Exam 5: Bonds, Bond Valuation, and Interest Rates

A) 10-year, zero coupon bond.
B) 20-year, 10% coupon bond.
C) 20-year, 5% coupon bond.
D) 1-year, 10% coupon bond.
E) 20-year, zero coupon bond.

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A) A bond is likely to be called if its coupon rate is below its YTM.
B) A bond is likely to be called if its market price is below its par value.
C) Even if a bond's YTC exceeds its YTM, an investor with an investment horizon longer than the bond's maturity would be worse off if the bond were called.
D) A bond is likely to be called if its market price is equal to its par value.
E) A bond is likely to be called if it sells at a discount below par.

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A) 5.01%
B) 5.27%
C) 5.54%
D) 5.81%
E) 6.10%

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A) If two bonds have the same maturity, the same yield to maturity, and the same level of risk, the bonds should sell for the same price regardless of the bond's coupon rates.
B) All else equal, an increase in interest rates will have a greater effect on the prices of short-term than long-term bonds.
C) All else equal, an increase in interest rates will have a greater effect on higher-coupon bonds than it will have on lower-coupon bonds.
D) If a bond's yield to maturity exceeds its coupon rate, the bond's price must be less than its maturity value.
E) If a bond's yield to maturity exceeds its coupon rate, the bond's current yield must be less than its coupon rate.

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A) 10-year, zero coupon bonds have higher reinvestment rate risk than 10-year, 10% coupon bonds.
B) A 10-year, 10% coupon bond has less reinvestment rate risk than a 10-year, 5% coupon bond (assuming all else equal) .
C) The total return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year.
D) The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10% bond.
E) A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%.

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A) The yield to maturity for a coupon bond that sells at a premium consists entirely of a positive capital gains yield; it has a zero current interest yield.
B) The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm has filed for bankruptcy.
C) Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices.
D) The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.
E) On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.

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A) 2.59%
B) 2.88%
C) 3.20%
D) 3.52%
E) 3.87%

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A) If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.
B) All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.
C) If a bond is selling at its par value, its current yield equals its yield to maturity.
D) If a bond is selling at a premium, its current yield will be greater than its yield to maturity.
E) All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.

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A) If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
B) Liquidity premiums are generally higher on Treasury than corporate bonds.
C) The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
D) Default risk premiums are generally lower on corporate than on Treasury bonds.
E) Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

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A) The company's bonds are downgraded.
B) Market interest rates rise sharply.
C) Market interest rates decline sharply.
D) The company's financial situation deteriorates significantly.
E) Inflation increases significantly.

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A) If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have the lower yield.
B) If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield.
C) If the yield curve for Treasury securities is upward sloping, Long's bonds must under all conditions have a higher yield than Short's bonds.
D) If the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as Long's bonds.
E) If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal.

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A) If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices.
B) The total yield on a bond is derived from dividends plus changes in the price of the bond.
C) Bonds are riskier than common stocks and therefore have higher required returns.
D) Bonds issued by larger companies always have lower yields to maturity (less risk) than bonds issued by smaller companies.
E) The market value of a bond will always approach its par value as its maturity date approaches, provided the bond's required return remains constant.

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A) Adding additional restrictive covenants that limit management's actions.
B) Adding a call provision.
C) The rating agencies change the bond's rating from Baa to Aaa.
D) Making the bond a first mortgage bond rather than a debenture.
E) Adding a sinking fund.

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A) The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm's total dollar interest charges will be.
B) If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of debentures.
C) In this situation, we cannot tell for sure how, or whether, the firm's total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. The interest rate on each of the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result might well be such that the firm's total interest charges would not be affected materially by the mix between the two.
D) The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures.
E) If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds.

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