CH07TBV7

CHAPTER 7Interest Rates and Bond Valuation

I. DEFINITIONS

COUPONa 1. The stated interest payment, in dollars, made on a bond each period is called the

bond’s:a. coupon.b. face value.c. maturity.d. yield to maturity.e. coupon rate.

FACE VALUEb 2. The principal amount of a bond that is repaid at the end of the loan term is called the


MATURITYc 3. The specified date on which the principal amount of a bond is repaid is called the


YIELD TO MATURITYd 4. The rate of return required by investors in the market for owning a bond is called the:

a. coupon.b. face value.c. maturity.d. yield to maturity.e. coupon rate.

COUPON RATEe 5. The annual coupon of a bond divided by its face value is called the bond’s:

a. coupon.b. face value.c. maturity.d. yield to maturity.e. coupon rate.

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PAR BONDSa 6. A bond with a face value of $1,000 that sells for $1,000 in the market is called a _____

bond.a. par valueb. discountc. premiumd. zero coupone. floating rate

DISCOUNT BONDSb 7. A bond with a face value of $1,000 that sells for less than $1,000 in the market is

called a _____ bond.a. parb. discountc. premiumd. zero coupone. floating rate

PREMIUM BONDSc 8. A bond with a face value of $1,000 that sells for more than $1,000 in the market is

called a _____ bond.a. parb. discountc. premiumd. zero coupone. floating rate

UNFUNDED DEBTd 9. The unfunded debt of a firm is generally understood to mean the firm’s:

a. preferred stock.b. debts that mature in more than one year.c. debentures.d. debts that mature in less than one year.e. secured debt.

INDENTUREa 10. The written, legally binding agreement between the corporate borrower and the lender

detailing the terms of a bond issue is called the:a. indenture.b. covenant.c. terms of trade.d. form 5140.e. call provision.

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REGISTERED BONDSb 11. The form of bond issue in which the registrar of the company records ownership of

each bond, with relevant payments made directly to the owner of record, is called the _____ form.

a. new-issueb. registeredc. bearerd. debenturee. collateral

BEARER BONDSc 12. The form of bond issue in which the bond is issued without record of the owner’s

name, with relevant payments made directly to whoever physically holds the bond, is called the _____ form.

a. new-issueb. registeredc. bearerd. debenturee. collateral

DEBENTURESe 13. The unsecured debts of a firm with maturities greater than 10 years are most literally

called:a. unfunded liabilities.b. sinking funds.c. bonds.d. notes.e. debentures.

NOTESd 14. The unsecured debts of a firm with maturities less than 10 years are most literally

called:a. unfunded liabilities.b. sinking funds.c. bonds.d. notes.e. debentures.

SENIORITYe 15. In the event of default, _____ debt holders must give preference to more _____ debt

holders in the priority of repayment distributions.a. short-term; long-termb. long-term; short-termc. senior; juniord. senior; subordinatede. subordinated; senior

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SINKING FUNDa 16. An account managed by the bond trustee for early bond redemption payments is called

a:a. sinking fund.b. collateral payment account.c. deed in trust account.d. call provision.e. par value fund.

CALL PROVISIONb 17. An agreement giving the bond issuer the option to repurchase the bond at a specified

price prior to maturity is the _____ provision.a. sinking fundb. callc. seniorityd. collaterale. trustee

CALL PREMIUMc 18. The amount by which the call price exceeds the bond’s par value is the:

a. coupon rate.b. redemption value.c. call premium.d. original-issue discount.e. call rate.

DEFERRED CALL PROVISIONd 19. A deferred call provision refers to the:

a. open market price of a callable bond on a certain date.b. seniority of callable bonds to noncallable bonds in the event of corporate default.c. prohibition of a company from ever redeeming callable bonds.d. prohibition of a company from redeeming callable bonds prior to a certain date.e. amount by which the call price for a callable bond exceeds its par value.

PROTECTIVE COVENANTe 20. Parts of the indenture limiting certain actions that might be taken during the term of

the loan to protect the interests of the lender are called:a. trustee relationships.b. sinking funds provisions.c. bond ratings.d. deferred call provisions.e. protective covenants.

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TREASURY BONDSa 21. The long-term bonds issued by the United States government are called _____ bonds.

a. Treasuryb. municipalc. floating-rated. junke. zero coupon

MUNICIPAL BONDSb 22. The long-term bonds issued by state and local governments in the United States are

called _____ bonds.a. Treasuryb. municipalc. floating-rated. junke. zero coupon

ZERO COUPON BONDSe 23. A bond that makes no coupon payments and is initially priced at a deep discount is

called a _____ bond.a. Treasuryb. municipalc. floating-rated. junke. zero coupon

FLOATING-RATE BONDSc 24. A bond that pays a variable amount of coupon interest over time is called a _____

bond.a. Treasuryb. municipalc. floating-rated. junke. zero coupon

CONVERTIBLE BONDSd 25. A bond which, at the election of the holder, can be swapped for a fixed number of

shares of common stock at any time prior to the bond’s maturity is called a _____ bond.

a. zero couponb. callablec. putabled. convertiblee. warrant

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PRICE TRANSPARENCYa 26. A financial market is _____ if it is possible to easily observe its prices and trading

volume.a. transparentb. openc. orderedd. in equilibriume. chaotic

CURRENT YIELDb 27. The annual coupon payment of a bond divided by its market price is called the:

a. coupon rate.b. current yield.c. yield to maturity.d. bid-ask spread.e. capital gains yield.

BID PRICESc 28. The price a dealer is willing to pay for a security held by an investor is called the:

a. equilibrium price.b. ask price.c. bid price.d. bid-ask spread.e. auction price.

ASK PRICESd 29. The price a dealer is willing to accept for selling a security to an investor is called the:

a. equilibrium price.b. auction price.c. bid price.d. ask price.e. bid-ask spread.

NOMINAL RATESe 30. Interest rates or rates of return on investments that have not been adjusted for the

effects of inflation are called _____ rates.a. couponb. strippedc. effectived. reale. nominal

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REAL RATESa 31. Interest rates or rates of return on investments that have been adjusted for the effects of

inflation are called _____ rates.a. realb. nominalc. effectived. strippede. coupon

FISHER EFFECTb 32. The relationship between nominal rates, real rates, and inflation is known as the:

a. Miller and Modigliani theorem.b. Fisher effect.c. Gordon growth model.d. term structure of interest rates.e. interest rate risk premium.

TERM STRUCTURE OF INTEREST RATESc 33. The relationship between nominal interest rates on default-free, pure discount securities

and the time to maturity is called the:a. liquidity effect.b. Fisher effect.c. term structure of interest rates.d. inflation premium.e. interest rate risk premium.

INFLATION PREMIUMd 34. The _____ premium is that portion of a nominal interest rate or bond yield that

represents compensation for expected future overall price appreciation.a. default riskb. taxabilityc. liquidityd. inflatione. interest rate risk

DEFAULT RISK PREMIUMa 35. The _____ premium is that portion of a nominal interest rate or bond yield that

represents compensation for the possibility of nonpayment by the bond issuer.a. default riskb. taxabilityc. liquidityd. inflatione. interest rate risk

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II. CONCEPTS

BOND FEATURESd 36. A bond with a 7 percent coupon that pays interest semi-annually and is priced at par

will have a market price of _____ and interest payments in the amount of _____ each.a. $1,007; $70b. $1,070; $35c. $1,070; $70d. $1,000; $35e. $1,000; $70

BOND PRICES AND YIELDSe 37. All else constant, a bond will sell at _____ when the yield to maturity is _____ the

coupon rate.a. a premium; higher thanb. a premium; equal toc. at par; higher thand. at par; less thane. a discount; higher than

BOND PRICES AND YIELDSd 38. All else constant, a coupon bond that is selling at a premium, must have:

a. a coupon rate that is equal to the yield to maturity.b. a market price that is less than par value.c. semi-annual interest payments.d. a yield to maturity that is less than the coupon rate.e. a coupon rate that is less than the yield to maturity.

BOND PRICESc 39. The market price of a bond is equal to the present value of the:

a. face value minus the present value of the annuity payments.b. annuity payments plus the future value of the face amount.c. face value plus the present value of the annuity payments.d. face value plus the future value of the annuity payments.e. annuity payments minus the face value of the bond.

BOND PRICESa 40. As the yield to maturity increases, the:

a. amount the investor is willing to pay to buy a bond decreases.b. longer the time to maturity.c. lower the coupon rate desired by that investor.d. higher the price the investor offers to buy a bond.e. lower the rate of return desired by the investor.

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SEMIANNNUAL BONDSe 41. American Fortunes is preparing a bond offering with an 8 percent coupon rate. The

bonds will be repaid in 10 years. The company plans to issue the bonds at par value and pay interest semiannually. Given this, which of the following statements are correct?

I. The initial selling price of each bond will be $1,000.II. After the bonds have been outstanding for 1 year, you should use 9 as the number of

compounding periods when calculating the market value of the bond.III. Each interest payment per bond will be $40.IV. The yield to maturity when the bonds are first issued is 8 percent.a. I and II onlyb. II and III onlyc. II, III, and IV onlyd. I, II, and III onlye. I, III, and IV only

SEMIANNUAL BONDS AND EFFECTIVE ANNUAL RATEd 42. The newly issued bonds of the Wynslow Corp. offer a 6 percent coupon with

semiannual interest payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be:

a. equal to 3 percent.b. greater than 3 percent but less than 4 percent.c. equal to 6 percent.d. greater than 6 percent but less than 7 percent.e. equal to 12 percent.

INTEREST RATE RISKd 43. Which one of the following statements is correct concerning interest rate risk as it

relates to bonds, all else equal?a. The shorter the time to maturity, the greater the interest rate risk.b. The higher the coupon rate, the greater the interest rate risk.c. For a bond selling at par value, there is no interest rate risk.d. The greater the number of semiannual interest payments, the greater the interest rate

risk.e. The lower the amount of each interest payment, the lower the interest rate risk.

INTEREST RATE RISKe 44. Which one of the following bonds has the greatest interest rate risk?

a. 5-year; 9 percent couponb. 5-year; 7 percent couponc. 7-year; 7 percent coupond. 9-year; 9 percent coupone. 9-year; 7 percent coupon

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INTEREST RATE RISKb 45. Interest rate risk _____ as the time to maturity increases.

a. increases at an increasing rateb. increases at a decreasing ratec. increases at a constant rated. decreases at an increasing ratee. decreases at a decreasing rate

INTEREST RATE RISKc 46. You own a bond that has a 7 percent coupon and matures in 12 years. You purchased

this bond at par value when it was originally issued. If the current market rate for this type and quality of bond is 7.5 percent, then you would expect:

a. the bond issuer to increase the amount of each interest payment on these bonds.b. the yield to maturity to remain constant due to the fixed coupon rate.c. to realize a capital loss if you sold the bond at the market price today.d. today’s market price to exceed the face value of the bond.e. the current yield today to be less than 7 percent.

INTEREST RATE RISKc 47. You expect interest rates to decline and wish to capitalize on the anticipated changes in

bond prices. To realize your maximum gain, all else constant, you should purchase _____ bonds.

a. short-term; low couponb. short-term; high couponc. long-term; zero coupond. long-term; low coupone. long-term; high coupon

YIELD TO MATURITY AND CURRENT YIELDe 48. All else constant, as the market price of a bond increases the current yield _____ and

the yield to maturity _____a. increases; increases.b. increases; decreases.c. remains constant; increases.d. decreases; increases.e. decreases; decreases.

BOND FEATURESd 49. Which of the following statements concerning bond features is (are) correct?

I. Bondholders generally have voting power in a corporation.II. Bond interest is tax-deductible as a business expense.III. The repayment of the bond principle is tax-deductible.IV. Failure to pay either the interest payments or the bond principle as agreed can cause a

firm to go into bankruptcy.a. II onlyb. I and II onlyc. III and IV onlyd. II and IV onlye. II, III, and IV only

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BOND INDENTUREd 50. Which of the following items are generally included in a bond indenture?

I. call provisionsII. security descriptionIII. current yieldIV. protective covenantsa. I and II onlyb. II and IV onlyc. II, III, and IV onlyd. I, II, and IV onlye. I, II, III, and IV

BOND CLASSIFICATIONSe 51. Which one of the following statements is correct concerning bond classifications?

a. A debenture is a long-term bond secured by the fixed assets of a firm.b. A mortgage security is a bond issued solely by a home builder.c. A note is a bond which has an original maturity date longer than 10 years.d. A subordinated bond receives preferential treatment over all other bonds in a

bankruptcy.e. A callable bond can be repurchased by the issuer prior to the initial maturity date.

CALLABLE BONDSb 52. Callable bonds generally:

a. allow the bondholder to decide when the bond is to be called.b. are associated with sinking funds.c. permit the issuer to repurchase the bonds at a discount.d. are called within the first couple of years after issuance.e. are required to have a deferred call provision if they have a “make-whole” call

provision.

PROTECTIVE COVENANTSc 53. Which of the following is a (are) positive covenant(s) that might be found in a bond

indenture?I. The company shall maintain a current ratio of 1.5 or better.II. The company must limit the amount of dividends it pays according to the stated

formula.III. The company cannot lease any major assets without approval by the lender.IV. The company must maintain the loan collateral in good working order.a. I onlyb. I and II onlyc. I and IV onlyd. II and IV onlye. I, II, and IV only

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PROTECTIVE COVENANTSe 54. Protective covenants:

a. are primarily designed to protect the issuing corporation from unreasonable demands of bondholders.

b. are consistent for all bonds issued by a corporation within the United States.c. are limited to stating actions which a firm must take.d. only apply to bonds that have a deferred call provision.e. are primarily designed to protect bondholders from future actions of the bond issuer.

BOND RATINGSb 55. Which one of the following statements concerning bond ratings is correct?

a. Standard and Poor’s and Value Line are the primary bond rating agencies.b. Bond ratings are solely an assessment of the creditworthiness of the bond issuer.c. Investment grade bonds include only those bonds receiving one of the highest three

bond ratings.d. Bond ratings evaluate the expected price volatility of a bond issue.e. All bonds receive the same rating classification from all rating agencies.

BOND RATINGSd 56. A “fallen angel” is a bond that:

a. lowered its annual interest payment.b. has moved from being a long-term obligation to being a short-term obligation.c. has moved from having a yield to maturity in excess of the coupon rate to having a

yield to maturity that is less than the coupon rate.d. has moved from being an investment-grade bond to being a junk bond.e. is rated as Ba by one rating agency and rated as BB by another rating agency.

TREASURY BONDSa 57. Bonds issued by the U.S. government:

I. are considered to be free of default risk.II. are considered to be free of interest rate risk.III. provide totally tax-free income.IV. pay interest that is exempt from federal income taxes.a. I onlyb. I and III onlyc. I and IV onlyd. II and III onlye. II and IV only

TREASURY BONDSd 58. Treasury bonds are:

a. those bonds issued by any governmental agency in the U.S.b. issued only on the first day of each fiscal year by the U.S. Department of Treasury.c. preferred by high-income individuals because they offer the best tax benefits.d. generally issued as coupon bonds.e. totally risk-free.

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MUNICIPAL BONDSa 59. Municipal bonds:

a. offer income tax advantages to individuals.b. generally pay a higher rate of return than corporate bonds.c. are those bonds issued only by local municipalities, such as a city or a borough.d. are rarely callable.e. pay interest that is always exempt from both federal and state income taxes.

TAXABLE VERSUS MUNICIPAL BONDSd 60. The break-even tax rate between a taxable corporate bond yielding 7 percent and a

comparable nontaxable municipal bond yielding 5 percent can be expressed as:a. .07 (1 - t*) = .05.b. .05 (1 - t*) = .07.c. .07 + (1 - t*) = .05.d. .07 (1 - t*) = .05.e. .05 (1 - t*) = .07.

ZERO COUPON BONDSe 61. A zero coupon bond:

a. is sold at a large premium.b. has a price equal to the future value of the face amount given a specified rate of

return.c. can only be issued by the U.S. Treasury.d. has less interest rate risk than a comparable coupon bond.e. has implicit interest which is calculated by amortizing the loan.

ZERO COUPON BONDSb 62. The total interest paid on a zero-coupon bond is equal to:

a. zero.b. the face value minus the issue price.c. the face value minus the market price on the maturity date.d. $1,000 minus the face value.e. $1,000 minus the par value.

FLOATING-RATE BONDSd 63. The collar of a floating-rate bond refers to the minimum and maximum:

a. call periods.b. maturity dates.c. market prices.d. coupon rates.e. yields to maturity.

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FLOATING-RATE BONDSd 64. Which of the following are common characteristics of floating-rate bonds?

I. adjustable coupon ratesII. adjustable maturity datesIII. put provisionIV. coupon capa. I and II onlyb. II and III onlyc. I, II, and IV onlyd. I, III, and IV onlye. I, II, III, and IV

FLOATING RATE BONDSc 65. A corporation is more prone to issue floating-rate bonds when they expect future

interest rates to _____ over the life of the bond.a. remain constantb. increase briefly and then decline slightlyc. continually declined. decline briefly and then increase significantlye. continually increase

CATASTROPHE BONDSe 66. “Cat” bonds are primarily designed to help:

a. cities recover from economic recessions.b. corporations recover from overseas competition.c. the federal government cope with huge deficits.d. animal food producers raise capital to compete internationally.e. insurance companies recover from natural disasters.

TYPES OF BONDS AND INVESTOR PREFERENCESc 67. Investors generally tend to buy:

a. Treasury bonds for their high yields.b. municipal bonds for their high yields.c. convertible bonds for their potential price appreciation.d. corporate bonds for their liquidity.e. Treasury bonds for their preferential tax treatment.

TYPES OF BONDSb 68. A convertible bond is a bond that can be:

a. exchanged for cash at prescribed points in time.b. exchanged for a stated number of shares of common stock of the bond issuer.c. modified from a fixed coupon bond into a floating coupon bond at prescribed points in

time.d. submitted to the issuer for redemption at the discretion of the bondholder.e. submitted for payment any time the economy converts into a recessionary period.

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PUT PROVISIONc 69. A put provision in a bond indenture allows:

a. a bond issuer to recall the bond after a specified period of time at a price that exceeds the face amount.

b. a bondholder to force the issuer to increase the coupon rate if inflation increases by more than a specified amount.

c. the bondholder to force the issuer to buy back the bond at a specified price prior to maturity.

d. the issuer to convert a coupon bond into a zero coupon bond at their discretion.e. the issuer to suspend interest payments for any year in which the interest expense

exceeds the net income of the firm.

BOND TRADINGb 70. If you want to sell a bond issued by a smaller corporation, you:

a. can always do so quite easily by trading it on the New York Stock Exchange.b. may encounter difficulties in executing the trade.c. can usually do so quite efficiently due to the high liquidity of the bond market.d. can do so quite quickly due to the high volume of trading in the bond markets.e. will most likely trade in an auction market, such as the New York Stock Exchange.

BASIS POINTa 71. One basis point is equal to:

a. .01 percent.b. .10 percent.c. 1.0 percent.d. 10 percent.e. 100 percent.

CORPORATE BOND QUOTEc 72. The “EST SPREAD” shown in The Wall Street Journal listing of corporate bonds

represents the estimated:a. yield to maturity.b. difference between the current yield and the yield to maturity.c. difference between the bond’s yield and the yield of a particular Treasury issue.d. range of yields to maturity provided by the bond over its life to date.e. difference between the yield to call and the yield to maturity.

TREASURY BOND QUOTEe 73. A Treasury bond that is quoted at 100:07 is selling:

a. at 7 percent over the face amount.b. at a 7 percent discount.c. at a 7 percent premium.d. at par and pays a 7 percent coupon.e. for about $2.19 over face value.

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TREASURY BONDSb 74. As of 2004, the longest maturity Treasury security currently being issued is the:

a. 5-year note.b. 10-year note.c. 15-year bond.d. 20-year bond.e. 30-year bond.

BID VERSUS ASKED PRICESa 75. A Treasury bond has an asked quote of 100:12 and a bid quote of 100:11. One bond:

a. can be purchased at a price of $1,003.75.b. can be sold at a price of $1,003.75.c. has a spread of 10 basis points.d. has a yield to maturity that lies between 11 and 12 percent.e. can be sold to a dealer at a price of $1,001.10.

CLEAN VERSUS DIRTY PRICESc 76. Today, August 13, you want to buy a bond with a quoted price of 101.5. The bond

pays interest on February 1 and August 1. The price you will pay to purchase this bond is equal to the:

a. clean price.b. muddy price.c. dirty price.d. par value price.e. bid price.

REAL RATE OF RETURNd 77. The increase you realize in buying power as a result of owning a bond is referred to as

the _____ rate of return.a. inflated b. realizedc. nominald. reale. risk-free

FISHER EFFECTe 78. The Fisher formula is expressed as:

a. 1 + r = (1 + R) (1 + h).b. 1 + r = (1 + R) (1 + h).c. 1 + h = (1 + r) (1 + R).d. 1 + R = (1 + r) (1 + h).e. 1 + R = (1 + r) (1 + h).

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FISHER EFFECTd 79. The Fisher Effect primarily emphasizes the effects of _____ risk on an investor’s rate

of return.a. defaultb. marketc. interest rated. inflatione. maturity

TERM STRUCTURE OF INTEREST RATESa 80. The term structure of interest rates reflects the:

a. pure time value of money for various lengths of time.b. actual risk premium being paid for corporate bonds of varying maturities.c. pure inflation adjustment applied to bonds of various maturities.d. interest rate risk premium applicable to bonds of varying maturities.e. nominal interest rates applicable to coupon bonds of varying maturities.

TERM STRUCTURE OF INTEREST RATESd 81. Which of the following statements are correct concerning the term structure of interest

rates?I. The outlook for future inflation influences the shape of the term structure of interest

rates.II. The term structure of interest rates includes only the real rate of return and the

inflation premium.III. The interest rate risk premium is included in the term structure of interest rates.IV. The term structure of interest rates can be downsloping.a. I and II onlyb. II and IV onlyc. III and IV onlyd. I, III, and IV onlye. I, II, and IV only

CORPORATE VERSUS TREASURY BONDSc 82. Two of the primary differences between a corporate bond and a Treasury bond with

identical maturity dates are related to:a. interest rate risk and time value of money.b. time value of money and inflation.c. taxes and potential default.d. taxes and inflation.e. inflation and interest rate risk.

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III. PROBLEMS

YIELD TO MATURITYc 83. The bonds issued by Jensen & Son bear a 6 percent coupon, payable semiannually. The

bond matures in 8 years and has a $1,000 face value. Currently, the bond sells at par. What is the yield to maturity?

a. 5.87 percentb. 5.97 percentc. 6.00 percentd. 6.09 percente. 6.17 percent

YIELD TO MATURITYa 84. A General Co. bond has an 8 percent coupon and pays interest annually. The face value

is $1,000 and the current market price is $1,020.50. The bond matures in 20 years. What is the yield to maturity?


YIELD TO MATURITYd 85. Winston Enterprises has a 15-year bond issue outstanding that pays a 9 percent

coupon. The bond is currently priced at $894.60 and has a par value of $1,000. Interest is paid semiannually. What is the yield to maturity?


PRICE OF COUPON BONDa 86. Wine and Roses, Inc. offers a 7 percent coupon bond with semiannual payments and a

yield to maturity of 7.73 percent. The bonds mature in 9 years. What is the market price of a $1,000 face value bond?

a. $953.28b. $953.88c. $1,108.16d. $1,401.26e. $1,401.86

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PRICE OF COUPON BONDc 87. Party Time, Inc. has a 6 percent coupon bond that matures in 11 years. The bond pays

interest semiannually. What is the market price of a $1,000 face value bond if the yield to maturity is 12.9 percent?

a. $434.59b. $580.86c. $600.34d. $605.92e. $947.87

PRICE OF COUPON BONDd 88. Gugenheim, Inc. offers a 7 percent coupon bond with annual payments. The yield to

maturity is 5.85 percent and the maturity date is 9 years. What is the market price of a

$1,000 face value bond?a. $742.66b. $868.67c. $869.67d. $1,078.73e. $1,079.59

TIME TO MATURITY OF COUPON BONDa 89. The Lo Sun Corporation offers a 6 percent bond with a current market price of

$875.05. The yield to maturity is 7.34 percent. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond matures?

a. 16 yearsb. 18 yearsc. 24 yearsd. 30 yearse. 36 years

TIME TO MATURITY OF COUPON BONDb 90. High Noon Sun, Inc. has a 5 percent, semiannual coupon bond with a current market

price of $988.52. The bond has a par value of $1,000 and a yield to maturity of 5.29 percent. How many years is it until this bond matures?

a. 4.0 yearsb. 4.5 yearsc. 6.5 yearsd. 8.0 yearse. 9.0 years

PRICE OF ZERO COUPONa 91. Your firm offers a 10-year, zero coupon bond. The yield to maturity is 8.8 percent.

What is the current market price of a $1,000 face value bond?a. $430.24b. $473.26c. $835.56d. $919.12e. $1,088.00

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PRICE OF ZERO COUPON BONDb 92. Ted’s Co. offers a zero coupon bond with an 11.3 percent yield to maturity. The bond

matures in 16 years. What is the current price of a $1,000 face value bond?a. $178.78b. $180.33c. $188.36d. $190.09e. $192.18

TIME TO MATURITY OF ZERO COUPON BONDc 93. The zero coupon bonds of Markco, Inc. have a market price of $394.47, a face value of

$1,000, and a yield to maturity of 6.87 percent. How many years is it until this bond matures?

a. 7 yearsb. 10 yearsc. 14 yearsd. 18 yearse. 21 years

INTEREST RATE RISKb 94. A 12-year, 5 percent coupon bond pays interest annually. The bond has a face value of

$1,000. What is the change in the price of this bond if the market yield rises to 6 percent from the current yield of 4.5 percent?

a. 11.11 percent decreaseb. 12.38 percent decreasec. 12.38 percent increased. 14.13 percent decreasee. 14.13 percent increase

INTEREST RATE RISKd 95. Jackson Central has a 6-year, 8 percent annual coupon bond with a $1,000 par value.

Earls Enterprises has a 12-year, 8 percent annual coupon bond with a $1,000 par value. Both bonds currently have a yield to maturity of 6 percent. Which of the following statements are correct if the market yield increases to 7 percent?

a. Both bonds would decrease in value by 4.61 percent.b. The Earls bond will increase in value by $88.25.c. The Jackson bond will increase in value by 4.61 percent.d. The Earls bond will decrease in value by 7.56 percent.e. The Earls bond will decrease in value by $50.68.

CURRENT YIELDa 96. D’Angelo’s bonds have a face value of $1,000 and a current market price of $1010.

The bonds have a 7 percent coupon rate. What is the current yield on these bonds?a. 6.93 percentb. 6.97 percentc. 7.00 percentd. 7.03 percente. 7.07 percent

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CURRENT YIELDd 97. Mitzi’s, II. Bonds offer a 6 percent coupon at a current market price of $989. The

bonds have a face value of $1,000 and a call price of $1,020. What is the current yield on these bonds?


CALL PREMIUMc 98. The bonds offered by Leo’s Pumps are callable in 3 years at a quoted price of 101.

What is the amount of the call premium on a $1,000 par value bond?a. $3.33b. $5.00c. $10.00d. $13.33e. $100.00

CORPORATE BOND QUOTEc 99. A corporate bond is quoted at a current price of 102.767. What is the market price of a

bond with a $1,000 face value?a. $1,000.28b. $1,002.77c. $1,027.67d. $1,102.77e. $1,276.70

ZERO COUPON BOND QUOTEc 100. A $1,000 face value zero coupon bond is quoted at a price of 43.30. What is the

amount you would pay to purchase this bond?a. $43.30b. $430.30c. $433.00d. $956.70e. $1,043.30

TREASURY BOND QUOTEb 101. A Treasury bond is quoted at a price of 106:13. What is the market price of this bond if

the face value is $1,000?a. $106.13b. $1,064.06c. $1,106.13d. $1,106.41e. $1,106.64

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TREASURY BOND QUOTE AND COUPON RATEc 102. A Treasury bond is quoted at a price of 101:00 with a current yield of 5.94 percent.

What is the coupon rate?a. 5.88 percentb. 5.94 percentc. 6.00 percentd. 6.06 percente. 6.88 percent

CORPORATE QUOTE AND CURRENT YIELDe 103. A corporate bond is quoted at a price of 98.625 with a 7.875 coupon. The bond pays

interest semiannually. What is the current yield on one of these bonds?a. 7.50 percentb. 7.76 percentc. 7.88 percentd. 7.97 percente. 7.98 percent

TREASURY QUOTE AND CURRENT YIELDa 104. A Treasury bond is quoted at a price of 103:23 with a 4.625 coupon. The bond pays

interest semiannually. What is the current yield on one of these bonds?a. 4.46 percentb. 4.54 percentc. 4.63 percentd. 4.68 percente. 4.74 percent

BID-ASK SPREADc 105. A Treasury bond is quoted as 101:18 asked and 101:16 bid. What is the bid-ask spread

in dollars on a $1,000 face value bond?a. $.02b. $.20c. $.625d. $2.00e. $6.25

EFFECTIVE ANNUAL RATES AND INTEREST PAYMENTSa 106. The semiannual, ten-year bonds of Adep, Inc. are selling at par and have an effective

annual yield of 4.295 percent. What is the amount of each interest payment on a $1,000 Adep bond?

a. $21.25b. $21.48c. $21.50d. $42.50e. $42.95

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FISHER EFFECTc 107. A bond that pays interest annually yields a 7.25 percent rate of return. The inflation

rate for the same period is 3.5 percent. What is the real rate of return on this bond?a. 3.50 percentb. 3.57 percentc. 3.62 percentd. 3.72 percente. 3.75 percent

FISHER EFFECTb 108. The bonds of Frank’s Welding, Inc. pay an 8 percent coupon, have a 7.98 percent yield

to maturity and have a face value of $1,000. The current rate of inflation is 2.5 percent. What is the real rate of return on these bonds?


FISHER EFFECTd 109. The outstanding bonds of Roy Thomas, Inc. provide a real rate of return of 3.6 percent.

The current rate of inflation is 2.5 percent. What is the nominal rate of return on these bonds?


FISHER EFFECTa 110. The nominal rate of return on the bonds of Stu’s Boats is 8.75 percent. The real rate of

return is 3.4 percent. What is the rate of inflation?a. 5.17 percentb. 5.28 percentc. 5.35 percentd. 5.43 percente. 5.49 percent

ZERO COUPON BOND AND IMPLICIT INTERESTc 111. A zero coupon bond with a face value of $1,000 is issued with an initial price of

$463.34. The bond matures in 25 years. What is the implicit interest, in dollars, for the first year of the bond’s life?

a. $9.08b. $12.56c. $14.48d. $21.47e. $31.25

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ZERO COUPON BOND PRICINGc 112. The MerryWeather Firm wants to raise $10 million to expand their business. To

accomplish this, they plan to sell 30-year, $1,000 face value zero-coupon bonds. The bonds will be priced to yield 6 percent. What is the minimum number of bonds they must sell to raise the $10 million they need?

a. 47,411b. 52,667c. 57,435d. 60,000e. 117,435

IV. ESSAYS

TREASURY YIELD CURVE113. Draw a graph of a typical Treasury yield curve and discuss why it usually takes that shape.

The student should draw a graph similar to the Treasury yield curve found in the text. Factors impacting the shape of the yield curve are the risk free rate, the inflation premium and the interest rate risk premium.

BOND YIELD PREMIUMS114. Explain why some bond investors are subject to liquidity risk, default risk, and/or taxability

risk. How do each of these risks affect the yield of a bond?

Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at their actual value. Default risk is the likelihood the corporation will default on its bond obligations. Taxability risk reflects the fact that some bonds are taxed disadvantageously compared to others. If any of these risks exist, investors will require compensation by demanding a high yield.

CROSSOVER BONDS115. Explain what a crossover bond is and the risks and expected rewards for investors when

they purchase such bonds.

A crossover bond is one that is rated investment grade by one rating agency and below investment grade by another. Since the ratings agencies disagree, investors must essentially take a position as to which one is correct. Given the added likelihood of default, investors should expect to earn a risk premium over investment grade bonds when purchasing crossovers.

INTEREST RATE RISK116. Define what is meant by interest rate risk. Assume you are the manager of a $100 million

portfolio of corporate bonds and you believe interest rates will fall. What adjustments should you make to your portfolio based on your beliefs?

Interest rate risk is the risk that arises for bond owners from fluctuating interest rates. All else the same, if interest rates are expected to fall you should purchase long-term bonds and/or low coupon bonds, and sell shorter-term, higher-coupon bonds.

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INTEREST RATE RISK AND THE ISSUER117. Why do corporations issue 100-year bonds, knowing that interest rate risk is highest for

very long-term bonds? How does the interest rate risk affect the issuer?

Essentially, the issuer takes the opposite side of the interest rate risk position. By issuing long-term bonds, the corporation is essentially betting that rates won’t fall significantly. If they do, the corporation will incur a loss due to borrowing at rates higher than the going market rates. On the other hand, if rates rise, the corporation benefits by having locked in its borrowing rate for up to 100 years. In addition, these bonds are a source of long-term financing where the cost, i.e. the interest, is tax deductible. If the firm should issue stocks, the cost, i.e. the dividends, are not tax deductible. This is why the IRS frowns on 100 year bonds.

YIELD CURVE118. In the early 1980s, the Treasury yield curve had a severe downward slope with short-term

yields near 20% and long-term yields below 15%. Explain how such a pattern might occur.

The downward slope occurs because the expected inflation premium is declining. The decline in the inflation premium is significant enough to overcome the interest rate risk premium.

BOND RATINGS119. Interest rate risk is often explained by using the concept of a teeter-totter. Explain interest

rate risk and how it is related to the movements of a teeter-totter.

Interest rates sit on one end of the teeter-totter while bond prices sit on the other end. As interest rates move up, bond prices move down as seen by the movements of a teeter-totter. Movement in the opposite direction also applies.

In addition, short-term bonds are located a short distance from the fulcrum while long-term bonds are situated towards the end of the teeter-totter illustrating that long-term bonds move further in reaction to a change in interest rates than do short-term bonds.

BOND VALUATION120. The discussion of asset pricing in the text suggests that an investor will be indifferent

between two bonds which have equal yields to maturity as long as they have equivalent default risk. Can you think of any real-world factors which might make a given investor prefer one of these bonds over the other?

Note that the question only implies the bonds have the same yields and bond ratings. There are the additional issues of taxability, liquidity and interest rate risk. Students should be able to recap the discussion on the determinants of bond yields found in section 7.7 of the text.

CH07TBV7

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