + $1,000(0.099) = $661.90 76.​What is the required rate of return to the investor who is willing to purchase a Duke Power preferred stock with an $8.70 dividend, a par value of $100, and a current market price of $87? a.​10.7% b.​8.7% c.​9.4% d.​10.0% ANSWER:​ d RATIONALE: Solution: kp = D0/P0 = $8.70/$87 = 10% 77.​ICX Company has an issue of perpetual bonds (par value to $1,000) that pays 5% annual interest. Determine the yield (to the nearest tenth of 1 percent) if the bonds are currently selling for $625. a.​5.0% b.​8.0% c.​3.1% d.​6.25% ANSWER:​ b RATIONALE: Solution: kd = $50/$625 = 0.08 or 8% © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 78.​Determine the yield to maturity (to the nearest tenth of 1 percent) of an 8-year zero coupon bond ($1,000 par value) that is currently selling for $521. a.​6.0% b.​11.5% c.​7.9% d.​8.5% ANSWER:​ d RATIONALE: Solution: $521 = $1,000(PVIFkd, 8) PVIFkd,8 = 0.521 kd = 8.5% by calculator or interpolation Solution using calculator: N=8 PV = –521 PMT = 0 FV = 1000 Solve for I = 8.49% 79.​Mid-States Utility Company sold a 10-year note with a 7 7/8% coupon and a par value of $1,000. If the note sold at a discount for $930, what was the implied yield-to-maturity to the nearest tenth of one percent? Assume interest is paid semiannually. a.​8.5% b.​8.7% c.​8.9% d.​9.4% ANSWER:​ c RATIONALE: Solution: N = 10 PV = –930 PMT = 78.75 FV = 1000 Solve for I = 4.47 × 2 = 8.94 Calculator solution: 4.47 percent per 6 months or 8.94% 80.​Baywa has an outstanding bond that has a coupon rate of 8.3%. What is the market price of this bond if it pays interest semi-annually, has 15 years to maturity, and the current required rate of return is 9% on bonds of similar quality? a.​$943 b.​$1059 c.​$954 d.​$1,000 ANSWER:​ a © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation RATIONALE: Solution: P0 = $41.50(16.29) + $1,000(.267) = $943 81.​Rascal Corporation bonds have a 10.60% coupon and a maturity value of $1,000. The bonds, which pay interest semi-annually, will mature in 15 years, but the firm has the option to call the bond in 10 years at a premium of 106. You believe that Rascal will call the bonds in 10 years. If you require a pre-tax return of 9.5% on bonds of this risk, how much would you pay for one of these bonds today? a.​$1,000 b.​$1,094 c.​$1,034 d.​$1,058 ANSWER: b RATIONALE: Solution: P0 = $53(PVIFA.0475,20) + $1060(PVIF.0475,20) = $1,094 82.​Zimmer, Inc. issued zero coupon bonds that sold for $190 and are due in 15 years. Determine the yield to maturity (to the nearest tenth of 1 percent) if you purchased the bond at the issue price. a.​19.0% b.​11.4% c.​10.9% d.​11.7% ANSWER: d RATIONALE: Solution: P0 = M(PVIFkd,15) PVIF = $190/$1,000 =.190 YTM = kd = 11.7% Solution using calculator: N = 15 PV = –190 PMT = 0 FV = 1000 Solve for I = 11.7% © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 83.​Crown King zero coupon bonds were issued in 1998 at $124. These bonds will mature in 2018. What will these bonds sell for in 2008 if the required rate of return in 2008 is 9.5%? a.​$352 b.​$404 c.​$413 d.​$163 ANSWER: b RATIONALE: Solution: P0 = $1,000(PVIF.095,10) = $1,000(.404) = $404 Solution using calculator: N = 10 I = 9.5% PMT = 0 FV = 1000 Solve for PV = $403.51 84.​Determine the value of a LASKA 6.25% cumulative preferred stock, series D, par value $75 to an investor who requires a 9.5% rate of return on a security with this risk. a.​$65.79 b.​$49.37 c.​$75.00 d.​$114.00 ANSWER:​ b RATIONALE: Solution: P0 =.0625($75) = $4.69 in annual dividends P0 = 4.69/.095 = $49.37 85.​Happy Nappy Mattress Company issued a 10-year, 16% bond in 2003 that is callable at $1,100 in 5 years. In 2008 (today) the required return on bonds of this risk was 11%. The bonds pay interest semi-annually. What would you be willing to pay for one of these bonds today if you believe the bond will be called today? a.​$1188 b.​$832.25 c.​$1,100 d.​$1,000 ANSWER:​ c RATIONALE: Solution using a calculator: N=5×2 I = 11/2 PMT = 160/2 FV = 1100 Solve for PV = $1,246.98 © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation The call price ($1,100) puts a ceiling on the value of the bond. © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 86.​At what price will Gohm have to sell a 10-year zero coupon bond that will yield 8.75% if held to maturity? a.​$453 b.​$875.00 c.​$87.50 d.​$432 ANSWER:​ d RATIONALE: Solution: P0 = $1,000(PVIF.0875,10) = $432 87.​ What is the issue price of a zero coupon bond with 15 years to maturity if it is sold to yield 7.55%? a.​$250.00 b.​$362.31 c.​$335.62 d.​$1000.00 ANSWER: c RATIONALE: Solution using a financial calculator: N = 15 I= 7.55 PMT=O FV = 1000 Solve for PV = $335.62 88.​ A U.S. Government bond was quoted at 95:13 "bid" and 95:15 "asked". How much would you have to pay for one of these $1,000.00 face value bonds? a.​$951.50 b.​$950.13 c.​$950.15 d.​$954.69 ANSWER: d RATIONALE: Solution: 95 15/32%(1,000) = $954.69 89.​ What is the value of an MDI $2.67 perpetual preferred stock to an investor who requires a 7% annual rate of return? Assume the par value is $60.00. a.​$85.71 b.​$38.14 c.​$59.33 d.​$60.00 ANSWER:​ b RATIONALE: Solution: P= $38.14 © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 90.​UOP, a petroleum processing technology firm, issued a 10% coupon, 20 year to maturity first mortgage bond five years ago. If the current market rate of debt for UOP is 8%, at what price should this bond sell, to the nearest dollar? Assume a par value of $1,000, and pays interest semi-annually. a.​$1,170. b.​$999 c.​$1,095 d.​$1,173 ANSWER:​ d RATIONALE: Solution: Po = 50(17.292) + 1000(.308) = $1,172.60 Solution using a financial calculator: N = 15 × 2 I = 8/2 PMT = 100/2 FV = 1000 Solve for PV = 1172.92 91.​National Medical has a zero coupon bond outstanding that sells for $242.60 and has 15 years to maturity. What is the yield to maturity on the bond to the nearest tenth of one percent? a.​10.5% b.​9.1% c.​9.9% d.​11.0% ANSWER:​ c RATIONALE: Solution using a financial calculator: N = 15 PV = -242.60 PMT = 0 FV = 1000 Solve for I = 9.9% 92.​An Exxon bond carries an 8 percent coupon, pays interest semiannually, and has 10 years to maturity. If this bond is currently selling for $925, what is the exact yield to maturity (to the nearest tenth of 1 percent)? a.​9.2% b.​8.8% c.​9.8% d.​10.2% ANSWER:​ a RATIONALE: Solution using a financial calculator: N = 10 × 2 PV = –925 © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation PMT = 80/2 FV = 1000 Solve for I = 4.58 × 2 = 9.16% 93.​The current required rate of return on a bond issued by Who LTD is 11 percent. “Who” has a bond issue outstanding that pays interest semiannually, is selling for $845 and matures in 8 years. What is the approximate coupon rate on the outstanding bond? a.​4.00% b.​8.00% c.​10.68% d.​6.05% ANSWER:​ b RATIONALE: Solution: $845 = I/2(PVIFA0.055,16) + $1000(PVIF0.055,16) I/2 = 40.01 so coupon is $80 or 8 percent Solution using a financial calculator: N = 8 × 2 = 16 I = 11/2 = 5.5 PV = –845 FV = 1000 Solve for PMT = 40.18 × 2 = 80.36 Convert $80 into a % = 80.36/1000 = 8.04% 94.​An EAL bond has a coupon rate of 16 percent, pays interest semiannually, and matures in 15 years. If the bond is selling for $968.82, what is its yield to maturity? a.​8.3% b.​16.1% c.​16.6% d.​14.3% ANSWER:​ c RATIONALE: Solution using a financial calculator: N = 15 × 2 PV = –968.82 PMT = 160/2 FV = 1000 Solve for I = 8.28% × 2 = 16.56% kd = 16.6 by calculator © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 95.​How many semiannual interest payments remain on a bond that is selling for $917.25? The coupon rate of the bond is 8 percent, interest is payable semiannually, and the current market rate of return on a similar risk bond is 10 percent. a.​5 b.​10 c.​11 d.​7 ANSWER:​ c RATIONALE: Solution: Solve by trial and error or calculator. Try 5.5 years or 11 payments $917.25 = $40(8.306) + $1000(0.585) = $917.24 Solution using a financial calculator: I = 10/2 PV = –917.25 PMT = 80/2 FV = 1000 Solve for N = 10.9 payments (roughly 11 payments) or 5.5 years 96.​CUP Company 8% bonds are currently selling for $950. These bonds (par value of $1,000) mature in one year and pay interest annually. Determine the yield to maturity (to the nearest tenth of 1 percent) on this bond issue. a.​13.7% b.​13.0% c.​13.3% d.​5.0% ANSWER:​ a RATIONALE: Solution: $950 = $1,080(PVIFkd,1) PVIFkd,1 = 0.880 kd = 13.7% by calculator or interpolation Solution using a financial calculator: N=1 PV = –950 PMT = 80 FV = 1000 Solve for I = 13.68% © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 97.​What is the yield to maturity of a TVA bond that has a 9 1/2 percent coupon, pays interest semi-annually, has 12 years to maturity, and sells for $871.50? a.​11.3% b.​11.5% c.​11.8% d.​12.1% ANSWER:​ b RATIONALE: Solution: YTM = 11.5% try 10%​ 871.50 = 47.50(13.799) + 1000(0.310) = $965.45 try 12%​ 871.50 = 47.50(12.55) + 1000(0.247) = $843.13 YTM = 10% +​ $93.95​ (12% - 10%) = 11.5% $93.95 + $28.37 Solution using a financial calculator: N = 12 × 2 PV = –871.50 PMT = 95/2 FV = 1000 Solve for I = 5.75% × 2 = 11.5% 98.​Grace Corp. has a zero-coupon bond outstanding that matures in 15 years. This bond is selling for $327.50 today and will pay $1,000 at maturity. What is the yield to maturity to the investor who buys the bond and holds it until maturity? a.​7.73% b.​9.33% c.​9.23% d.​9.77% ANSWER:​ a RATIONALE: Solution: 327.50 = 1000(PVIFkd,15) kd = 7.73% © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 99.​ WPI has a bond issue outstanding that has a coupon rate of 10%, and a current yield of 11%. The yield to maturity on this bond is 12%. What is the market price, to the nearest dollar, of the WPI bond if it pays interest semi- annually and has 10 years to mature? a.​$ 941 b.​$1021 c.​$1000 d.​$ 885 ANSWER: d RATIONALE: Solution: P0 = $50(11.470) + $1000(0.312) = $885 Solution using a financial calculator: N = 10 × 2 I = 12/2 PMT = 100/2 FV = 1000 Solve for PV = 885.30 100.​What is the yield to maturity of a bond with 10 years to maturity, and a coupon of 15%? The current price of this bond is $1,109. Assume interest is paid annually. a.​12.0% b.​12.5% c.​13.0% d.​13.5% ANSWER: c RATIONALE: Solution: at kd = 13% then P0 = $150(5.426) + $1000(0.295) = $1,109 101.​What is the yield-to-maturity of an Acme bond selling for $1107.50 with 5 years to maturity, a 12 1/2% coupon, and semi-annual compounding? a.​10.36% b.​11.29% c.​9.74% d.​10.20% ANSWER: c RATIONALE: Solution: 9.73% by financial calculator N=5×2 PV = –1,107.50 PMT = 125/2 FV = 1000 Solve for I = 4.87 × 2 = 9.74% © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 102.​WXAM has an outstanding bond issue with a coupon rate of 6 1/8%, and a current yield of 6.9%. The yield to maturity on this bond is 7 5/8%. What is the market price of this bond if it pays interest semi-annually and has 12 years to maturity? a.​$883.42 b.​$937.45 c.​$943.65 d.​$1000.00 ANSWER: a RATIONALE:​ Solution: $883.42 by financial calculator N = 12 × 2 I = 7.625/2 PMT = (.06125 × 1000)/2 FV = 1000 Solve for PV = $883.42 103.​What is the yield-to-maturity of a Viacom bond which is selling for $948.75 with 6 years to maturity and a 7% coupon? a.​7.01% b.​8.11% c.​8.38% d.​7.38% ANSWER:​ b RATIONALE:​ Solution: 8.11% by financial calculator N = 6 PV = –948.75 PMT =.07 × 1000 = 70 FV = 1000 Solve for I = 8.11% 104.​What would a GMA 6% coupon bond maturing in 14 years sell (approximately) for if the current yield is 6.8633% and the yield-to-maturity is 7.48%? a.​$950.20 b.​$920.02 c.​$1051.54 d.​$874.21 ANSWER:​ d RATIONALE:​ Solution: $874.21 by financial calculator N = 14 I = 7.48 PMT =.60 × 1000 = 60 FV = 1000 Solve for PV = $874.21 Alternative method: Annual interest payment/current yield = Price of the bond © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation $60/.068633 = $874.215 105.​Which of the following is NOT one of the many differences between long-term debt and preferred stock? a.​Long-term debt pays interest which is tax-deductible to the borrower. b.​Preferred stockholders are paid before bondholders if the company bankrupts. c.​Preferred stockholders are considered non-voting owners of the company. d.​The firm is not legally required to pay preferred stock dividends, but must pay interest to bondholders. ANSWER: b 106.​There are consequences associated with not paying interest to bondholders. Which of the following apply? I.​ Not paying an interest payment automatically puts the company in default making the entire loan due. II.​ Interest on debt is not required to be paid, but the corporation generally pays it for public relations reasons. a.​Only statement I is correct b.​Only statement II is correct c.​Both statements I and II are correct d.​Neither statement I nor II is correct ANSWER: a 107.​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. a.​I only b.​II only c.​Both I and II d.​Neither I nor II ANSWER: c 108.​Debt is usually issued with a par value of a.​$500. b.​$0. c.​$1000. d.​$5000. ANSWER: c 109.​Which of the following is NOT one of the various types of long-term debt? a.​Junior debentures b.​Secured loans c.​Senior debentures d.​Preferred stock ANSWER: d © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Chapter 6: Fixed-Income Securities: Characteristics and Valuation 110.​The largest user of mortgage bonds is a.​credit unions. b.​commercial banks. c.​utility companies. d.​small companies. ANSWER: a 111.​ 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. a.​Only statement I is correct b.​Only statement II is correct c.​Both statements I and II are correct d.​Neither statement I nor II is correct ANSWER: b 112.​An indenture on long-term debt does all of the following EXCEPT: a.​It lists restrictions placed on the borrower by the lender. b.​It specifies the manner in which the principal must be repaid. c.​It allows the borrower to borrow extensively so that the interest may be regularly paid. d.​It details the nature of the debt issue. ANSWER: c 113.​Mighty Mollusk, Inc. issued a 30-year bond which is callable in 8 years. It has a coupon rate of 5.5% payable semi-annually, a yield to maturity of 8% and a call premium of one year’s interest. What is the yield to call? a.​6.75% b.​13,67% c.​4.82% d.​11.42% ANSWER: d RATIONALE:​ Solution using a financial calculator: First find the price of the bond: N = 30 × 2 = 60 I = 8/2 = 4 PMT = 55/2 = 27.50 FV = 1000 Solve for PV = 717.21 Solve for Yield to Call: N = 8 × 2 = 16 PV = –717.21 PMT = 55/2 = 27.50 © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation FV = 1055 Solve for I = 5.71 × 2 = 11.42% © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 114.​An advantage of preferred stock financing is: a.​Preferred stockholders can vote for the Board of Directors and be an integral part of the direction of the company. b.​Preferred stock dividends are tax-deductible for the investor. c.​Preferred stock dividends are flexible. The penalties for not paying a dividend are not severe. d.​Preferred stock is the most preferred method of raising capital. ANSWER: c 115.​Unsecured income bonds are considered​ securities. a.​strong b.​government c.​weak d.​non-corruptible ANSWER: c 116.​There are various types of government debt securities. Which of the following is considered a long term government debt instrument? a.​Treasury bills b.​Treasury notes c.​Commercial paper d.​Debentures ANSWER: b © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 117.​Yummy Tummy Bakeries has issued a 30 year par value bond that is callable in 5 years. If the coupon rate is 5.5% payable semi­annually, what is the bond’s yield to call if the yield to maturity is 8% and the call premium is one year’s interest? a.​12.65% b.​18.91% c.​14.42% d.​10.62% ANSWER:​ c RATIONALE: Solution found by using a financial calculator: First, find the price of the bond using regular bond information: N = 30 × 2 = 60 I = 8/2 = 4 PMT =.055 × 1000 = 55/2 = 27.50 FV = 1000 Solve for PV = –$717.21 Second, find the yield to call: N = 5 × 2 = 10 PV = –$717.21 PMT = 27.50 FV = 1000 + 55 = 1055 (Note: the call premium is one year’s interest) I = 7.21% × 2 = 14.42% 118.​List the restrictions that an indenture places on the borrower of long-term debt. ANSWER: 1.​ It thoroughly details the nature of the debt issue. 2.​ It specifies the manner in which the principal must be repaid. 3.​ It lists any covenants that are placed on the borrower. Among these are: a.​a minimum interest coverage ratio that must be maintained. b.​A minimum level of working capital that must be maintained. c.​The maximum amount of dividends that the firm can pay on its preferred and common stock. d.​Restrictions on further leasing or borrowing that the firm may utilize. 119.​What is the collateral used in collateral trust bonds and who is its primary user? ANSWER: Collateral trust bonds are backed by stocks or bonds of other corporations. This type of financing is principally used by holding companies whereby it pledges the stocks and/or bonds of its subsidiaries as collateral. © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 120.​List the advantages and disadvantages of long-term debt financing: ANSWER: Advantages: 1.​The firm has a relatively low after-tax cost due to the tax deductibility of interest. 2.​The firm has increased earnings per share possible through financial leverage. 3. This type of financing allows the firm’s owners to maintain greater control over the firm. Disadvantages: 1.​This type of financing can increase the financial risk of the firm. 2.​It may require that restrictions be placed on the firm by the lenders. 121.​How does a firm value an asset? ANSWER: The value of any asset is based on the expected future benefits that the owner will receive over the life of the asset. The cash flows are derived from increased revenues and/or reduced costs plus any salvage value received from the sale of the asset. The value of a financial asset is based on the expected cash flows the asset will generate for the owner during the holding period. These payments are usually dividend payments or interest received while the asset is owned plus any money received when the asset is sold. 122.​What is a “payment­in­kind” bond and why is it considered a “weak security”? ANSWER: PIK bonds allow a cash-strapped company to issue more debt to bondholders in lieu of cash interest payments. Companies add more to their debt obligations in order to conserve cash during lean times. Unsecured income bonds are generally considered to be “weak” securities. 123.​Explain a sinking fund. ANSWER: Lenders require that the borrowing company gradually reduce the outstanding balance of a debt issue over its life instead of paying the entire principal when it comes due in 20 or 30 years. The usual method of providing for the gradual pay-down of the principal is with a sinking fund where money is set aside annually into a “sinking fund account”. 124.​What is a eurobond? a.​A bond issued in Europe and sold in the United States b.​A bond issued in Japan and sold in Europe c.​A bond issued by a U.S. corporation and sold to investors in Europe d.​A bond issued by U.S. corporations, denominated in euros, and sold to investors in the United States ANSWER: c 125.​Foreign bonds have all of the following characteristics EXCEPT: a.​They are underwritten by an investment banking syndicate. b.​They are denominated in the currency of the country of sale. c.​They are denominated in euros. d.​The bond issuer is from a country other than the country in which the bonds are being issued. ANSWER: c © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 126.​The length of time that an investor keeps an asset is called: a.​the retention period b.​the holding period c.​the maintenance period d.​none of the answers listed is correct. ANSWER: b 127.​When an investor is trying to find the market value of an asset, he/she is trying to determine: a.​the exchange rate b.​the par value c.​the interest payment d.​the market price ANSWER: d 128.​When does market equilibrium for an asset exist? a.​when there is no tendency for the price of the asset to move higher or lower b.​when the bid price equals the ask price c.​when the asset can be resold at a profit d.​when the asset can be bought at a discount ANSWER: a 129.​A unique characteristic of bearer bonds is: a.​The name and country of the bond owner is on the bond. b.​The name and country of the bond owner is not on the bond. c.​The name and country of the bond owner is on the bond but the owner does not need to pay taxes on interest received. d.​The bond is heavily regulated and requires full disclosure to avoid fraud. ANSWER: b 130.​All of the following are characteristics of leveraged buyouts EXCEPT: a.​A large amount of the purchase price is borrowed. b.​The purchased assets of the bought firm are used as collateral for the buyout. c.​LBOs have led to enormous wealth increases for the common stockholders of the acquired firm. d.​The impact of most LBOs has been an increase in the bond ratings of the acquired firm because of the decrease in perceived risk. ANSWER: d © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 6: Fixed-Income Securities: Characteristics and Valuation 131.​Penny Pincher Discount Grocers has issued a bond with a coupon rate of 11%. It recently closed at a price of $1023.75. What is the bond's current yield? a.​10.75% b.​3.25%% c.​12.8% d.​8.9% ANSWER: a © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.