Chapter 6: Interest Rates and Bond Valuation

 A corporate bond’s yield to maturity: changes over time / is usually not the same as a bond’s coupon rate.
 Assume a bond has a $1,000 par value, a coupon rate of 6 percent, annual interest payments, and 7 years to maturity. If the yield on
similar bonds is 8 percent, what is the current market value of this bond? $895.87
 Which of the following variables is NOT required to calculate the value of a bond? Original issue price of bond
 ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the
expected cash flows from one of these bonds? $60 in interest at the end of each year for 10 years and a $1,000 repayment of
principal at the end of 10 years.
 The degree of interest rate risk depends on the sensitivity of the bond’s price to interest rate changes.
 A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a call
provision.
 Equity represents a(n) ownership interest of a firm.
 As a general rule, which of the following are true of debt and equity? The maximum reward for owning debt is fixed / Equity
represents an ownership interest.
 What does historical data suggest about the nature of short-term interest rates? Sometimes short-term rates are higher and
sometimes long-term rates are higher.
 Which of the following terms apply to a bond? Time to maturity / Par value / Coupon rate
 The US government borrows money by issuing: Treasury notes / Treasury bonds

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 What does a Treasury yield curve show? It shows the yield for different maturities of Treasury notes and bonds

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 Which three of the following are common shapes for the term structure of interest rates? Upward sloping / downward sloping/

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 The relationship between nominal rates, real rates and inflation is called the Fisher Effect.
 What does the dirty price represent? It includes the quoted price and accrued interest.

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 What is the price of a U.S. Treasury bond that is listed at 90 if the par value is $1,000? $900
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What is the bid price? It is the price an investor will receive if he sells a bond to a dealer. / It is the price at which a dealer is willing
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to buy securities.
 What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100
per year? 10%
 What are the two major forms of long-term debt? Private issue / public issue
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 True or False: The price you actually pay to purchase a bond will generally exceed the clean price.
 If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond’s price will
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be more sensitive to interest rate risk? The 10-year bond

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 What will happen to a bond’s time to maturity as the years go by? It will decline
 If you are holding a municipal bond that is trading at par to yield 6%, by how much will your after-tax yield change if your federal
income tax bracket increases from 15% to 20%. Assume there are no states or local taxes. 0%
 What does a bond’s rating reflect? The ability of the firm to repay its debt and interest on time.
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 Which three components determine the shape of the term structure of interest rates? Interest rate risk premium / Real interest rate
/ Inflation premium
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 Most of the time, a floating-rate bond’s coupon adjusts with a lag to some base rate.
 Which type of debt is given preference in the event of default? Senior
 When using trial and error to compute the yield to maturity (YTM) for a 6 percent coupon bond that trades at a premium, the
process can be shortened if the initial guess is lower than 6 percent.
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 Junk bonds have the following features: They are rated below investment grade bonds.
 What is a discount bond? Discount bonds are bonds that sell for less than the face value.
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 What are crossover bonds? Bonds that have both an investment grade and a junk bond rating.
 Why is the bond market less transparent than the stock market? Many bond transactions are negotiated privately.
 A key difference between interest payments and dividends payments is? Dividends are not tax deductible / interest is tax deductible
 A part of the indenture limiting certain actions during the term of the loan are termed protective covenants.
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 A limitation of bond ratings is that they focus exclusively on default risk.

 True or False: A debenture is a bond secured with collateral.
 Which of the following is the most important source of risk from owning bonds? Market interest rate fluctuations
 Which of the following is not a difference between debt and equity? Equity is publicly traded while debt is not
 Which of the following are bonds that have actually been issued? A convertible bond / A CoCo bond / A put bond
 Which of the following are usually included in a bond’s indenture? The total amount of bonds issued / The repayment arrangements
 Which of the following are true about a bond’s face value? It is the principal amount repaid at maturity./ It is also known as the par
value.

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  Which of the following are features of municipal bonds? The interest on municipal bonds is exempt from federal taxes. / The
interest on municipal bonds is, in some cases exempt from state taxes in the state of issue. / They are issued by state and local
governments.
 Which of the following may increase the yield on corporate bonds as compensation to investors but will not impact Treasury bond
yields? Liquidity premium / Default risk premium
 What four variables are required to calculate the value of a bond? Par value / Coupon rate / Time remaining to maturity / Yield to
maturity
 What is the nominal rate or return on an investment? It is the percentage change in the dollar value of an investment.
 What is a real rate of return? It is a rate of return that has been adjusted for inflation. / It is a percentage change in buying power.
 What is a bond’s current yield? Current yield=Annual coupon payment/Price
 What are some features of the OTC market for bonds? OTC dealers are connected electronically / The OTC has no designated
physical location
 What are the two unique features of a U.S. federal government bond? U.S. Treasury issues are considered to be default-free / U.S.
Treasury issues are exempt from state income taxes.
 What are “fallen angel” bonds? Bonds that have dropped from investment grade to junk bond status.
 A zero-coupon bond is a bond that makes no interest payments
 What is the current yield on a $1,000 par value bond that sells for $900 if the coupon rate is 10 percent? 11.11%
 A corporation issues 50,000 bonds at a face value of $1,000 each. The bonds mature in 5 years and have a coupon rate of 7 percent.
What will the total annual interest expense be for the corporation? 3.5 million

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 The sensitivity of a bond’s price to interest rate changes is dependent on which of the following two variables? Coupon rate / Time to

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maturity
 When interest rates in the market fall, bond values will increase because the present value of the bond’s remaining cash flows

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increases.
 Bond ratings are based on the probability of default risk, which is the risk that the bond’s issuer may not be able to make all the

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required payments.
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A bond with a BB rating has a higher risk of default than a bond with a BBB rating.
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