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Principles of Managerial Finance, 13e, Global Edition (Gitman) Chapter 6 Interest Rates and Bond Valuation 6.1 Describe interest rate fundamentals, the term structure of interest rates, and risk s. 1) The real rate of interest is the actual rate of interest charged by the suppliers of funds and paid by the demanders. Answer: FALSE Topic: Real Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills 2) The longer the maturity of a Treasury (or any other) security, the smaller the interest rate risk. Answer: FALSE Topic: Interest Rate Risk Question Status: Revised AACSB Guidelines: Reflective thinking skills 3) A downward-sloping yield curve indicates generally cheaper short-term borrowing costs than long-term borrowing costs. Answer: FALSE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 4) The nominal rate of interest is the rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where funds suppliers and demanders have no liquidity preference and all outcomes are certain. Answer: FALSE Topic: Nominal Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills 5) An inverted yield curve is an upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs. Answer: FALSE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 6) Although Treasury securities have no risk of default or illiquidity, they do suffer from "maturity risk"the risk that interest rates will change in the future and thereby impact longer maturities more than shorter maturities. Answer: TRUE Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills 1 Copyright © 2012 Pearson Education

7) The liquidity preference theory suggests that for any given issuer, long-term interest rates tend to be higher than short-term rates due to the lower liquidity and higher responsiveness to general interest rate movements of longer-term securities; this causes the yield curve to be upwardsloping. Answer: TRUE Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 8) The term structure of interest rates is the graphical presentation of the relationship between the annual rate of interest earned on a security purchased on a given day and held to maturity and the remaining time to maturity. Answer: FALSE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 9) An inverted yield curve is a downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs. Answer: TRUE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 10) A yield curve that reflects relatively similar borrowing costs for both short- and long-term loans is called a normal yield curve. Answer: FALSE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 11) Upward-sloping yield curves result from higher future inflation expectations, lender preferences for shorter maturity loans, and greater supply of short-term as opposed to long-term loans relative to their respective demand. Answer: TRUE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 12) The real rate of interest is the compensation paid by the borrower of funds to the lender. From the borrower's point of view, the real rate represents the cost of borrowing funds. Answer: FALSE Topic: Real Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills

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13) The nominal rate of interest is equal to the sum of the real rate of interest plus the risk free rate of interest. Answer: FALSE Topic: Nominal Rate of Interest Question Status: Revised AACSB Guidelines: Analytic skills 14) The risk free rate of interest is equal to the sum of the real rate of interest plus an inflation risk . Answer: TRUE Topic: Risk Free Rate of Interest Question Status: Revised AACSB Guidelines: Analytic skills 15) The nominal rate of interest is equal to the sum of the real rate of interest plus an inflation plus a risk . Answer: TRUE Topic: Nominal Rate of Interest Question Status: Revised AACSB Guidelines: Analytic skills 16) An inverted yield curve is upward-sloping and indicates generally cheaper long-term borrowing costs than short-term borrowing costs. Answer: FALSE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 17) A normal yield curve is upward-sloping and indicates generally cheaper short-term borrowing costs than long-term borrowing costs. Answer: TRUE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 18) An inverted yield curve is downward-sloping and indicates generally cheaper long-term borrowing costs than short-term borrowing costs. Answer: TRUE Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 19) During the past twenty years, the rate of return on U.S. treasury bills always exceeded the rate of inflation as measured by the consumer price index. Answer: FALSE Topic: Risk Free Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills 3 Copyright © 2012 Pearson Education

20) In theory, the rate of return on U.S. treasury bills should always exceed the rate of inflation as measured by the consumer price index. Answer: TRUE Topic: Risk Free Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills 21) The market segmentation theory suggests that the shape of the yield curve is determined by the supply and demand for funds within each maturity segment. Answer: TRUE Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 22) The liquidity preference theory suggests that the shape of the yield curve is determined by the supply and demand for funds within each maturity segment. Answer: FALSE Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 23) The liquidity preference theory suggests that short-term rates should be lower than long-term rates. Answer: TRUE Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 24) The expectations theory suggests that the shape of the yield curve reflects investors expectations about future inflation rates. Answer: TRUE Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 25) The reason for a difference in the yield between a Aaa corporate bond and an otherwise identical Baa bond is the risk ; the real interest rate and the inflation rate is the same for both. Answer: TRUE Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills

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26) The possibility that the issuer of a bond will not pay the contractual interest or principal payments as scheduled is called maturity risk. Answer: FALSE Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills 27) The possibility that the issuer of a bond will not pay the contractual interest or principal payments as scheduled is called default risk. Answer: TRUE Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills 28) The ________ rate of interest creates equilibrium between the supply of savings and the demand for investment funds. A) nominal B) real C) risk-free D) inflationary Answer: B Topic: Real Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills 29) The ________ rate of interest is the actual rate charged by the supplier and paid by the demander of funds. A) nominal B) real C) risk-free D) inflationary Answer: A Topic: Nominal Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills 30) The ________ is the annual rate of interest earned on a security purchased on a given date and held to maturity. A) term structure B) yield curve C) risk-free rate D) yield to maturity Answer: D Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 5 Copyright © 2012 Pearson Education

31) The ________ is/are a graphic depiction of the term structure of interest rates. A) yield curve B) supply and demand functions C) risk-return profile D) aggregate demand curve Answer: A Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 32) ________ yield curve reflects higher expected future rates of interest. A) An upward-sloping B) A flat C) A downward-sloping D) A linear Answer: A Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 33) ________ yield curve reflects lower expected future rates of interest. A) An upward-sloping B) A flat C) A downward-sloping D) A linear Answer: C Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 34) Generally, an increase in risk will result in ________ required return or interest rate. A) a lower B) a higher C) an unchanged D) an undetermined Answer: B Topic: Nominal Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills

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35) The nominal rate of interest is composed of A) the real rate plus an inflationary expectation. B) the real rate plus a risk . C) the risk-free rate plus an inflationary expectation. D) the risk-free rate plus a risk . Answer: D Topic: Nominal Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills 36) The ________ rate of interest is typically the required rate of return on a three-month U.S. Treasury bill. A) nominal B) real C) risk-free D) Answer: C Topic: Risk Free Rate of Interest Question Status: Revised AACSB Guidelines: Reflective thinking skills 37) Generally, long-term loans have higher interest rates than short-term loans because of A) the general expectation of higher future rates of inflation. B) lender preferences for shorter-term, more liquid loans. C) greater demand for long-term rather than short-term loans relative to the supply of such loans. D) all of the above. Answer: D Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 38) A downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs is called A) normal yield curve. B) inverted yield curve. C) flat yield curve. D) none of the above. Answer: B Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills

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39) An upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs is called A) normal yield curve. B) inverted yield curve. C) flat yield curve. D) none of the above. Answer: A Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 40) A yield curve that reflects relatively similar borrowing costs for both short-term and longterm loans is called A) normal yield curve. B) inverted yield curve. C) flat yield curve. D) none of the above. Answer: C Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Reflective thinking skills 41) The theory suggesting that for any given issuer, long-term interest rates tends to be higher than short-term rates is called A) expectation hypothesis. B) liquidity preference theory. C) market segmentation theory. D) none of the above. Answer: B Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 42) The yield curve in an economic period where higher future inflation is expected would most likely be A) upward-sloping. B) flat. C) downward-sloping. D) linear. Answer: A Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills

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43) The yield curve in an economic period where lower future inflation is expected would most likely be A) upward-sloping. B) flat. C) downward-sloping. D) linear. Answer: C Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 44) The three theories cited to explain the general shape of the yield curve are all of the following EXCEPT A) expectations hypothesis. B) market segmentation theory. C) liquidity preference theory. D) security markets theory. Answer: D Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 45) The theory that explains only the tendency for the yield curve to be upward sloping is A) expectations hypothesis. B) liquidity preference theory. C) market segmentation theory. D) investor perception theory. Answer: B Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 46) The risk over and above the risk free rate consists of a number of components, including all of the following EXCEPT A) default risk. B) inflation risk. C) tax treatment risk. D) liquidity risk. Answer: B Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills

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47) At any time, the slope of the yield curve is affected by A) inflationary expectations. B) liquidity preferences. C) the comparative equilibrium of supply and demand in the short-term and long-term market segments. D) all of the above. Answer: D Topic: Term Structure Theories Question Status: Revised AACSB Guidelines: Reflective thinking skills 48) Nico Nelson, a management trainee at a large New York-based bank is trying to estimate the real rate of return expected by investors. He notes that the 3-month T-bill currently yields 3 percent and has decided to use the consumer price index as a proxy for expected inflation. What is the estimated real rate of interest if the I is currently 2 percent? A) 5% B) 1% C) 3% D) 2% Answer: B Topic: Real Rate of Interest Question Status: Revised AACSB Guidelines: Analytic skills 49) Consider the following returns and yields: U.S. T-bill = 8%, 5-year U.S. T-note = 7%, IBM common stock = 15%, IBM AAA Corporate Bond = 12% and 10-year U.S. T-bond = 6%. Based on this information, the shape of the yield curve is A) upward sloping. B) downward sloping. C) flat. D) normal. Answer: B Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Analytic skills

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50) What is the nominal rate of return on an IBM bond if the real rate of interest is 3 percent, the inflation risk is 2 percent, the U.S. T-bill rate is 5 percent, the maturity risk on the IBM bond is 3 percent, the default risk on the IBM bond is 2 percent, and the liquidity risk on the bond is 1 percent? A) 16% B) 13% C) 11% D) 9% Answer: C Topic: Nominal Rate of Interest Question Status: Revised AACSB Guidelines: Analytic skills 51) Nico bought an investment one year ago and just calculated his return on investment. He found that his purchasing power had increased by 15 percent as a result of his investment. If inflation during the year was 4 percent, then Nico's A) real return on investment is more than 15 percent. B) nominal return on investment is more than 15 percent. C) nominal return on investment is less than 11 percent. D) real return on investment is equal to 4 percent. Answer: B Topic: Semi-Annual Yield to Maturity Question Status: Revised AACSB Guidelines: Analytic skills 52) Draw a graph of a typical Treasury yield curve and discuss why it usually takes that shape. Answer: The student should draw a normal, upward-sloping yield curve as shown in the text. Factors impacting the shape of the yield curve are the risk free rate, the inflation , and the interest rate risk . Topic: Term Structure of Interest Rates Question Status: Revised AACSB Guidelines: Analytic skills 6.2 Review the legal aspects of bond financing and bond cost. 1) Restrictive covenants are contractual clauses in long-term debt agreements that place certain operating and financial constraints on the borrower. Answer: TRUE Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 2) Standard debt provisions specify certain criteria of satisfactory record keeping and reporting, tax payment, and general business maintenance on the part of the lending firm. Answer: FALSE Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 11 Copyright © 2012 Pearson Education

3) A trustee is a paid party representing the bond issuer in the bond indenture. Answer: FALSE Topic: Bond Indenture Question Status: Revised AACSB Guidelines: Reflective thinking skills 4) Restrictive covenants, coupled with standard debt provisions, allow the lender to monitor and control the borrower's activities in order to protect itself against increases in borrower risk. Answer: TRUE Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 5) The purpose of the restrictive debt covenant that imposes fixed assets restrictions is to limit the amount of fixed-payment obligations. Answer: FALSE Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 6) In a practical sense, the longer the term of a bond, the greater the default risk associated with the bond. Answer: TRUE Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills 7) The size of the bond offering and the cost of issuing the bond (as a percentage of the amount raised) are inversely related. Answer: TRUE Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills 8) To carry out the sinking fund requirements, corporations often make semi-annual or annual payments to trustees, who uses these funds to retire bonds by purchasing them in the marketplace. Answer: TRUE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills

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9) A sinking-fund requirement is a restrictive provision often included in a bond indenture providing for periodic payments representing only interest and a large lump-sum payment at the maturity of the loan representing the entire loan principal. Answer: FALSE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 10) Restrictive covenants, which are also known as standard debt provisions, place operating and financial constraints on the borrower. Answer: FALSE Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 11) In a bond indenture, the term security interest refers to the fact that most firms that issue bonds are required to establish sinking fund provisions to protect bondholders. Answer: FALSE Topic: Bond Indenture Question Status: Revised AACSB Guidelines: Reflective thinking skills 12) In a bond indenture, the term security interest refers to collateral pledged against the bond. Answer: TRUE Topic: Bond Indenture Question Status: Revised AACSB Guidelines: Reflective thinking skills 13) The length of the maturity on a bond offering affects its cost. In general, the longer the maturity, the higher the cost. Answer: TRUE Topic: Cost of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 14) The length of the maturity on a bond offering affects its cost. In general, the longer the maturity, the lower the cost. Answer: FALSE Topic: Cost of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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15) All of the following are examples of long-term debt EXCEPT A) bonds. B) lines of credit. C) term loans. D) debentures. Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 16) The legal contract setting forth the and provisions of a corporate bond is a(n) A) indenture. B) debenture. C) loan document. D) promissory note. Answer: A Topic: Bond Indenture Question Status: Revised AACSB Guidelines: Reflective thinking skills 17) The cost of long-term debt generally ________ that of short-term debt. A) is less than B) is equal to C) is greater than D) has no relation to Answer: C Topic: Cost of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 18) A ________ is a restrictive provision on a bond which provides for the systematic retirement of the bonds prior to their maturity. A) redemption clause B) sinking-fund requirement C) conversion feature D) subordination clause Answer: B Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills

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19) A ________ is a complex and lengthy legal document stating the conditions under which a bond has been issued. A) bond debenture B) warrant C) sinking fund D) bond indenture Answer: D Topic: Bond Indenture Question Status: Revised AACSB Guidelines: Reflective thinking skills 20) ________ is a paid individual, corporation, or commercial bank trust department that acts as a third party to a bond indenture to ensure that the issuer does not default on its contractual responsibilities to the bondholders. A) A trustee B) An investment banker C) A bond issuer D) A bond rating agency Answer: A Topic: Bond Indenture Question Status: Revised AACSB Guidelines: Reflective thinking skills 21) If a bond pays $1,000 plus interest at maturity, $1,000 is called the A) stated value. B) market value. C) par value. D) long-term value. Answer: C Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 22) All of the following are examples of restrictive debt covenants EXCEPT A) prohibition on selling s receivable. B) supplying the creditor with audited financial statements. C) constraint on subsequent borrowing. D) prohibition on entering certain types of lease arrangements. Answer: B Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills

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23) All of the following are examples of restrictive debt covenants EXCEPT A) limiting the firm's annual cash dividend payments. B) supplying audited financial records. C) prohibiting combinations with other firms. D) management restrictions to maintaining certain key employees. Answer: B Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 24) All of the following are examples of standard debt provisions EXCEPT A) maintaining all facilities in good working order. B) paying taxes and liabilities when due. C) maintaining satisfactory ing records. D) limiting the annual dividend payment. Answer: D Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 25) An example of a standard debt provision is the A) limiting of the corporation's annual cash dividend payments. B) requirement to pay taxes and other liabilities when due. C) restricting the corporation from disposing of fixed assets. D) constraints on subsequent borrowing. Answer: B Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 26) A debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined is called A) discount bond. B) corporate bond. C) bond indenture. D) treasury bond. Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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27) The major factor(s) affecting the cost, or interest rate, on a bond is (are) its A) maturity. B) size of the offering. C) issuer risk. D) basic cost of money. E) all of the above. Answer: E Topic: Cost of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 28) The purpose of the restrictive debt covenant that requires maintaining a minimum level of net working capital is to A) protect the lender by controlling the risk and marketability of the borrower's security investment alternatives. B) limit the amount of fixed-payment obligations. C) ensure a cash shortage does not cause an inability to meet current obligations. D) prevent liquidation of assets through large salary increases of key employees. Answer: C Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 29) The purpose of the restrictive debt covenant that prohibits borrowers from entering into certain types of leases is to A) protect the lender by controlling the risk and marketability of the borrower's security investments alternatives. B) limit the amount of fixed-payment obligations. C) ensure a cash shortage does not cause an inability to meet current obligations. D) prevent liquidation of assets through large salary increases of key employees. Answer: B Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 30) The purpose of the restrictive debt covenant that imposes fixed assets restrictions is to A) protect the lender by controlling the risk and marketability of the borrower's security investment alternatives. B) limit the amount of fixed-payment obligations. C) ensure a cash shortage does not cause an inability to meet current obligations. D) prevent the firm from liquidation, acquisition, or encumbrance of capital assets. Answer: D Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills

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31) The purpose of the restrictive debt covenant that prohibits the sale of s receivable is to A) assure the lender that the borrowed funds are put to the use for which they were intended. B) limit the amount of fixed-payment obligations. C) ensure that a cash shortage does not cause an inability to meet current obligations. D) prevent liquidation of assets through large salary increases of key employees. Answer: C Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 32) The purpose of the restrictive debt covenant that requires that subsequent borrowing be subordinated to the original loan is to A) ensure that certain key employees are maintained. B) limit the amount of fixed-payment obligations. C) ensure a cash shortage does not cause an inability to meet current obligations. D) protect the lender by maintaining its position in the priority of claims in the event of liquidation. Answer: D Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 33) ________ is a stipulation in a long-term debt agreement that subsequent or less important creditors agree to wait until all claims of the ________ are satisfied before having their claims satisfied. A) Subordination; common stockholders B) Subordination; senior debt C) The combination restriction; senior debt D) The senior debt; common stockholders Answer: B Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 34) Violation of any standard or restrictive provision by the borrower gives the lender the right to do all of the following EXCEPT A) alter the of the initial agreement, for example accelerate the maturity date. B) demand immediate repayment. C) increase the interest rate. D) seize the loan collateral. Answer: D Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills

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35) To compensate for the uncertainty of future interest rates and the fact that the longer the term of a loan the higher the probability that the borrower will default, the lender typically A) charges a higher interest rate on long-term loans. B) reserves the right to change the of the loan at any time. C) includes excessively restrictive debt provisions. D) reserves the right to demand immediate payment at any time. Answer: A Topic: Cost of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 36) The size of the loan and its issuance costs (as a percentage of the amount borrowed) are A) not related. B) inversely related. C) independent. D) correlated. Answer: B Topic: Cost of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 37) The major factors affecting the cost of long-term debt include all of the following EXCEPT A) restrictive covenants. B) loan maturity. C) loan size. D) the basic cost of money. Answer: A Topic: Cost of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 38) Explain liquidity, default risk, and maturity risk s. Answer: Liquidity problems exist in thinly traded bonds, default risk is the likelihood the corporation will default on its bond obligations, and the maturity reflects the fact that longer-term bonds possess greater interest rate risk and sensitivity than shorter term bonds. If any of these exist, investors will demand to be compensated for the risk by demanding a yield to own the bonds. Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills

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6.3 Discuss the general features, yields, prices, ratings, popular types, and international issues of corporate bonds. 1) Debentures such as convertible bonds are unsecured bonds that, in general, only the most creditworthy firms can issue. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 2) A call is the amount by which the call price exceeds the market price of the bond. Answer: FALSE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 3) A bond issued by an American Company that is denominated in Swiss Francs and sold in Switzerland would be an example of a foreign bond. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Dynamics of the global economy 4) Stock-purchase warrants are instruments that give their holder the right to purchase a certain number of shares of the firm's common stock at the market price over a certain period of time. Answer: FALSE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 5) A foreign bond is a bond issued in a host country's financial market, in the host country's currency, by a foreign borrower. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Dynamics of the global economy 6) Putable bonds give the bondholders an option to sell the bond at a price higher than par value by the amount of one year interest payment when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt. Answer: FALSE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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7) Since a putable bond gives its holder the right to "put the bond" at specified times or because of specified actions by the issuing firm, the bond's yield would be lower than that of an otherwise equivalent non-putable bond. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 8) High-quality (high-rated) bonds provide lower returns than lower-quality (low-rated) bonds. Answer: TRUE Topic: Bond Ratings Question Status: Revised AACSB Guidelines: Reflective thinking skills 9) A Eurobond is a bond issued by an international borrower and sold to investors in countries with currencies other than the country in which the bond is denominated. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Dynamics of the global economy 10) A call feature is a feature included in all corporate bonds and allows the issuer to repurchase bonds at the market price prior to maturity. Answer: FALSE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 11) There is an inverse relationship between the quality or rating of a bond and the rate of return it must provide bondholders. Answer: TRUE Topic: Bond Ratings Question Status: Revised AACSB Guidelines: Reflective thinking skills 12) In a bond indenture, subordination is the stipulation that subsequent creditors agree to wait until all claims of the senior debt are satisfied. Answer: TRUE Topic: Bond Provisions Question Status: Revised AACSB Guidelines: Reflective thinking skills 13) Bondholders will convert their convertible bonds into shares of stock only when the conversion price is greater than the market price of the stock. Answer: FALSE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 21 Copyright © 2012 Pearson Education

14) To sell a callable bond, the issuer must pay a higher interest rate than on an otherwise equivalent noncallable bond. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 15) The conversion feature of a bond is a feature that is included in all corporate bond issues that gives the issuer the opportunity to repurchase bonds at a stated price prior to maturity. Answer: FALSE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 16) With subordinated debentures, payment of interest by the firm is required only when earnings are available. Answer: FALSE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 17) A foreign bond is issued in a host country's financial market, in the host country's currency, by a foreign borrower. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Dynamics of the global economy 18) Since the issuer of zero (or low) coupon bonds can annually deduct the current year's interest accrual without having to actually pay the interest until the bond matures (or is called), its cash flow each year is increased by the amount of the tax shield provided by the interest deduction. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 19) The market price of a callable bond will not generally exceed its call price, except in the case of a convertible bond. Answer: TRUE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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20) Floating-rate bonds are bonds that can be redeemed at par at the option of their holder either at specific date after the date of issue and every 1 to 5 years thereafter or when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt. Answer: FALSE Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 21) A call feature in a bond allows bondholders to change each bond into a stated number of shares of common stock. Answer: FALSE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 22) A conversion feature in a bond allows bondholders to change each bond into a stated number of shares of common stock. Answer: TRUE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 23) A call feature in a bond allows the issuer the opportunity to repurchase bonds at a stated price prior to maturity. This option has a greater chance of being exercised (to the detriment of the bondholder) if market interest rates have fallen since the bond was issued. Answer: TRUE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 24) A call feature in a bond allows the issuer the opportunity to repurchase bonds at a stated price prior to maturity. This option has a greater chance of being exercised (to the benefit of the bondholder) if market interest rates have fallen since the bond was issued. Answer: FALSE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 25) A call feature in a bond allows the issuer the opportunity to repurchase bonds at a stated price prior to maturity. This option has a greater chance of being exercised (to the detriment of the bondholder) if market interest rates have risen since the bond was issued. Answer: FALSE Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 23 Copyright © 2012 Pearson Education

26) In general, IBM bonds will experience greater trading activity (in of the number of bonds traded on a given day) compared to IBM stock. Answer: FALSE Topic: Bond Quotations Question Status: Revised AACSB Guidelines: Reflective thinking skills 27) In general, IBM bonds will experience less trading activity (in of the number of bonds traded on a given day) compared to IBM stock. Answer: TRUE Topic: Bond Quotations Question Status: Revised AACSB Guidelines: Reflective thinking skills 28) Any bond rated according to Moody's Caa through Aaa would be considered investment grade debt. Answer: FALSE Topic: Bond Ratings Question Status: Revised AACSB Guidelines: Reflective thinking skills 29) According to Moody's, a bond rated A should provide investors with a higher yield than an otherwise identical bond rated B. Answer: FALSE Topic: Risk s Question Status: Revised AACSB Guidelines: Reflective thinking skills 30) Any bond rated according to Moody's Ba or lower would be considered speculative or "junk." Answer: TRUE Topic: Bond Ratings Question Status: Revised AACSB Guidelines: Reflective thinking skills 31) As an outstanding bond approaches maturity, the price of the bond will always trend toward par value until, at maturity, the bond is worth its face value. Answer: TRUE Topic: Bond Ratings Question Status: Revised AACSB Guidelines: Reflective thinking skills

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32) The ________ feature permits the issuer to repurchase bonds at a stated price prior to maturity. A) call B) conversion C) put D) capitalization Answer: A Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 33) The ________ feature allows the bondholder to change each bond into a stated number of shares of stock. A) call B) conversion C) put D) capitalization Answer: B Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 34) Another name for a deeply discounted bond that pays no coupon interest is a A) junk bond. B) floating rate bond. C) zero coupon bond. D) subordinated debenture. Answer: C Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 35) A ________ gives purchasers inflation protection. A) zero coupon bond B) junk bond C) floating rate bond D) income bond Answer: C Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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36) ________ became popular vehicle used to finance mergers and takeovers during the 1980s. A) Income bonds B) Junk bonds C) Floating rate bonds D) Convertible debentures Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 37) ________ allow the holder to purchase a certain number of shares of the firm's common stock at a specified price over a certain period of time and are occasionally part of a debt agreement. A) Rights B) Stock-purchase warrants C) Debentures D) Puts and calls Answer: B Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 38) ________ is secured by real estate. A) An income bond B) A debenture C) A mortgage bond D) A subordinated debenture Answer: C Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 39) ________ is issued with a very low coupon and sells significantly below its par value. A) An income bond B) A zero or no coupon bond C) A mortgage bond D) A subordinated debenture Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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40) On ________, the stated interest rate is adjusted periodically within stated limits in response to changes in specified money or capital market rates. A) a floating rate bond B) a deep/zero discount bond C) a mortgage bond D) an equipment trust certificate Answer: A Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 41) ________ are commonly issued in the reorganization of a failed or failing firm. A) Floating rate bonds B) Income bonds C) Mortgage bonds D) Equipment trust certificates Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 42) ________ bonds are characterized by interest payments that are required only when earnings are available from which to make such payment. A) Floating rate B) Income C) Mortgage D) Junk Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 43) ________ are debt rated Ba or lower by Moody's or BB or lower by Standard & Poor's and are commonly used by rapidly growing firms to obtain growth capital, most often to finance mergers and takeovers of other firms, particularly during the 1980s. A) Subordinated debentures B) Mortgage bonds C) Junk bonds D) Equipment trust certificates Answer: C Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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44) Convertible bonds are normally A) debentures. B) income bonds. C) subordinated debentures. D) mortgage bonds. Answer: A Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 45) A debenture is A) a lengthy legal document stating the conditions under which a bond has been issued. B) a secured bond that is secured by unspecified assets. C) a bond secured by specific asset. D) an unsecured bond that only creditworthy firms can issue. Answer: D Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 46) ________ are secured by stock and/or bonds that are owned by the issuer. A) Mortgage bonds B) Equipment trust certificates C) Collateral trust bonds D) Subordinated debentures Answer: C Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 47) ________ are bonds that have a short maturity, typically one to five years, and which can be redeemed or renewed for a similar period at the option of their holders. A) Floating rate bonds B) Extendible notes C) Putable bonds D) Junk bonds Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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48) Payment of interest required only when earnings are made available from which to make a payment is characteristic of a(n) A) floating rate bond. B) income bond. C) mortgage bond. D) equipment trust certificate. Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 49) A feature that allows bondholders to change each bond into a stated number of shares of common stock is called A) stock purchase warrants. B) call feature. C) conversion feature. D) none of the above. Answer: C Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 50) A feature that gives the issuer the opportunity to repurchase bonds at a stated price prior to maturity is called A) stock purchase warrants. B) call feature. C) conversion feature. D) none of the above. Answer: B Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills 51) An instrument that give their holders the right to purchase a certain number of shares of the firm's common stock at a specified price over a certain period of time is called A) stock purchase warrants. B) call feature. C) conversion feature. D) none of the above. Answer: A Topic: Bond Features Question Status: Revised AACSB Guidelines: Reflective thinking skills

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52) The riskiness of publicly traded bond issues is rated by independent agencies. According to Moody's rating system, an Aaa bond and a Caa bond are ________ and ________, respectively. A) speculative; investment grade B) prime quality; medium grade C) prime quality; speculative D) medium grade; lowest grade Answer: C Topic: Bond Ratings Question Status: Revised AACSB Guidelines: Reflective thinking skills 53) A ________ bond generally has an interest rate that is higher than a similar risk ________ bonds, and a ________ bond generally has an interest rate that is lower than a similar risk ________ bond. A) callable; non-callable; convertible; non-convertible B) convertible; non-convertible; callable; non-callable C) convertible; callable; non-convertible; non-callable D) callable; non-callable; non-convertible; convertible Answer: A Topic: Bond Features Question Status: New AACSB Guidelines: Reflective thinking skills 54) A putable bond gives the bondholder A) the right to sell the bond back to the corporation at the original purchase price. B) the right to sell the bond back to the corporation at a stated . C) the right to sell the bond back to the corporation at the current market value. D) the right to sell the bond back to the corporation at par. Answer: D Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 55) The significant portion of the return on a zero coupon bond is in the form of A) interest and gain in value. B) interest. C) gain in value. D) tax reduction. Answer: C Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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56) In utilizing a ________ the issuer can annually deduct the current year's interest accrual without having to actually pay the interest until the bond matures. A) junk bond B) zero coupon bond C) floating rate bond D) extendible notes Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 57) High-risk, high-yield junk bonds have declined in popularity over time due to A) the decline in mergers and takeovers, which these bonds were used to finance. B) the declining need of growth capital. C) the stabilizing of interest rates. D) a number of major defaults on these bonds. Answer: D Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 58) ________ are claims that are not satisfied until those of the creditors holding certain (senior) debts have been fully satisfied. A) Convertible debentures B) Subordinated debentures C) Mortgage bonds D) Collateral trust bonds Answer: B Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills 59) Bonds that can be redeemed at par at the option of their holders either at specific date after the date of issue and every 1 to 5 years thereafter or when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt are called A) zero coupon bonds. B) junk bonds. C) floating-rate bonds. D) putable bonds. Answer: D Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills

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60) The decision to refund a callable bond A) should be made only if interest rates have increased. B) is a net working capital decision. C) is a capital budgeting decision. D) is a financing decision. Answer: C Topic: Types of Bonds Question Status: Revised AACSB Guidelines: Reflective thinking skills Table 6.1 Use the below information to answer the following question(s).

61) Based on the table 6.1, on this trading day, the number of Ford bonds which changed hands was A) 5,100. B) 51,000. C) 510,000. D) 5,100,000. Answer: D Topic: Corporate Bond Quotes Question Status: Revised AACSB Guidelines: Analytic skills 62) Based on the Table 6.1, assume this bond's face value is $1,000. What is the bond's current market price? A) $65.00 B) $655.00 C) $650.00 D) $6,550.00 Answer: B Topic: Corporate Bond Quotes Question Status: Revised AACSB Guidelines: Analytic skills

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63) Based on the Table 6.1, what is the last yield for this bond? A) 11.0% B) 14.2% C) 16.8% D) 18.9% Answer: C Topic: Corporate Bond Quotes Question Status: Revised AACSB Guidelines: Analytic skills 6.4 Understand the key inputs and basic model used in the bond valuation process. 1) The value of an asset depends on the historical cash flow(s) up to the present time. Answer: FALSE Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills 2) Valuation is the process that links risk and return to determine the worth of an asset. Answer: TRUE Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills 3) The value of an asset is determined by discounting the expected cash flows back to its present value, using the rate of return on the market portfolio as a discount rate. Answer: FALSE Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills 4) In the valuation process, the higher the risk, the greater the required return. Answer: TRUE Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills 5) The level of risk associated with a given cash flow positively affects its value. Answer: FALSE Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills

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6) The process that links risk and return in order to determine the worth of an asset is termed A) evaluation. B) valuation. C) discounting. D) variable growth. Answer: B Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills 7) A type of long-term financing used by both corporations and government entities is A) common stock. B) bonds. C) preferred stock. D) retained earnings. Answer: B Topic: Bond Basics Question Status: Revised AACSB Guidelines: Reflective thinking skills 8) Bonds are A) a series of short-term debt instruments. B) a form of equity financing that pays interest. C) long-term debt instruments. D) a hybrid form of financing used to raise large sums of money from a diverse group of lenders. Answer: C Topic: Bond Basics Question Status: Revised AACSB Guidelines: Reflective thinking skills 9) The less certain a cash flow, the ________ the risk, and the ________ the present value of the cash flow. A) lower; higher B) lower; lower C) higher; lower D) higher; higher Answer: C Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills

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10) ________ of all future cash flows an asset is expected to provide over a relevant time period is the market value of the asset. A) The future value B) The present value C) The stated value D) The sum Answer: B Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills 11) The return expected from an asset is fully defined by its A) risk and cash flow. B) cash flow and timing. C) discount rate. D) beta. Answer: B Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills 12) The key inputs to the valuation process include A) returns and risk. B) cash flow, cash flow timing, and risk. C) cash flows and discount rate. D) returns, discount rate, and risk. Answer: B Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills 13) In the present value model, risk is generally incorporated into the A) cash flows. B) timing. C) discount rate. D) total value. Answer: C Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Reflective thinking skills

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14) A record collector has agreed to sell her entire collection to a historical museum in three years at a price of $100,000. The current risk-free rate is 7 percent. At what price should she value her collection today? Answer: $100,000(1.07)-3 = $81,600 Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Analytic skills 15) A corporate financial analyst must calculate the value of an asset which produces year-end annual cash flows of $0 the first year, $2,000 the second year, $3,000 the third year, and $2,500 the fourth year. Assuming a discount rate of 15 percent, what is the value of this asset? Answer: = $0(1.15)1 + $2,000(1.15)2 + $3,000(1.15)3 + $2,500(1.15)4 = $0 + $1,512 + $1,974 + $1,430 = $4,916 Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Analytic skills 16) What is the value of an asset which pays $200 a year for the next 5 years and can be sold for $1,500 at the end of five years from now? Assume that the opportunity cost is 10 percent. Answer: Using Financial calculator: FV=1500, PMT=200, N=5, I=10, T PV =1689.54 Topic: Valuation Fundamentals Question Status: Revised AACSB Guidelines: Analytic skills 6.5 Apply the basic valuation model to bonds, and describe the impact of required return and time to maturity on bond values. 1) Interest rate risk is the risk that results from the impact that changes in interest rates have on asset values. Answer: TRUE Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 2) The value of a bond that pays semiannual interest is greater than that on an otherwise equivalent annual coupon interest paying bond. Answer: TRUE Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills

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3) When a bond's required return is greater than its coupon interest rate, the bond value will be less than its par value. Answer: TRUE Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 4) Increases in the basic cost of long-term funds or in risk will raise the required return on the bond. Answer: TRUE Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 5) A bond will sell at a when its required return rises above its coupon interest rate. Answer: FALSE Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 6) The required return on the bond is likely to differ from the stated interest rate for either of two reasons: 1) economic conditions have changed, causing a shift in the basic cost of long-term funds, or 2) the firm's risk has changed. Answer: TRUE Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 7) The ________ value of a bond is also called its face value. Bonds which sell at less than face value are priced at a ________, while bonds which sell at greater than face value sell at a ________. A) discount; par; B) ; discount; par C) par; discount; D) coupon; ; discount Answer: C Topic: Bond Basics Question Status: Revised AACSB Guidelines: Reflective thinking skills

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8) Corporate bonds typically have A) a face value of $5,000. B) a market price of $1,000. C) a specified coupon rate paid annually. D) a par value of $1,000. Answer: D Topic: Bond Basics Question Status: Revised AACSB Guidelines: Analytic skills 9) The value of a bond is the present value of the A) dividends and maturity value. B) interest and dividend payments. C) maturity value. D) interest payments and maturity value. Answer: D Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 10) When the required return is constant and equal to the coupon rate, the price of a bond as it approaches its maturity date will A) remain constant. B) increase. C) decrease. D) change depending on whether it is a discount or bond. Answer: A Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 11) The market price of outstanding issues often varies from par because A) the maturity date has changed. B) the coupon rate has changed. C) the market rate of interest has changed. D) old bonds sell for less than new bonds. Answer: C Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills

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12) The price of a bond with a fixed coupon rate and the market required return have a relationship that is best described as A) varying. B) constant. C) direct. D) inverse. Answer: D Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 13) If the required return is less than the coupon rate, a bond will sell at A) par. B) a discount. C) a . D) book value. Answer: C Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 14) When the required return is constant but different from the coupon rate, the price of a bond as it approaches its maturity date will A) remain constant. B) increase. C) decrease. D) approach par. Answer: D Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 15) If the required return is greater than the coupon rate, a bond will sell at A) par. B) a discount. C) a . D) book value. Answer: B Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills

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16) The ABC company has two bonds outstanding that are the same except for the maturity date. Bond D matures in 4 years, while Bond E matures in 7 years. If the required return changes by 15 percent A) Bond D will have a greater change in price. B) Bond E will have a greater change in price. C) the price of the bonds will be constant. D) the price change for the bonds will be equal. Answer: B Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 17) A firm has an issue of $1,000 par value bonds with a 12 percent stated interest rate outstanding. The issue pays interest annually and has 10 years remaining to its maturity date. If bonds of similar risk are currently earning 8 percent, the firm's bond will sell for ________ today. A) $1,000 B) $805.20 C) $851.50 D) $1,268.20 Answer: D Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 18) When valuing a bond, the characteristics of the bond that remain fixed are all of the following EXCEPT the A) coupon rate. B) price. C) face value. D) interest payment. Answer: B Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 19) A firm has an issue of $1,000 par value bonds with a 9 percent stated interest rate outstanding. The issue pays interest annually and has 20 years remaining to its maturity date. If bonds of similar risk are currently earning 11 percent, the firm's bond will sell for ________ today. A) $1,000 B) $716.67 C) $840.67 D) $1,123.33 Answer: C Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 40 Copyright © 2012 Pearson Education

20) Hewitt Packing Company has an issue of $1,000 par value bonds with a 14 percent annual coupon interest rate. The issue has ten years remaining to the maturity date. Bonds of similar risk are currently selling to yield a 12 percent rate of return. The current value of each Hewitt bond is ________. A) $791.00 B) $1,000 C) $1,052.24 D) $1,113.00 Answer: D Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 21) A bond will sell ________ when the stated rate of interest exceeds the required rate of return, ________ when the stated rate of interest is less than the required return, and ________ when the stated rate of interest is equal to the required return. A) at a ; at a discount; equal to the par value B) at a ; equal to the par value; at a discount C) at a discount; at a ; equal to the par value D) equal to the par value; at a ; at a discount Answer: A Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 22) If a corporate bond is issued with a coupon rate that varies directly with the required return, the price of the bond will A) equal the face value. B) be less than the face value. C) be greater than the face value. D) be greater than or less than the face value depending on how interest rates vary. Answer: A Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 23) Calculate the value of a $1,000 bond which has 10 years until maturity and pays quarterly interest at an annual coupon rate of 12 percent. The required return on similar-risk bonds is 20 percent. A) $656.77 B) $835.45 C) $845.66 D) $2,201.08 Answer: A Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 41 Copyright © 2012 Pearson Education

24) Jia Hua Enterprises wants to issue sixty 20-year, $1,000 par value, zero-coupon bonds. If each bond is priced to yield 7 percent, how much will Jia Hua receive (ignoring issuance costs) when the bonds are first sold? A) $11,212 B) $12,393 C) $15,505 D) $18,880 E) $20,000 Answer: C Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 25) On January 1, 2002, Zheng Corporation will issue new bonds to finance its expansion plans. In its efforts to price the issue, Zheng Corporation has identified a company of similar risk with an outstanding bond issue that has an 8 percent coupon rate that is due January 1, 2017. This firm's bonds currently are selling for $1,091.96. If interest is paid semiannually for both bonds, what must the coupon rate of the new bonds be in order for the issue to sell at par? A) 5.75% B) 6.00% C) 6.50% D) 7.00% Answer: D Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills Table 6.2

26) (a) Calculate the current value of Bond L. (See Table 6.2) (b) What will happen to the value/price as the bond approaches maturity? Answer: (a) Using Financial calculator: PMT= 90, N=5, I=6, FV=1000, T PV = $1,126.08 (b) The bond price will decrease and come closer to par. Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills

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27) Calculate the current value of Bond M. (See Table 6.2) Answer: Annual coupon interest rate = required rate of return Therefore, value = par value = $100 Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 28) Calculate the current value of Bond M if the time of maturity is six years. (See Table 6.2) Answer: The bond is at par, or $100, because the annual coupon interest rate is equal to the required rate of return. Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 29) (a) Calculate the current value of Bond N. (See Table 6.2) (b) What will happen to value/price as the bond approaches maturity? Answer: (a) Using financial calculator: PMT=$90, N=17, I=15, FV=500, T PV = $590.73 (b) The bond price will decrease and come closer to par. Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 30) Hewitt Packing Company has an issue of $1,000 par value bonds with a 14 percent coupon interest rate outstanding. The issue pays interest semiannually and has 10 years remaining to its maturity date. Bonds of similar risk are currently selling to yield a 12 percent rate of return. What is the value of these Hewitt Packing Company bonds? Answer: B: Using financial calculator: PMT=$70, N=20, FV=1000, I=6, T PV = $1,114.90 Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 31) To expand its business, the Kingston Outlet factory would like to issue a bond with par value of $1,000, coupon rate of 10 percent, and maturity of 10 years from now. What is the value of the bond if the required rate of return is 1) 8 percent, 2) 10 percent, and 3) 12 percent? Answer: Coupon payment = 1,000 × 0.10 = $100 1) Using Financial calculator: PMT=100, N=10, I=8, FV=1000, T PV = $1,134.00 2) $1,000 since coupon rate and required rate of return are equal. 3) Using Financial calculator: PMT=100, N=10, I=12, FV=1000, T PV = $887 Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills

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32) To finance a new line of product, the Tangshan Toys has issued $1,000,000 bond with a par value of $1,000, coupon rate of 8 percent, and maturity of 30 years. Compute the price of the bond if the opportunity cost is 11 percent. Answer: Coupon payment = 1,000 × 0.08 = $80 Using financial calculator: PMT= 80, I=11, N=30, FV=1000, T PV= $739.52 Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 33) Gong Li has recently inherited $10,000 and is considering purchasing 10 bonds of the Lucky Corporation. The bond has a par value of $1,000 with 10 percent coupon rate and will mature in 10 years. Does Gong Li have enough money to buy 10 bonds if the required rate of return is 9 percent? Answer: No. Since the required rate of return (9%) is less than the bond's coupon rate (10%), the bond's price is greater than its par value ($1,000). Thus, the total price of 10 bonds is greater than $10,000. Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 34) Yantai Food, Inc. has issued a bond with par value of $1,000, a coupon rate of 9 percent that is paid semi-annually, and that matures in 10 years. What is the value of the bond if the required rate of return is 12 percent? Answer: Coupon payment = 1,000 × 0.09 = $90 Semi-annual coupon payment = 90/2 =$45 Using financial calculator: PMT= 45, I=6, N=20, FV=1000, T PV = $828.15 Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 35) Zhen Yi Computers has an outstanding issue of bond with a par value of $1,000, paying 12 percent coupon rate semi-annually. The bond was issued 25 years ago and has 5 years to maturity. What is the value of the bond assuming 14 percent rate of interest? Answer: Coupon payment = 1,000 × 0.12 = $120 Semi-annual coupon payment = 120/2 = $60 Using financial calculator: PMT= 60, I=7, N=10, FV=1000, T PV = $929.44 Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills

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6.6 Explain yield to maturity (YTM), its calculation, and the procedure used to value bonds that pay interest semiannually. 1) Yield to maturity (YTM) is the rate investors earn if they buy the bond at a specific price and hold it until maturity. Answer: TRUE Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 2) The yield to maturity on a bond with a current price equal to its par, or face, value will always be equal to the coupon interest rate. Answer: TRUE Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 3) If a bond's required return always equals its coupon interest rate, its bond's value will remain at par until it matures. Answer: TRUE Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 4) When the required return is different from the coupon interest rate and is assumed to be constant until maturity, the value of the bond will approach its par value as the age of time moves the bond's value closer to maturity. Answer: TRUE Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 5) When a bond's value differs from par, its yield to maturity will differ from its coupon interest rate. Answer: TRUE Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 6) Because a rise in interest rates, and therefore the required return, results in an increase in bond value, bondholders are typically more concerned with dropping interest rates. Answer: FALSE Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills

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7) Whenever a bond's required return is different from its coupon interest rate, the age of time will affect the bond's value, even if the required return remains constant until maturity. Answer: TRUE Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 8) The shorter the amount of time until a bond's maturity, the more responsive is its market value to a given change in the required return. Answer: FALSE Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 9) A bond with short maturity has less "interest rate risk" than a bond with long maturity when all other featurescoupon interest rate, par value, and interest payment frequencyare the same. Answer: TRUE Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 10) Interest rate risk and the time to maturity have a relationship that is best characterized as A) constant. B) varying. C) direct. D) inverse. Answer: C Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills 11) For an investor who plans to purchase a bond maturing in one year, the primary consideration should be A) interest rate risk. B) changes in the risk of the issue. C) yield to maturity. D) coupon rate. Answer: C Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Reflective thinking skills

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12) The yield to maturity on a bond with a price equal to its par value will A) be less than the coupon rate. B) be more than the coupon rate. C) always be equal to the coupon rate. D) be more or less than the coupon rate depending on the required return. Answer: C Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Reflective thinking skills 13) What is the current price of a $1,000 par value bond maturing in 9 years with a coupon rate of 8 percent, paid annually, that has a YTM of 9 percent? A) $700 B) $945 C) $940 D) $1,062 Answer: C Topic: Bond Pricing Question Status: New AACSB Guidelines: Analytic skills 14) What is the approximate yield to maturity for a $1,000 par value bond selling for $1,120 that matures in 6 years and pays 12 percent interest annually? A) 8.5 percent B) 9.4 percent C) 12.0 percent D) 13.2 percent Answer: B Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Analytic skills 15) Tangshan Industries has issued a bond which has a $1,000 par value and a 15 percent annual coupon interest rate. The bond will mature in ten years and currently sells for $1,250. Using this information, the yield to maturity on the Tangshan Industries bond is A) 10.79 percent. B) 11.39 percent. C) 12.19 percent. D) 13.29 percent. Answer: A Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Analytic skills

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16) What is the yield to maturity, to the nearest percent, for the following bond: current price is $908, coupon rate is 11 percent, $1,000 par value, interest paid annually, eight years to maturity? A) 11 percent B) 12 percent C) 13 percent D) 14 percent Answer: C Topic: Yield to Maturity Question Status: Revised AACSB Guidelines: Analytic skills 17) Danno is trying to decide which of two bonds to buy. Bond H is a 10 percent coupon, 10year maturity, $1,000 par, January 1, 2000 issue paying annual interest. Bond F is a 10 percent coupon, 10-year maturity, $1,000 par, January 1, 2000 issue paying semiannual interest. The market required return for each bond is 10 percent. When using present value to determine the prices of the bonds, Danno will find that A) there is no difference in price. B) the price of F is greater than H. C) the price of H is greater than F. D) he needs more information before determining the prices. Answer: A Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 18) What is the current price of a $1,000 par value bond maturing in 12 years with a coupon rate of 14 percent, paid semiannually, that has a YTM of 13 percent? A) $604 B) $1,090 C) $1,060 D) $1,073 Answer: C Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills 19) Nico Corp issued bonds bearing a coupon rate of 12 percent, pay coupons semiannually, have 3 years remaining to maturity, and are currently priced at $940 per bond. What is the yield to maturity? A) 12.00% B) 13.99% C) 14.54% D) 15.25% Answer: C Topic: Semi-Annual Yield to Maturity Question Status: Revised AACSB Guidelines: Analytic skills 48 Copyright © 2012 Pearson Education

20) Tangshan Coal, Inc. just issued a 10 percent, 25-year bond with a $1,000 par value that pays interest semiannually. (a) How much can the investor expect in annual interest (in dollars)? (b) How much can the investor expect in interest every six months (in dollars)? (c) How much can the investor expect in par value at the end of the 25th year? Answer: (a) $100 (b) $50 (c) $1,000 Topic: Bond Pricing Question Status: Revised AACSB Guidelines: Analytic skills

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