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Chapter 6. Interest Rates and Bond Valuation
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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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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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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