FIN 7020 Chapter 7 Review Questions PDF

FIN 7020 Dr. Amine Khayati **Chapter 7 Review Questions** ------------------------------ **Interest Rates and Bond Valuation** ------------------------------------- 1- Face value and par value are synonymous terms. a. true b. false 2- To determine the value of a bond at a particular point i...

FIN 7020 Dr. Amine Khayati **Chapter 7 Review Questions** ------------------------------ **Interest Rates and Bond Valuation** ------------------------------------- 1- Face value and par value are synonymous terms. a. true b. false 2- To determine the value of a bond at a particular point in time we use the yield to maturity, which is the market interest rate at that time for bonds with similar features. a. true b. false 3- The value of a bond equals to the sum of the.......................... of both the future................ and the........................ a. present value; coupon rate; face value b. future value; coupon payments; par value c. future value; coupon payments; face value d. present value; coupon payments; face value 4- A bond coupon payments are calculated based on the..................... when the bond is issued. However, bond valuation requires that we determine the......................, which is the market required rate of return on that bond at the time of the valuation. a. coupon rate; required rate b. coupon rate; yield to maturity c. default risk; coupon rate d. nominal rate; real rate 5- All other things being equal, the longer the time to maturity, the............... interest rate risk, and the lower the coupon rate, the...................... the interest rate risk. a. lower; lower b. lower; greater c. greater; lower d. greater; greater 6- Among the following bonds, which one has a price that is most sensitive to changes in interest rate. a. a 30-year, zero coupon b. a 30-year, 5 percent coupon bond c. a 10-year, 15 percent coupon bond d. a 5-year callable bond 7- The yield to maturity for a bond is the bond's.................. When the market value of the bond is equal to its face value, the yield to maturity should be equal to the................. a. coupon rate; rate of return b. rate of return; coupon rate c. default rate; rate of return d. rate of return; coupon payment 8- If a bond is................, the company's registrar mails the interest payment to the owner of record. However,....................... bonds have dated coupons attached to them; the bondholder has to detach a coupon and mail to the firm which then makes the interest payment. a. bearer; registered b. premium; discount c. registered; bearer d. discount; premium 9- A premium bond is a bond that: a. is selling for less than par value b. has a par value smaller than the face value c. is a bond that will mature in less than 12 months d. has a market value greater than the par value 10- When the yield to maturity is lower than the coupon rate, the bond should be: a. discount bond b. par value bond c. perpetuity d. premium bond 11- A bond selling for less than the face value is a...................; and a bond with the yield to maturity higher than the coupon rate is.......................... a. discount bond; premium bond b. callable bond, discount bond c. discount bond; discount bond d. risk-free bond; premium bond 12- The written agreement between the corporation and the lender detailing the terms of the debt issue is called the bond: a. security agreement b. bond mortgage c. indenture d. debenture 13- A.................. is an unsecured debt that generally matures in less than ten years; a.......................... is an unsecured debt that generally matures in ten years or more. a. perpetuity; note b. note; debenture c. debenture; bond d. debenture; note 14- The profit that a securities dealer earns from the purchase and the subsequent sale of a security is called: a. current yield b. discount c. yield to maturity d. spread 15- The Fisher effect addresses the relationship between: a. term structure of interest rate and curve yield b. municipal bonds yield and corporate bonds yield c. the dirty price and clean price d. nominal rates, real rates, and inflation rates 16-....................... is the right of the bond's issuer to repurchase the bond at a predetermined price prior to maturity. However, the...................... is the provision prohibiting the company from redeeming the bond prior to a certain date. a. call provision; deferred call provision b. call premium; call protection c. bond indenture; call provision d. protective covenant; sinking fund 17- the account managed by the bond trustee for the purpose of the early bond redemption is the: a. debenture b. bond covenant c. indenture d. sinking fund 18-.....................governs priority of payment to creditors in the event of bankruptcy. A debt is........................ when creditors must be repaid first. a. sinking fund; registered form b. seniority; subordinated c. subordination; senior d. indenture; preferred 19- A........................... allows the issuer to repurchase the bond debt issue prior to maturity. In most cases, the call price will be equal to the..............................of the bond plus a............................ a. put provision; face value; call premium b. put provision; repurchase value; call premium c. call provision; face value; plus value d. call provision; face value; call premium 20- When a bond cannot be called for a number of years after issue; this is a...\...\...\..... call, and the bond is..................... during this period. a. subordinated; deferred b. deferred; protected c. deferred; call protected d. default; deferred 21- A.................. restricts actions of the bond issuer. A...................... restricts the issuer actions, where as a.................. requires that certain actions be taken by the corporation. a. debenture; call protection; protective covenant b. protective covenant; negative covenant; positive covenant c. protective covenant; subordination covenant; seniority d. registered bearer; protective covenant; indenture 22- The bond-ratings of Moody's and Standard and Poor's are concerned only with the possibility of...................; these bond ratings do not address the volatility of the bond price due to........................ a. default; interest rate risk b. liquidity risk; liquidity premium c. loss; call protection d. default; equity risk 23- Bonds are rated according to the likelihood of................; high ratings indicate................ probability of default. a. maturity date; low b. interest rate risk; low c. interest rate risk; high d. default; low 24- A....................... bond makes no coupon payments and is initially priced at a deep discount from par value. A......................... bond has adjustable coupon payments, which are tied to a specific index. a. level-coupon; zero-coupon b. zero-coupon; floating-rate c. floating-rate; level-coupon d. zero-coupon; level-coupon 25- The coupon payments of a..................... bond are paid only when the firm's income is sufficient to do so. A............. Bond can be swapped (exchanged) for a fixed number of stocks. a. income; convertible b. convertible; equity c. risky; convertible d. premium; exchangeable 26- A..................... bond have no default risk. A.................. bond carries some default risk and is exempt from federal income taxation. a. zero-coupon; federal b. convertible; municipal c. treasury; municipal; d. level-coupon; call-protected bond 27- Most bond trading takes place..................., therefore it is............. to obtain data on bond prices and volumes and the bond market is considered................... a. stock exchange; easy; transparent b. overnight; difficult; volatile c. over the counter; difficult; not transparent d. between banks; easy; monetary 28- The price of a bond quoted net of accrued interest is the................... price; the price which includes accrued interest (and which the buyer actually pays) is the.................. price a. clean; dirty b. dirty; clean c. market; clean d. quoted; market 29-................. rates are "observed" rates, since they are what we observe in the financial markets, these rates are not adjusted for inflation. However,................ rates are rates that have been adjusted for inflation. a. market; clean b. effective; real c. nominal; real d. quoted; nominal 30- The observed relationship between short-term and long-term interest rates is known as the.....................; it is depicted graphically as the....................... a. term structure of interest rates; yield curve b. long-term structure; interest curve c. yield to maturity; interest rate yield d. fisher effect; yield curve 31- The........................ is the portion of a nominal rate that represents compensation for unfavorable tax status. The................ is the portion of a nominal rate that represents compensation for illiquidity. a. default premium; liquidity premium b. taxability premium; liquidity premium c. call premium; default premium d. taxability premium; default premium 32- The compensation investors require to offset expected future increases in prices is generally called: a. taxability premium b. default premium c. inflation premium d. real rate premium 33- The portion of a bond's yield that investors require to compensate for the possibility that the bond's interest or principal might not be paid is called: a. liquidity premium b. default risk premium c. coupon insurance premium d. interest rate risk premium 34- A par value bond is a bond having the following features: I. yield to maturity equals the coupon rate II. market price lower than the face value III. market price equal to the face value a. I only b. I and II only c. I and III only d. All of them 35- The current yield on a bond is defined as: a. the bond annual coupon divided by the current price b. the bond interest rate times the yield to maturity c. the bond yield to maturity d. the bond annual coupon divided by the face value 36- The yield to maturity of a bond is also the bond: a. coupon rate b. real rate c. current yield d. nominal rate 37- the interest rate risk premium is the compensation that investors require for their assumption of the risk related to: a. fluctuations in inflation rates b. the bond's call feature c. changes in interest rates d. the liquidity of the bond 38- The relationship between the nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money is called the: a. current yield b. term structure of interest rates c. short-term yield to maturity d. fisher effect 39- A............................. bond is a bond that pays fixed coupon payments at regular period of time. A........................ bond is a bond that is sold at a deep discount and it makes only one payment at maturity. a. floating-rate; level-coupon b. zero-coupon; floating-rate c. level-coupon; floating-rate d. level-coupon; zero-coupon 40- A......................... is an unsecured bond, for which no specific pledge of property is made. a. subordinated bond b. bearer bond c. debenture d. indenture 41- A bond that was previously rated as investment grade but has been downgraded to a junk bond status is called a: a. bearer bond b. convertible bond c. fallen angel d. investment grade bond 42- A bond that has the features of both debt and equity, and can be exchanged for shares of stock of the issuing firm is called: a. callable bond b. convertible bond c. risk free bond d. junk bond 43- A bond that gives the bondholder the right to force the issuer to purchase the bond at a stated price is called: a. put bond b. callable bond c. convertible bond d. junk bond 44- Which one of the following statements are correct about bond market? I. bond market is less transparent that stock market II. Bonds are generally bought from and sold to electronically-connected dealers III. Getting up-to-date prices on individual bonds is often difficult a. I only b. I and II c. II and III d. I , II and III 45- The dirty price of a bond includes which of the following? I. quoted price II. bid price III. accrued interest a. I only b. I and II c. II and III d. I and III 46- A corporate bond with a \$1,000 face value quoted as 102.78 sells for................... and a \$1,000 face value treasury bond quoted as 97:09 sells for: a. \$102.78; \$97.09 b. \$ 1,027.80; \$ 972.8125 c. \$1,027.80; \$ 97.28 d. \$1,027.80; \$970.90 47- When investors expect that interest rates in the future to be higher than the current interest rates, the graph depicting the term structure of interest rates will be: a. convex b. upward-sloping c. concave d. downward-sloping 48- Which of the following bonds is expected to have a higher taxability premium? a. municipal bond b. corporate bond c. treasury bond d. bond issued by a state 49- A bond with a \$1,000 face value is currently quoted as 98.42. The bond pays semi-annual payments of \$45 and matures in 6 years. What is the coupon rate? a. 9 percent b. 4.5 percent c. 4.39 percent d. 9.13 percent 50- A bond with 7.5 coupon rate has a yield to maturity of 8%, 25 years to maturity, a \$1,000 face value, and pays interest semi-annually. What is the amount of each coupon payment? a. \$ 80.00 b. \$ 75.00 c. \$ 40.00 d. \$ 37.50 51- Last year, your bond investment has earned you a 8.25 % rate of return. During that time the inflation rate was 1.75%. What is your real rate of return? a. 6.39 percent b. 6.5 percent c. 6.42 percent d. 5.14 percent 52- Last year, your bond investment has a 5.05% real rate of return and during that time the inflation rate was 3.25%. What is your actual nominal rate of return? a. 8.3 percent b. 8.12 percent c. 8.00 percent d. 8.46 percent **Answers:** +-----------------+-----------------+-----------------+-----------------+ | 1- true | 16-a | 31-b | 46-b | | | | | | | 2-true | 17-d | 32-c | 47-b | | | | | | | 3-d | 18-b | 33-b | 48-b | | | | | | | 4-b | 19-d | 34-c | 49-a | | | | | | | 5-d | 20-c | 35-a | 50-d | | | | | | | 6-a | 21-b | 36-d | 51-a | | | | | | | 7-b | 22-a | 37-c | 52-d | | | | | | | 8-c | 23-d | 38-b | | | | | | | | 9-d | 24-b | 39-d | | | | | | | | 10-d | 25-a | 40-c | | | | | | | | 11-c | 26-c | 41-c | | | | | | | | 12-c | 27-c | 42-b | | | | | | | | 13-b | 28-a | 43-a | | | | | | | | 14-d | 29-c | 44-d | | | | | | | | 15-d | 30-a | 45-d | | +-----------------+-----------------+-----------------+-----------------+ : Answers **Example 1** - A bond has a face value of \$1,000, a current yield of 8.553%, annual interest payments, and a 15 years to maturity. The bond quote is 93.539. What is the amount of each coupon payment? a. \$85.53 b. \$80.00 c. \$93.53 d. \$76.58 The bond 93.539 % of \$1,000 which is equal to \$935.39 Current yield = annual coupon payment / current price So the coupon payment = current yield current price = 0.08553 935.39 = 80.00 **Example 2** -- A bond has 6% coupon rate, a \$1,000 face value, pays interest semi-annually, matures in 9 years, and has a yield to maturity of 6.75%. What is the current market price of the bond? First, you need to set up the calculator to assume semi-annual compounding. Press  enter 2 and then press Now the calculator is set to assume 2 payments per year. Clear memory by pressing and then. Next, enter the following data: 9  you enter 18 as the number of years and the calculator will compute the number of periods for you in this case 18 as displayed, don't forget to press again  to enter 18 as your number of periods. 6.75 30  The bond pays \$30 every six months 1,000 Press the key PVand the calculator will display -950.02 **Example 3** -- A bond has an 8% annual coupon rate, is selling for \$1,052.75, have a face value of \$1,000, pays coupons semi-annually and has a yield to maturity of 7.45%. How many years will it take the bond to mature? First, you need to set up the calculator to assume semi-annual compounding. Press P/Y enter 2 and then press  Now the calculator is set to assume 2 payments per year. Clear memory by pressing2nd and then . Next, enter the following data: 7.45 I/Y \- 1,052.75  1,000 FV 40  Press the key CPTand the calculator will display 34.28. This gives the number of six months periods which is roughly 17.14 years. **Example 4**- A bond pays \$80 annual coupon, is selling for \$1,025.18. If the bond has a \$1,000 face value and mature in 8 years, what is the yield to maturity? First, you need to set up the calculator to assume annual compounding. Press 2nd enter 1 and then press Enter Now the calculator is set to assume 1 payment per year. Clear memory by pressing and then CLR TVM. Next, enter the following data: 8  -1,025.18 PV 80  1,000 FV Press the key I/Yand the calculator will display 7.5689% **Example 5** -- A company wants to issue zero-coupon bonds that yield 7% annually and will mature in 15 years. What price should they charge for these bonds if they have a face value of \$1,000? First, you need to set up the calculator to assume annual compounding. Press P/Y enter 1 and then press  Now the calculator is set to assume 1 payment per year. Clear memory by pressing2nd and then . Next, enter the following data: 15 N 7  0 PMT 1,000  Press the key CPT and the calculator will display -362.45