1) Which one of the following is NOT a typical negative bond covenant?

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1 Questions in Chapter 7 concept.qz 1) Which one of the following is NOT a typical negative bond covenant? [A] The firm must limit dividend payments. [B] The firm cannot merge with another firm. [C] The firm cannot issue additional long-term debt. [D] The firm cannot allow its bond ratings to fall below their initial level. [E] The firm cannot pledge any assets to other lenders. [A] :This is a common negative bond covenant. Review section 7.2. [B] :This is a common negative bond covenant. Review section 7.2. [C] :This is a common negative bond covenant. Review section 7.2. Bond ratings are a measure of repayment ability and assessed independently of the company. [E] :This is a common negative bond covenant. Review section ) J&&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 7 percent. If the bond has a life of 30 years, pays annual coupons, and the yield to maturity is 6.8 percent, what is the present value of the bond's face value? [A] $ [B] $ [C] $ [D] $1, [E] $1, [B] :You need to review this computation in section 7.1. [C] :You need to review this computation in section 7.1. [D] :You need to review this computation in section 7.1. [E] :You need to review this computation in section ) For a bond selling at par, the yield to maturity must be: [A] greater than the coupon rate. [B] less than the coupon rate. [C] greater than the current yield. [D] greater than the required rate of return. [E] equal to the current yield. [A] :If the YTM is greater than the coupon rate, the bond will sell at a discount. Review section 5.1. [B] :If the YTM is lower than the coupon rate, the bond will sell at a premium. Review section 5.1. [C] :If the YTM is greater than the current yield the bond cannot sell for par. Review section 5.1. [D] :The YTM and the required return are generally the same thing. Review section ) Which bond most likely has the highest degree of interest rate risk? [A] 8 percent coupon rate with 10 years to maturity [B] 8 percent coupon rate with 20 years to maturity [C] 10 percent coupon rate with 10 years to maturity [D] 10 percent coupon rate with 20 years to maturity [E] 12 percent coupon rate with 20 years to maturity

2 [A] :You are correct that the lower the coupon rate the higher the interest rate risk, but what about interest rate risk and the time to maturity? Review section 7.1. [C] :This bond probably has the lowest interest rate risk of the choices listed. Review section 7.1. [D] :You are correct that the longer the time to maturity the higher the interest rate risk, but what about interest rate risk and the size of the coupon payment? Review section 7.1. [E] :You are correct that the longer the time to maturity the higher the interest rate risk, but what about interest rate risk and the size of the coupon payment? Review section ) In common usage, "short-term" debt refers to debt with a maturity of one year or less. [B] :This usage is consistent with the classification of current assets and liabilities discussed back in chapter 2. Review section ) Which of the following bonds can be terminated prior to maturity by the issuer? I. callable bond II. bond with sinking fund provision III. convertible bond IV. put bond [A] I and II only [B] II and III only [C] III and IV only [D] I, II, and IV only [E] I, II, and III only [B] :At least one of these is terminated early by the bondholder, not the issuer. Review section 7.4. [C] :At least one of these is terminated early by the bondholder, not the issuer. Review section 7.4. [D] :At least one of these is terminated early by the bondholder, not the issuer. Review section 7.4. [E] :At least one of these is terminated early by the bondholder, not the issuer. Review section ) Which of the following features are generally described in a bond indenture? I. face amount II. interest payment dates III. call provision, if applicable IV. protective covenants, if applicable [A] I and II only [B] III and IV only [C] I, II and III only [D] II, III and IV only [E] I, II, III and IV [A] :Correct, but other features are also included in the indenture. Review section 7.2. [B] :Correct, but other features are also included in the indenture. Review section 7.2. [C] :The protective covenants are also included. Review section 7.2. [D] :The face amount would also be included. Review section 7.2.

3 8) A(n) is secured only by the reputation of the issuing firm. [A] unfunded bond [B] straight bond [C] bearer bond [D] registered bond [E] debenture [A] :This is another name for short-term debt. Review section 7.2. [B] :This term does not relate to the security on a bond. Review section 7.2. [C] :This term relates to whether or not the bond purchaser is known to the company. Review section 7.2. [D] :This term relates to whether or not the bond purchaser is known to the company. Review section ) A zero coupon bond: [A] typically pays coupons only for the first five years. [B] sells for a price that is greater than the face value. [C] has no interest payments and is thus non-taxable until maturity. [D] is also known as a deep discount bond. [E] provides no cash flow to the holder at maturity. [A] :If it's a zero coupon bond, what is the coupon rate? Review section 7.4. [B] :Why would an investor pay more than par for an investment that only provides one cash flow, equal to par, at the maturity of the bond? Review section 7.4. [C] :Zero coupon bonds are taxed according to their imputed interest payment. Review section 7.4. [E] :These bonds provide a cash flow only at maturity. Review section ) The call premium typically starts at ten percent of par and decreases to zero with the passage of time. [A] :The call premium often starts at the annual coupon rate and then declines over time. Review section ) If bond X is selling at a premium, then the required return on the bond is less than the: I. current yield. II. yield-to-maturity. III. coupon rate. [A] I only [B] I and II only [C] II and III only [D] I and III only [E] I, II, and III

4 [A] :Correct, but at least one other choice is correct as well. Review section 7.1. [B] :At least one of these choices is incorrect. Review section 7.1. [C] :At least one of these choices is incorrect. Review section 7.1. [E] :At least one of these choices is incorrect. Review section ) J&&J Enterprises wants to issue eighty 20-year $1,000 zero-coupon bonds. If each bond is to yield 8 percent, how much will J&&J receive (ignoring issuance costs) when the bonds are issued? [A] $11,212 [B] $12,393 [C] $17,164 [D] $18,880 [E] $20,000 [A] :Did you get a price of $ for each bond issued? Review sections 7.1 and 7.4. [B] :Did you get a price of $ for each bond issued? Review sections 7.1 and 7.4. [D] :Did you get a price of $ for each bond issued? Review sections 7.1 and 7.4. [E] :Did you get a price of $ for each bond issued? Review sections 7.1 and ) A premium bond is a bond that sells for less than its par value. [A] :If so, then what is a discount bond? Review section ) Suppose you purchase a zero coupon bond with a face value $1,000. The bond matures in twenty years and sells for $ If the yield to maturity on the bond remains unchanged, what will the price of the bond be at the end of five years from now? [A] $ [B] $ [C] $ [D] $ [E] $1, [B] :To solve this, you must first find the initial yield to maturity. Did you find the YTM to be 8 percent? Then, after five years pass, there are only fifteen years remaining to maturity but the YTM and payment at maturity have not changed. Review sections 7.1 and 7.4. [C] :To solve this, you must first find the initial yield to maturity. Did you find the YTM to be 8 percent? Then, after five years pass, there are only fifteen years remaining to maturity but the YTM and payment at maturity have not changed. Review sections 7.1 and 7.4. [D] :To solve this, you must first find the initial yield to maturity. Did you find the YTM to be 8 percent? Then, after five years pass, there are only fifteen years remaining to maturity but the YTM and payment at maturity have not changed. Review sections 7.1 and 7.4. [E] :To solve this, you must first find the initial yield to maturity. Did you find the YTM to be 8 percent? Then, after five years pass, there are only fifteen years remaining to maturity but the YTM and payment at maturity have not changed. Review sections 7.1 and 7.4.

5 15) A firm intends to take on a significant amount of new debt in order to fund the purchase of a close competitor. However the firm cannot complete the transaction unless it first calls in one of its outstanding bond issues. It must be true that the called bonds: [A] are backed by the corporation's fixed assets. [B] have a higher interest rate than the new bonds will. [C] have an inferior tax status than the new bonds will. [D] can be called at a price equal to par value. [E] have covenants which restrict the amount of debt outstanding. [A] :How would the existence of this feature require the firm to call the bonds before issuing new debt? Review section 7.2. [B] :How would the existence of this feature require the firm to call the bonds before issuing new debt? Review section 7.2. [C] :How would the existence of this feature require the firm to call the bonds before issuing new debt? Review section 7.2. [D] :How would the existence of this feature require the firm to call the bonds before completing this transaction? Review section ) Unlike Treasury bonds, corporate bonds are quoted in the Wall Street Journal as a percent of par expressed in 32nds of one percent. [A] :Treasury bonds are the ones that are quoted in 32nds. Review section ) A sinking fund is used to pay off a portion of an outstanding bond issue each year. [B] :This is the objective of a sinking fund arrangement. Review section ) An expected increase in the will cause the slope of the term structure of interest rates to increase. I. rate of inflation II. interest rate risk premium III. real rate of interest [A] I only [B] II only [C] I and II only [D] I and III only [E] I, II, and III [A] :Correct, but at least one other choice is also correct. Review section 7.7. [B] :Correct, but at least one other choice is also correct. Review section 7.7.

6 [D] :At least one of these choices affects the magnitude of the rates in the term structure but does not impact the slope of the term structure. Review section 7.7. [E] :At least one of these choices affects the magnitude of the rates in the term structure but does not impact the slope of the term structure. Review section ) All else equal, interest rate risk rises when: I. the coupon rate decreases. II. a fixed rate is changed to a variable rate. III. the time to maturity increases. [A] I only [B] I and II only [C] I and III only [D] II and III only [E] I, II, and II [A] :Correct, but there is at least one more correct option. Review section 7.1. [B] :At least one of these options is incorrect. Review section 7.1. [D] :At least one of these options is incorrect. Review section 7.1. [E] :At least one of these options is incorrect. Review section ) Which of the following statements is (are) true? I. All else equal, the value of a perpetual bond will remain unchanged from one year to the next, unless market interest rates change. II. All else equal, bond prices and coupon rates are inversely related. III. All else equal, given two bonds identical except for the coupon, the market price of the lower coupon bond will change more (in percentage terms) than that of the higher coupon bond for a given change in market interest rates. [A] I only [B] I and II only [C] I and III only [D] II and III only [E] I, II, and III [A] :Correct, but at least one other statement is also correct. Review section 7.1. [B] :At least one of these statements is incorrect. Review section 7.1. [D] :At least one of these statements is incorrect. Review section 7.1. [E] :At least one of these statements is incorrect. Review section ) If you multiply a bond's current yield by its market price you get the: [A] yield to maturity. [B] investors' required rate of return. [C] annual coupon rate. [D] cost of capital. [E] annual coupon payment. [A] :This is not a direct factor in computing the current yield. Review section 7.1. [B] :This is not a direct factor in computing the current yield. Review section 7.1. [C] :You are close but not quite correct. Review section 7.1. [D] :This is not a direct factor in computing the current yield. Review section 7.1.

7 22) The Fisher effect illustrates the relationship between real returns, the rate of inflation, and interest rate risk. [A] :Interest rate risk is not a part of the Fisher effect. What should the third component be? Review section ) A bond that pays no coupons at all and is sold at a discount is called a zero coupon bond. [B] :This is the textbook definition of a zero coupon bond. Review section ) Which of the following statements are true? I. If the rate of inflation is expected to decline by a small amount, there could still be an upwardsloping term structure. II. A bond's yield is typically calculated assuming that all of the promised coupon and principal payments will be made. III. The compensation investors demand for bearing interest rate risk adds an upward slope to the term structure of interest rates. IV. The compensation investors demand for buying bonds that don't trade very often is called a liquidity premium. [A] I and II only [B] II and IV only [C] II, III, and IV only [D] I, II, and III only [E] I, II, III, and IV [A] :Correct, but there is at least one more correct statement. Review section 7.7. [B] :Correct, but there is at least one more correct statement. Review section 7.1. [C] :Can t the interest rate premium increase over time exceed a small increase in inflation? Review section 7.7. [D] :What does the liquidity premium relate to if not the ability to sell a security quickly at full value? Review section ) All else being equal, if interest rates fall: I. bond prices will rise. II. coupon payments on floating rate bonds will fall. III. prices on long-term bonds will change more (on a percentage basis) than prices on short-term bonds. IV. prices on low coupon bonds will change more (on a percentage basis) than prices on high coupon bonds.

8 [A] I and III only [B] I and IV only [C] II and IV only [D] I, III, and IV only [E] I, II, III, and IV [A] :Correct, but at least one other choice is also correct. Review section 7.1. [B] :Correct, but at least one other choice is also correct. Review section 7.1. [C] :Correct, but at least one other choice is also correct. Review section 7.1. [D] :Correct, but the coupon rate on floating rate bonds will be adjusted downward as well. Review section ) A is an account into which periodic payments are made for the purpose of retiring a bond issue. [A] deed of trust [B] debenture [C] covenant [D] call option [E] sinking fund [A] :This is not the correct definition of a deed of trust. Review section 7.2. [B] :This is not the correct definition of a debenture. Review section 7.2. [C] :This is not the correct definition of a covenant. Review section 7.2. [D] :This is not the correct definition of a call option. Review section ) What is the market value of a bond that will pay a total of forty semiannual coupons of $50 each over the remainder of its life? Assume the bond has a $1,000 face value and an 8 percent yield to maturity. [A] $ [B] $ [C] $1, [D] $1, [E] $1, [A] :You need to review semiannual coupon bonds in section 7.1. [B] :You need to review semiannual coupon bonds in section 7.1. [C] :You need to review semiannual coupon bonds in section 7.1. [E] :You need to review semiannual coupon bonds in section ) A call provision, but not a sinking fund, allows a company to retire its debt early. [A] :Both of these are methods of retiring debt early. Review section 7.2.

9 29) Which of the following statements about bond ratings is (are) correct? I. Bondholders are the ones who always pay to have their bonds rated. II. Bond ratings are based solely on information acquired from sources other than the corporation itself. III. Bond ratings represent an independent assessment of the credit-worthiness of bonds. [A] II only [B] I and II only [C] III only [D] I and III only [E] II and III only [A] :The corporation generally provides information to the bond rating agency. Review section 7.3. [B] :At least one of these statements is incorrect. Review section 7.3. [D] :At least one of these statements is incorrect. Review section 7.3. [E] :At least one of these statements is incorrect. Review section ) An upward sloping yield curve reflects investors' desire for compensation for interest rate risk. [B] :To buy long-term bonds, investors typically require additional compensation in terms of yield. Review section ) Considering the time period since the Great Depression, the real push to raise capital by issuing junk bonds really began in the late 1970 s. [B] :Prior to this time, the junk bonds that existed primarily were bonds that had originally been issued as investment grade but had declined in quality. Review section ) Your neighbor is bragging that the coupon payment on the bonds he bought five years ago has increased in each of the last three years. You know he must own a bond. [A] zero coupon [B] government [C] convertible [D] put [E] floating-rate [A] :These bonds make no coupon payments. Review section 7.4. [B] :These bonds generally have fixed rates. Review section 7.4. [C] :How does the ability to convert a bond into stock relate to the interest payments? Review section 7.4. [D] :How does the ability to force an issuer to buy back a bond relate to the interest payments? Review section 7.4.

10 33) A financially stable, well-established corporation wants to issue 20-year bonds to finance a highrisk, expansion project. Which one of the following statements is most likely to apply in this situation. [A] The company can probably issue low-coupon premium bonds for this purpose. [B] The company will probably have to pay semi-annual interest payments on the bonds. [C] The company can not issue these bonds if they already have bonds outstanding. [D] The bonds will probably sell at a premium since they are financing a high-risk project. [E] The bonds will probably be rated as low-class junk bonds. [A] :It is unlikely that investors will pay a premium for a low coupon bond especially when the money is going to a high-risk project. Review section 7.1. [C] :Nothing in the statement of the question precludes the company from already having debt outstanding. Review section 7.2. [D] :Risky bonds are usually sold at a discount. Review section 7.1. [E] :Bond ratings reflect default risk. This is a financially stable firm so there is no indication that default risk is a major concern, thus there is no reason for a low-class junk rating. Review section ) Which of the following are duties of the trust company that is appointed when bonds are issued? I. ensure the terms of the indenture are obeyed II. manage the sinking fund III. determine when the bonds should be called IV. represent the bondholders if the company defaults on the bonds [A] I and II only [B] I and IV only [C] I, II, and IV only [D] II, III, and IV only [E] I, II, III, and IV [A] :Correct, but there is at least one more duty listed. Review section 7.2. [B] :Correct, but there is at least one more duty listed. Review section 7.2. [D] :At least one of these duties is incorrect. Review section 7.2. [E] :At least one of these duties is incorrect. Review section ) Suppose you read that a bond with a face value of $1,000 and a coupon of 8 percent has a current yield of exactly 8 percent. Which of the following statements are true if interest is paid annually? I. The current yield is equal to the yield to maturity. II. The current yield is equal to the market required rate of return. III. The bond is selling at par. IV. The bond has to be selling at a discount. [A] I and II only [B] II and III only [C] II and IV only [D] I, II, and III only [E] I, II, and IV only [A] :Correct, but at least one other option is also correct. Review section 7.1. [B] :Correct, but at least one other option is also correct. Review section 7.1. [C] :At least one of these options is incorrect. Review section 7.1.

11 [E] :Since the coupon is $80 and the current yield is 8 percent, the price must be $1,000. Review section ) You want to own equity in a foreign oil company, but no shares of stock are currently being offered for sale. If there are for sale, you could purchase these and then trade them in for shares of stock. [A] convertible bonds [B] put bonds [C] debentures [D] zero coupon bonds [E] subordinated debentures [B] :How would the addition of this feature allow you to exchange the bonds for stock? Review section 7.2. [C] :This feature does not relate to the ability to exchange the bonds for stock. Review section 7.2. [D] :The coupon rate does not determine whether or not the bonds are exchangeable for stock. Review section 7.2. [E] :This feature does not relate to the ability to exchange the bonds for stock. Review section ) All else constant, the price of a bond will over the course of a year. [A] perpetual; rise [B] premium; rise [C] premium; remain constant [D] discount; rise [E] discount; remain constant [A] :The price of a perpetuity does not change from one year to the next if the discount rate remains unchanged. Review section 7.1. [B] :All else equal, the value of a premium bond will approach par as the bond approaches maturity. Review section 7.1. [C] :All else equal, the value of a premium bond will approach par as the bond approaches maturity. Review section 7.1. [E] :All else equal, the price of a discount bond will approach par as the bond approaches maturity. Review section ) What would you pay for a bond that pays an annual coupon of $35, has a face value of $1,000, matures in 7 years, and has a yield to maturity of 8 percent? [A] $ [B] $ [C] $ [D] $ [E] $ [B] :You need to review this calculation in section 7.1. [C] :You need to review this calculation in section 7.1. [D] :You need to review this calculation in section 7.1. [E] :You need to review this calculation in section 7.1.

12 39) The bonds of Microhard, Inc. carry a 10 percent annual coupon, have a $1,000 face value, and mature in 4 years. Bonds of equivalent risk yield 7 percent. The market value of Microhard's bonds should be: [A] $1, [B] $1, [C] $1, [D] $1, [E] $1, [A] :Use the yield on the bonds of similar risk as the yield on the Microhard bonds. Review section 7.1. [B] :Use the yield on the bonds of similar risk as the yield on the Microhard bonds. Review section 7.1. [C] :Use the yield on the bonds of similar risk as the yield on the Microhard bonds. Review section 7.1. [E] :Use the yield on the bonds of similar risk as the yield on the Microhard bonds. Review section ) J&&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 7 percent. If the bond has a life of 30 years, pays annual coupons, and the yield to maturity is 6.8 percent, what will the bond sell for? [A] $ [B] $1, [C] $1, [D] $1, [E] $1, [A] :If the yield to maturity is less than the coupon rate, the bond can't sell for a discount. You need to review this computation in section 7.1. [B] :If the yield to maturity is less than the coupon rate, the bond can't sell for par. You need to review this computation in section 7.1. [D] :You need to review this computation in section 7.1. [E] :You need to review this computation in section ) All else equal, the existence of a will increase the required return on a bond. [A] call provision [B] conversion feature [C] sinking fund [D] trust deed [E] protective covenant [B] :Only terms that are bad for the bond investor will increase the required return on a bond. Is a conversion feature bad for the bond investor? Review section 7.2. [C] :Only terms that are bad for the bond investor will increase the required return on a bond. Is a sinking fund feature bad for the bond investor? Review section 7.2. [D] :Only terms that are bad for the bond investor will increase the required return on a bond. Is a trust deed bad for the bond investor? Review section 7.2.

13 [E] :Only terms that are bad for the bond investor will increase the required return on a bond. Is a protective covenant bad for the bond investor? Review section ) Bond ratings issued by Moody's and Standard && Poor's specifically account for default risk. [B] :This is the only type of risk bond ratings attempt to assess. Review section ) Which of the following risks do debt ratings specifically attempt to assess? I. interest rate risk II. default risk III. call risk [A] I only [B] II only [C] I and II only [D] II and III only [E] I, II, and III [A] :This is not the type of risk bond ratings attempt to assess. Review section 7.3. [C] :At least one of these choices is incorrect. Review section 7.3. [D] :At least one of these choices is incorrect. Review section 7.3. [E] :At least one of these choices is incorrect. Review section ) Suppose you purchase a zero coupon bond with a face value $1,000, a maturity period of twenty years, and a market price of $ What is the implicit interest, in dollars, in the first year of the bond's life? [A] $14.86 [B] $16.84 [C] $17.16 [D] $39.27 [E] $80.00 [A] :To find this, you must first find the yield to maturity and then multiply this rate by the beginning price. Did you find the YTM to be 8 percent? Review sections 7.1 and 7.4. [B] :To find this, you must first find the yield to maturity and then multiply this rate by the beginning price. Did you find the YTM to be 8 percent? Review sections 7.1 and 7.4. [D] :To find this, you must first find the yield to maturity and then multiply this rate by the beginning price. Did you find the YTM to be 8 percent? Review sections 7.1 and 7.4. [E] :To find this, you must first find the yield to maturity and then multiply this rate by the beginning price. Did you find the YTM to be 8 percent? Review sections 7.1 and ) Which of the following may be a component of a nominal return but NOT included in the Fisher effect? I. real rate of return II. default risk premium

14 III. taxability premium IV. inflation premium [A] II only [B] I and III only [C] II and III only [D] II, III and IV only [E] I, II, III and IV [A] :Correct, but at least one other choice is also correct. Review sections 7.6 and 7.7. [B] :At least one of these choices is incorrect. Review sections 7.6 and 7.7. [D] :At least one of these choices is incorrect. Review sections 7.6 and 7.7. [E] :At least one of these choices is incorrect. Review sections 7.6 and ) J&&J Enterprises wants to issue 20-year, $1,000 face value zero-coupon bonds. If each bond is to yield 8 percent, what is the minimum number of bonds J&&J must sell if they wish to raise at least $2 million from the issue? (Ignore issuance costs.) [A] 4,290 [B] 9,322 [C] 10,164 [D] 13,880 [E] 16,159 [A] :Did you determine that each bond will sell for $214.55? Review sections 7.1 and 7.4. [C] :Did you determine that each bond will sell for $214.55? Review sections 7.1 and 7.4. [D] :Did you determine that each bond will sell for $214.55? Review sections 7.1 and 7.4. [E] :Did you determine that each bond will sell for $214.55? Review sections 7.1 and ) The market price of a bond is $1,236.94, it has 14 years to maturity, a $1,000 face value, and pays an annual coupon of $100. What is the yield to maturity? [A] 3.18 percent [B] 4.26 percent [C] 5.37 percent [D] 6.11 percent [E] 7.25 percent [A] :You need to review this calculation in section 7.1. [B] :You need to review this calculation in section 7.1. [C] :You need to review this calculation in section 7.1. [D] :You need to review this calculation in section ) The term structure of interest rates is associated with: I. default-free securities. II. pure discount securities. III. the pure time value of money. IV. the relationship between long and short maturities. [A] I and III only [B] III and IV only

15 [C] I, II, and III only [D] I, II, and IV only [E] I, II, III, and IV [A] :True, but there is at least one more correct option. Review section 7.7. [B] :True, but there is at least one more correct option. Review section 7.7. [C] :What variable is used for the horizontal axis of a term structure of interest rates graph? Review section 7.7. [D] :What is the purpose of graphing the term structure of interest rates? Review section ) George bought an investment one year ago and just calculated his rate of return. He found that for every $100 he invested, he now has $115 in his account. If inflation over the period was 4 percent then his: [A] real rate of return is more than 15 percent. [B] nominal return is 15 percent. [C] real return is 15 percent. [D] real return is 4 percent. [E] ability to purchase goods has declined over the past year. [A] :What is the difference between a nominal and a real rate? Review section 7.6. [C] :What is the difference between a nominal and a real rate? Review section 7.6. [D] :What is the relationship between nominal, real, and inflation rates? Review section 7.6. [E] :What rate measures the change in your buying power? Review section ) The inflation premium in the yield curve can either increase or decrease as the time to maturity increases, depending on expectations about future rates of inflation. [B] :What about the case where inflation five years from now is expected to be lower than inflation today? Review section ) If a bond's coupon rate is less than the required rate, then: [A] the bondholder is assured of a profit when the bond is sold regardless of when it was purchased. [B] a portion of the income a buyer of this bond will receive comes from buying the bond at less than the par value. [C] the bond sells at par because the required rate of return is adjusted to reflect the discrepancy. [D] the bond sells at a premium regardless of the time to maturity. [E] the bond issuer must revise the coupon rate if the bond is to be resold. [A] :This statement depends on what the investor paid for the bond originally. Review section 7.1. [C] :This statement is incorrect. Review sections 7.1 and 7.7. [D] :Why should a purchaser pay a premium to receive less income? Review section 7.1. [E] :Coupon rates are generally fixed once a bond is issued. Review section 7.1.

16 52) In general, bond yields increase as investors demand compensation for: I. increases in expected future inflation. II. interest rate risk. III. default risk. IV. increased liquidity. [A] I and II only [B] II and III only [C] III and IV only [D] I, II, and III only [E] I, II, III, and IV [A] :Correct, but there is at least one more correct option. Review section 7.7. [B] :Correct, but there is at least one more correct option. Review section 7.7. [C] :At least one of these options is incorrect. Review section 7.7. [E] :At least one of these options is incorrect. Review section ) The relationship between nominal returns, real returns, and inflation is described by the: [A] required rate of return. [B] yield to maturity. [C] Fisher effect. [D] risk premium. [E] term structure. [A] :This does not illustrate how nominal returns, real returns, and inflation are linked. Review section 7.6. [B] :This does not illustrate how nominal returns, real returns, and inflation are linked. Review section 7.6. [D] :This does not illustrate how nominal returns, real returns, and inflation are linked. Review section 7.6. [E] :This is partially correct, but there is a better answer. Review section ) J&&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 7 percent. If the bond has a life of 30 years, pays annual coupons, and the yield to maturity is 6.8 percent, what percent of the bond's price is the present value of the coupons? [A] 85.7 percent [B] 86.1 percent [C] 86.4 percent [D] 93.0 percent [E] percent [A] :You need to first find the price of the bond. Did you find it to be $1,025.32? Then compute the present value of the coupons alone. Review section 7.1. [B] :You need to first find the price of the bond. Did you find it to be $1,025.32? Then compute the present value of the coupons alone. Review section 7.1. [D] :You need to first find the price of the bond. Did you find it to be $1,025.32? Then compute the present value of the coupons alone. Review section 7.1. [E] :You need to first find the price of the bond. Did you find it to be $1,025.32? Then compute the present value of the coupons alone. Review section 7.1.

17 55) Assume you are considering two bonds identical in every way except for coupon frequency. Bond A pays interest annually while bond B pays interest semiannually. Then, if they have the same price and sell at a premium over par, the yield-to-maturity on bond A will always be greater than that on bond B. [A] :Do you think investors prefer to receive interest payments more or less frequently? Review section ) A (an) bond generally has a put option and also a "collar". [A] floating rate [B] act of God [C] zero-coupon [D] junk [E] convertible [B] :These bonds do not typically carry put and collar features. Review section 7.4. [C] :These bonds do not typically carry put and collar features. Review section 7.4. [D] :These bonds do not typically carry put and collar features. Review section 7.4. [E] :These bonds do not typically carry put and collar features. Review section ) Moody's and Standard and Poor's primarily consider interest rate risk rather than default risk when they rate debt. [A] :They consider default risk, not interest rate risk. Review section ) Which of the following factors affect the term structure of interest rates? I. expected rate of inflation II. interest rate risk premium III. real rate of interest [A] I only [B] II only [C] I and II only [D] I and III only [E] I, II, and III [A] :Correct, but at least one other choice is also correct. Review section 7.7. [B] :Correct, but at least one other choice is also correct. Review section 7.7. [C] :What is the third factor included in the term structure? Review section 7.7. [D] :What is the third factor included in the term structure? Review section 7.7.

18 59) The rating given to income bonds on which no interest is being paid is a(n): [A] F. [B] D. [C] C. [D] Ca. [E] B. [A] :There is no such bond rating. Review section 7.3. [B] :This rating is not reserved only for income bonds. Review section 7.3. [D] :This rating is not reserved only for income bonds. Review section 7.3. [E] :This rating is not reserved only for income bonds. Review section ) The term structure of interest rates is the relationship between real interest rates on default-free, pure discount securities and time to maturity. [A] :The term structure relates nominal interest rates and time to maturity. Review section ) King Noodles' bonds have a 7.5 percent coupon rate. Interest is paid quarterly and the bonds have a maturity of 8 years. If the appropriate discount rate is 8 percent on similar bonds, what is the value of King Noodles' bonds? [A] $ [B] $ [C] $ [D] $ [E] $ [B] :Note that coupons are paid quarterly so there are 32 coupon payments rather than 8 or 16. Review section 7.1. [C] :Note that coupons are paid quarterly so there are 32 coupon payments rather than 8 or 16. Review section 7.1. [D] :Note that coupons are paid quarterly so there are 32 coupon payments rather than 8 or 16. Review section 7.1. [E] :Note that coupons are paid quarterly so there are 32 coupon payments rather than 8 or 16. Review section ) Carson Productions is going to issue 15-year, $1,000 par, zero-coupon bonds. The required return on bonds in this risk class is 8.94 percent. How much will the firm receive (ignoring issuance costs) for each bond? [A] $ [B] $ [C] $ [D] $ [E] $526.08

19 [A] :You need to review this computation in sections 7.1 and 7.4. [B] :You need to review this computation in sections 7.1 and 7.4. [D] :You need to review this computation in sections 7.1 and 7.4. [E] :You need to review this computation in sections 7.1 and ) D&&G Enterprises issues bonds with a $1,000 face value that pay coupon payments of $30 every 3 months. What is the coupon rate? [A] 0.30 percent [B] 3.00 percent [C] 6.00 percent [D] 9.00 percent [E] percent [A] :The coupon rate is 3 percent per quarter, and there are four quarters in a year. Review section 7.1. [B] :The coupon rate is 3 percent per quarter, and there are four quarters in a year. Review section 7.1. [C] :The coupon rate is 3 percent per quarter, and there are four quarters in a year. Review section 7.1. [D] :The coupon rate is 3 percent per quarter, and there are four quarters in a year. Review section ) Bond yields and prices move inversely with one another. [B] :Your answer indicates that when the yield-to-maturity rises, the bond price also rises, which is incorrect. Review section ) is an unsecured obligation of the issuing company. [A] An indenture [B] A debenture [C] A covenant [D] The deed of trust [E] Dedicated capital [A] :This is not the correct definition of an indenture. Review section 7.2. [C] :This is not the correct definition of a covenant. Review section 7.2. [D] :Please try again! Review section 7.2. [E] :Please try again! Review section ) All else equal, the market value of a corporate bond is always inversely related to its: I. time to maturity. II. coupon rate. III. yield-to-maturity.

20 [A] I only [B] II only [C] III only [D] I and III only [E] I, II, and III [A] :How a bond's price changes as time to maturity changes depends on whether the bond sells for a premium or a discount. Review section 7.1. [B] :The value of a bond is directly related to the coupon rate, not inversely related. Review section 7.1. [D] :At least one of these statements is incorrect. Review section 7.1. [E] :At least one of these statements is incorrect. Review section ) J&&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 7 percent. If the bond has a life of 30 years, pays annual coupons, and the yield to maturity is 6.8 percent, what percent of the bond's price is the present value of the bond s face value? [A] 7.0 percent [B] 13.6 percent [C] 13.9 percent [D] 14.3 percent [E] percent [A] :You need to first find the price of the bond. Did you find it to be $1,025.32? Then compute the present value of the face value itself. Review section 7.1. [C] :You need to first find the price of the bond. Did you find it to be $1,025.32? Then compute the present value of the face value itself. Review section 7.1. [D] :You need to first find the price of the bond. Did you find it to be $1,025.32? Then compute the present value of the face value itself. Review section 7.1. [E] :You need to first find the price of the bond. Did you find it to be $1,025.32? Then compute the present value of the face value itself. Review section ) If investors require a 7 percent nominal return and the expected inflation rate is 3 percent, what is the expected real return? [A] 1.04 percent [B] 3.00 percent [C] 3.88 percent [D] 4.25 percent [E] percent [A] :You need to review this computation in section 7.6. [B] :You need to review this computation in section 7.6. [D] :You need to review this computation in section 7.6. [E] :You need to review this computation in section ) If a firm is allowed to miss a coupon payment on a bond in a year in which it reports an operating loss, the bond is most likely a(n) bond. [A] put

21 [B] zero-coupon [C] income [D] floating-rate [E] callable [A] :The issuer is not allowed to miss payments on these bonds without going into default. Review section 7.4. [B] :There are no coupon payments on these bonds. Review section 7.4. [D] :The issuer is not allowed to miss payments on these bonds without going into default. Review section 7.4. [E] :The issuer is not allowed to miss payments on these bonds without going into default. Review section ) Which of the following items are included in the bond indenture? I. call provisions, if any II. sinking fund provisions, if any III. negative covenants, if any IV. description of the property used as security, if any [A] I and II only [B] I and III only [C] I, II, and IV only [D] II, III, and IV only [E] I, II, III, and IV [A] :Correct, but at least one more item is listed as well. Review section 7.2. [B] :Correct, but at least one more item is listed as well. Review section 7.2. [C] :Where would negative covenants be detailed if not in the bond indenture? Review section 7.2. [D] :Where would call provisions be detailed if not in the bond indenture? Review section ) If investors are uncertain that they will be able to sell a corporate bond quickly, the investors will demand a higher yield in the form of an increased: [A] inflation premium. [B] interest rate risk premium. [C] default risk premium. [D] liquidity risk premium. [E] real rate of interest. [A] :How does this premium relate to whether or not investors can sell a bond quickly? Review section 7.7. [B] :How does this premium relate to whether or not investors can sell a bond quickly? Review section 7.7. [C] :How does this premium relate to whether or not investors can sell a bond quickly? Review section 7.7. [E] :How does the real rate of interest relate to whether or not investors can sell a bond quickly? Review section ) Which one of the following is classified as a positive protective covenant? [A] The firm must furnish audited annual financial statements.

22 [B] The firm cannot pledge any assets to other lenders. [C] The firm must not issue additional long-term debt. [D] The firm cannot merge with another firm. [E] The firm must limit the amount of dividends it pays according to some formula. [B] :This is stated in the "thou shalt not" form. Is that how positive covenants are stated? Review section 7.2. [C] :This is stated in the "thou shalt not" form. Is that how positive covenants are stated? Review section 7.2. [D] :This is stated in the "thou shalt not" form. Is that how positive covenants are stated? Review section 7.2. [E] :Isn t this limiting something a firm can do? Placing limitations is part of the "thou shalt not" restrictions, which are negative covenants. Review section ) You purchased a bond a year ago for $ and just received the annual coupon of $80. You sell the bond today for $ What is the real return if inflation for the year is 5 percent? [A] 3.14 percent [B] 6.02 percent [C] 6.47 percent [D] 9.80 percent [E] percent [B] :Did you get a nominal return of 8.3 percent? Review section 7.6. [C] :Did you get a nominal return of 8.3 percent? Review section 7.6. [D] :Did you get a nominal return of 8.3 percent? Review section 7.6. [E] :Did you get a nominal return of 8.3 percent? Review section ) Suppose you are trying to evaluate a bond. Which one of the following is FALSE? [A] The lower the discount rate, the more valuable the coupon payments are at t = 0. [B] All else equal, bonds with high coupon payments are generally more sensitive to changes in interest rates than bonds with lower coupon payments. [C] All else equal, when market interest rates rise, bond prices will fall. [D] All else equal, bonds with long maturities are generally more sensitive to changes in interest rates than bonds with shorter maturities. [E] All else equal, bonds with larger coupon payments will have a higher value at t = 0. [A] :This relates to how bond prices change as yields change. Review section 7.1. [C] :Note that market interest rates and yields to maturity are the same thing. Review section 7.1. [D] :This is a correct statement of interest rate risk. Review section 7.1. [E] :In general, the higher the cash flows the more valuable the financial asset. Review section ) The component of the term structure of interest rates does not influence the shape of the term structure, rather it affects the overall level of interest rates. [A] inflation premium [B] interest rate risk premium [C] real rate of interest [D] default risk premium [E] liquidity premium

23 [A] :Doesn't this add either an upward or downward slope to the term structure? Review section 7.7. [B] :Doesn't this add an upward slope to the term structure? Review section 7.7. [D] :The term structure is created using default-free bonds. Review section 7.7. [E] :The liquidity premium is not a factor in the basic term structure of interest rates. Review section ) J&&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 7 percent. If the bond has a life of 30 years, pays annual coupons, and the yield to maturity is 6.8 percent, what is the present value of the bond's coupons? [A] $ [B] $ [C] $ [D] $ [E] $1, [A] :You need to review this computation in section 7.1. [B] :You need to review this computation in section 7.1. [D] :You need to review this computation in section 7.1. [E] :You need to review this computation in section ) A bond is reported in the Wall Street Journal as having an estimated spread of 101. This means that the bond a comparable Treasury security. [A] is priced at $1.01 over the price of [B] yields 1.01 basis points over [C] yields 1.01 percent more than [D] has a coupon rate that is 1.01 basis points higher than [E] has a coupon rate that is 1.01 percent higher than [A] :Are spreads related to prices or yields? Review section 7.5. [B] :The spread is listed at 101 not 1.01 basis points. Review section 7.5. [D] :Are coupon rates and yields always the same? Review section 7.5. [E] :Are coupon rates and yields always the same? Review section ) A bond with a face value of $1,000 has annual coupon payments of $100 and was issued 7 years ago. The bond currently sells for $1,000 and has 8 years left to maturity. This bond's must be 10 percent. I. yield to maturity II. current yield III. coupon rate [A] I only [B] I and II only [C] III only [D] II and III only [E] I, II, and III [A] :Correct, but at least one other choice is correct as well. Review section 7.1.

24 [B] :If the yield to maturity and current yield are the same, how can the coupon rate differ from these two? Review section 7.1. [C] :Correct, but at least one other choice is correct as well. Review section 7.1. [D] :If the current yield and coupon rate are the same, how can the yield to maturity differ from these two? Review section ) Cornerstone Industries has a bond outstanding that has a 7 percent coupon rate and a market price of $ If the bond matures in 5 years and interest is paid on a semi-annual basis, what is the yield to maturity on the bond? [A] 4.9 percent [B] 5.5 percent [C] 7.5 percent [D] 9.9 percent [E] 14.9 percent [A] :This choice is irrational since the bond sells at a discount, meaning the yield must exceed the coupon rate. Review section 7.1. [B] :This choice is irrational since the bond sells at a discount, meaning the yield must exceed the coupon rate. Review section 7.1. [C] :You need to review this calculation in section 7.1. [E] :You need to review this calculation in section ) The return that measures the percentage change in one's purchasing power is the return. [A] real [B] nominal [C] yield to maturity [D] holding period [E] inflated [B] :This is a measure of the percentage change in the amount of dollars one has. Review section 7.6. [C] :This does not correctly complete the sentence. Review section 7.6. [D] :This does not correctly complete the sentence. Review section 7.6. [E] :This does not correctly complete the sentence. Review section ) Assume the required return on a zero-coupon bond will remain constant over the remainder of its life. The market value of the bond will each year by an amount equal to the : [A] increase; imputed coupon rate for the period. [B] increase; imputed interest for the period. [C] increase; bond's current yield. [D] decrease; the bond's yield to maturity. [E] decrease; bond s discount. [A] :The imputed rate on a zero-coupon bond is not called an imputed coupon rate. Review section 7.4. [C] :A zero-coupon bond has a current yield of zero. Review section 7.4.

25 [D] :If the bond price decreases each year, what would it be worth immediately prior to maturity? Review section 7.4. [E] :If the bond price decreases each year, what would it be worth immediately prior to maturity? Review section ) You presently own a bond that you purchased one year ago. Your return on the bond for the past year was 12 percent. You calculated your real return as 9.27 percent. The rate of inflation for last year was percent. [A] 1.10 [B] 2.23 [C] 2.34 [D] 2.50 [E] 3.82 [A] :You need to review the Fisher effect in section 7.6. [B] :You need to review the Fisher effect in section 7.6. [C] :You need to review the Fisher effect in section 7.6. [E] :You need to review the Fisher effect in section ) "Unfunded debt" refers to long-term debt. [A] :This is the term sometimes used when referring to short-term debt. Review section ) Your firm seeks to obtain a short-term loan from a local bank. The banker quotes you a rate of 9 percent. This is a real rate of interest. [A] :Are most rates quoted as real rates or nominal rates? Review section ) An unsecured bond, for which no specific pledge of property is made, is called a: [A] collateral bond. [B] debenture. [C] mortgage bond. [D] registered bond. [E] bearer bond. [A] :Isn t a collateral bond secured by the collateral? Review section 7.2. [C] :Isn t a mortgage bond secured by property? Review section 7.2. [D] :How is a registered bond related to bond ownership? Review section 7.2. [E] :How is a bearer bond related to bond ownership? Review section 7.2.