Solved MCQs
Bond Prices and Yields
1-Consider a $1,000 par value 20-year zero coupon bond issued at a yield to maturity of 10%. If you buy that bond when it is issued and continue to hold the bond as yields decline to 9%, the imputed interest income for the first year of that bond is
A) zero.
B) $14.87.
C) $45.85.
D) $7.44.
E) none of the above.
Rationale: $1,000/(1.10)20 = $148.64; $1,000/(1.10)19 = $163.51; $194.49 - $148.64 = $14.87.
2. The bond indenture includes
A) the coupon rate of the bond.
B) the par value of the bond.
C) the maturity date of the bond.
D) all of the above.
E) none of the above.
Rationale: The bond indenture includes the coupon rate, par value and maturity date of the bond as well as any other contractual features.
3. A Treasury bond quoted at 107:16 107:18 has a bid price of _______ and an asked price of _____.
A) $107.16, $107.18
B) $1,071.60, $1,071.80
C) $1,075.00, $1,075.63
D) $1,071.80, $1,071.60
E) $1,070.50, $1,070.56
Rationale: Treasury bonds are quoted as a percentage of par value ($1,000) with the number after the colon representing the fractions of a point in 32nds. The bid price is quoted first and is the lower of the two.
4. Bearer bonds are
A) bonds traded without any record of ownership.
B) helpful to tax authorities in the enforcement of tax collection.
C) rare in the United States today.
D) all of the above.
E) both A and C.
Rationale: Bearer bonds are not registered so there is no record of ownership. They are rare in the United Statestoday. Tax authorities find registered bonds helpful in tax enforcement but not bearer bonds.
5. Most corporate bonds are traded
A) on a formal exchange operated by the New York Stock Exchange.
B) by the issuing corporation.
C) over the counter by bond dealers linked by a computer quotation system.
D) on a formal exchange operated by the American Stock Exchange.
E) on a formal exchange operated by the Philadelphia Stock Exchange.
Rationale: Most corporate bonds are traded in a loosely organized network of bond dealers linked by a computer quote system. Only a small proportion is traded on the New York Exchange.
6. The process of retiring high-coupon debt and issuing new bonds at a lower coupon to reduce interest payments is called
A) deferral.
B) reissue.
C) repurchase.
D) refunding.
E) none of the above.
Rationale: The process of refunding refers to calling high-coupon bonds and issuing new, lower coupon debt.
7. Convertible bonds
A) give their holders the ability to share in price appreciation of the underlying stock.
B) offer lower coupon rates than similar nonconvertible bonds.
C) offer higher coupon rates than similar nonconvertible bonds.
D) both A and B are true.
E) both A and C are true.
Rationale: Convertible bonds offer appreciation potential through the ability to share in price appreciation of the underlying stock but offer a lower coupon and yield than similar nonconvertible bonds.
8. TIPS are
A) securities formed from the coupon payments only of government bonds.
B) securities formed from the principal payments only of government bonds.
C) government bonds with par value linked to the general level of prices.
D) government bonds with coupon rate linked to the general level of prices.
E) zero-coupon government bonds.
Rationale: Treasury Inflation Protected Securities (TIPS) are bonds whose par value adjusts according to the general level of prices. This changes coupon payments, but not the stated coupon rate.
9. Altman's Z scores are assigned based on a firm's financial characteristics and are used to predict
A) required coupon rates for new bond issues.
B) bankruptcy risk.
C) the likelihood of a firm becoming a takeover target.
D) the probability of a bond issue being called.
E) none of the above.
Rationale: Z-scores are used to predict significant bankruptcy risk.
10. When a bond indenture includes a sinking fund provision
A) firms must establish a cash fund for future bond redemption.
B) bondholders always benefit, because principal repayment on the scheduled maturity date is guaranteed.
C) bondholders may lose because their bonds can be repurchased by the corporation at below-market prices.
D) both A and B are true.
E) none of the above is true.
Rationale: A sinking fund provisions requires the firm to redeem bonds over several years, either by open market purchase or at a special call price from bondholders. This can result in repurchase in advance of scheduled maturity at below-market prices.
11. Subordination clauses in bond indentures
A) may restrict the amount of additional borrowing the firm can undertake.
B) are sometimes referred to as "me-first" rules.
C) provide higher priority to senior creditors in the event of bankruptcy.
D) all of the above are true.
E) both B and C are true.
Rationale: All of the statements correctly describe subordination clauses.
12. Collateralized bonds
A) rely on the general earning power of the firm for the bond's safety.
B) are backed by specific assets of the issuing firm.
C) are considered the safest assets of the firm.
D) all of the above are true.
E) both B and C are true.
Rationale: Collateralized bonds are considered the safest assets of the firm because they are backed by specific assets of the firm, rather than relying on the firm's general earning power.
13. Debt securities are often called fixed-income securities because
A) the government fixes the maximum rate that can be paid on bonds.
B) they are held predominantly by older people who are living on fixed incomes.
C) they pay a fixed amount at maturity.
D) they promise either a fixed stream of income or a stream of income determined by a specific formula.
E) they were the first type of investment offered to the public, which allowed them to "fix" their income at a higher level by investing in bonds.
Rationale: This definition is given in the chapter's introduction. It helps the student understand the nature of bonds.
14. A zero-coupon bond is one that
A) effectively has a zero percent coupon rate.
B) pays interest to the investor based on the general level of interest rates, rather than at a specified coupon rate.
C) pays interest to the investor without requiring the actual coupon to be mailed to the corporation.
D) is issued by state governments because they don't have to pay interest.
E) is analyzed primarily by focusing ("zeroing in") on the coupon rate.
Rationale: Zero-coupon bonds pay no interest. Investors receive the face value at maturity.
15. Swingin' Soiree, Inc. is a firm that has its main office on the Right Bank in Paris. The firm just issued bonds with a final payment amount that depends on whether the Seine River floods. This type of bond is known as
A) a contingency bond
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B) a catastrophe bond
C) an emergency bond
D) an incident bond
E) an eventuality bond
Rationale: Catastrophe bonds are used to transfer risk from the firm to the capital markets.
16. One year ago, you purchased a newly issued TIPS bond that has a 6% coupon rate, five years to maturity, and a par value of $1,000. The average inflation rate over the year was 4.2%. What is the amount of the coupon payment you will receive and what is the current face value of the bond?
A) $60.00, $1,000
B) $42.00, $1,042
C) $60.00, $1,042
D) $62.52, $1,042
E) $102.00, $1,000
Rationale: The bond price, which is indexed to the inflation rate, becomes $1,000*1.042 = $1,042. The interest payment is based on the coupon rate and the new face value. The interest amount equals $1,042*.06 = $62.52.
17. Bond analysts might be more interested in a bond's yield to call if
A) the bond's yield to maturity is insufficient.
B) the firm has called some of its bonds in the past.
C) the investor only plans to hold the bond until its first call date.
D) interest rates are expected to rise.
E) interest rates are expected to fall.
Rationale: If interest rates fall the firm is more likely to call the issue and refinance at lower rates. This is similar to an individual refinancing a home. The student has to think through each of the reasons given and make the connection between falling rates and the motivation to refinance.
18. What is the relationship between the price of a straight bond and the price of a callable bond?
A) The straight bond's price will be higher than the callable bond's price for low interest rates.
B) The straight bond's price will be lower than the callable bond's price for low interest rates.
C) The straight bond's price will change as interest rates change, but the callable bond's price will stay the same.
D) The straight bond and the callable bond will have the same price.
E) There is no consistent relationship between the two types of bonds.
Rationale: For low interest rates, the price difference is due to the value of the firm's option to call the bond at the call price. The firm is more likely to call the issue at low interest rates, so the option is valuable. At higher interest rates the firm is less likely to call and this option loses value. The prices converge for high interest rates.
19. Three years ago you purchased a bond for $974.69. The bond had three years to maturity, a coupon rate of 8%, paid annually, and a face value of $1,000. Each year you reinvested all coupon interest at the prevailing reinvestment rate shown in the table below. Today is the bond's maturity date. What is your realized compound yield on the bond?
A) 6.43%
B) 7.96%
C) 8.23%
D) 8.97%
E) 9.13%
Rationale: The investment grows to a total future value of $80*(1.072)*(1.094) + $80*1.094) + $1,080 = $1,261.34 over the three year period. The realized compound yield is the yield that will compound the original investment to yield the same future value: $974.69*(1+rcy)3 = $1,261.34, (1+rcy)3 = 1.29409, 1+rcy = 1.0897, rcy = 8.97%.
20. Which of the following is not a type of international bond?
A) Samurai bonds
B) Yankee bonds
C) bulldog bonds
D) Elton bonds
E) All of the above are international bonds.
Rationale: Samurai bonds, Yankee bonds, and bulldog bonds are mentioned in the textbook.
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Umeed
MBA 3rd Sem
