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Financial Management, 12e (Titman/Keown/Martin) Chapter 9   Debt Valuation and Interest Rates   9

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Financial Management, 12e (Titman/Keown/Martin)

Chapter 9   Debt Valuation and Interest Rates

 

9.1   Overview of Corporate Debt

 

1) The par value of a bond

A) never equals its market value.

B) is determined by the investor.

C) generally is $1,000.

D) is never returned to the bondholder.

2) The interest on corporate bonds is typically paid

A) semiannually.

B) annually.

C) quarterly.

D) monthly.

3) On any given day, a bond can be issued at

A) a discount.

B) a premium.

C) par.

D) all of the above.

4) Advantages to borrowing in the private market include

A) less restrictive covenants.

B) reduced initial costs.

C) lower interest costs.

D) avoiding future SEC registration.

 

5) Advantages of privately placing debt include all of the following except

A) speed.

B) reduced placement costs.

C) restrictive covenants.

D) flexibility.

 

6) Corporate debt can be privately placed with

A) union pension funds.

B) life insurance companies.

C) state pension funds.

D) all of the above

 

7) Which of the following is generally NOT a characteristic of a bond?

A) Voting rights

B) Par value

C) Claims on assets and income

D) Indenture

 

8) The detailed legal agreement between a bond's issuer and its trustees is known as the

A) collateral agreement.

B) call provision.

C) indenture.

D) covenant.

9) The issuance of bonds to raise capital for a corporation

A) magnifies the returns to the stockholders.

B) increases risk to the stockholders.

C) is a cheaper form of capital than the issuance of common stock.

D) all of the above.

10) A(n)________ is used to outline the issuing company's contractual obligations to bondholders.

A) mortgage

B) debenture

C) bond rating

D) indenture

11) Bonds with ratings lower than Standard & Poor's BBB or Moody's Baa are classified as

A) in default.

B) investment grade.

C) not investment grade.

D) medium quality.

12) Which of the following features allows a borrower to redeem or repurchase a bond issue before its maturity date?

A) The call provision

B) Convertibility

C) Floating rate

D) The priority of claims

 

13) The par value of a corporate bond indicates the level of interest payments that will be paid to investors.

14) Any unsecured long-term debt instrument is a debenture.

 

15) A conversion feature confers the option of redeeming a bond for the company's stock rather than cash.

 

16) The debenture is the legal agreement between the firm issuing a bond and the bond trustee who represents the bondholders.

 

17) The current yield is the average rate of interest a bond will from the time of purchase until it matures.

 

18) If the issuing company becomes insolvent, the claims of the bondholders are honored before those of preferred stockholders.

9.2   Valuing Corporate Debt

 

1) The yield to maturity on a bond

A) is fixed in the indenture.

B) is lower for higher-risk bonds.

C) is the required return on the bond.

D) is generally equal to the coupon interest rate.

 

2) All of the following affect the value of a bond EXCEPT

A) investors' required rate of return.

B) the recorded value of the firm's assets.

C) the coupon rate of interest.

D) the maturity date of the bond.

 

3) A $1,000 par value 10-year bond with a 10% coupon rate recently sold for $900. The yield to maturity

A) is 10%.

B) is greater than 10%.

C) is less than 10%.

D) cannot be determined.

4) Sterling Corp. bonds pay 10% annual interest and are selling at 97. The market rate of interest

A) is less than 10%.

B) is greater than 10%.

C) equals 10%.

D) cannot be determined.

5) The Blackburn Group has recently issued 20-year, unsecured bonds rated BB by Moody's. These bonds yield 443 basis points above the U.S. Treasury yield of 2.76%.  The yield to maturity on these bonds is

A) 4.43%.

B) 7.19%.

C) 12.23%.

D) mortgage bonds.

6) Colby & Company bonds pay semiannual interest of $50. They mature in 15 years and have a par value of $1,000. The market rate of interest is 8%. The market value of Colby bonds is (round to the nearest dollar)

A) $1,173.

B) $743.

C) $1,000.

D) $827.

7) Caldwell, Inc. sold an issue of 30-year, $1,000 par value bonds to the public. The bonds carry a 10.85% coupon rate and pay interest semiannually. It is now 12 years later. The current market rate of interest on the Caldwell bonds is 8.45%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.

A) $751

B) $1,177

C) $1,220

D) $976

8) MI has a $1,000 par value, 30-year bond outstanding that was issued 20 years ago at an annual coupon rate of 10%, paid semiannually. Market interest rates on similar bonds are 7%. Calculate the bond's price.

A) $956.42

B) $1,000.00

C) $1,168.31

D) $1,213.19

9) Davis & Davis issued $1,000 par value bonds at 102. The bonds pay 12% interest annually and mature in 30 years. The market rate of interest is (round to the nearest hundredth of a percent)

A) 12.00%.

B) 11.71%.

C) 10.12%.

D) 11.29%.

 

10) What is the yield to maturity of a nine-year bond that pays a coupon rate of 20% per year, has a $1,000 par value, and is currently priced at $1,407? Assume annual coupon payments.

A) 21.81%

B) 6.14%

C) 12.28%

D) 11.43%

11) What is the expected rate of return on a bond that matures in seven years, has a par value of $1,000, a coupon rate of 14%, and is currently selling for $911?  Assume annual coupon payments.

A) 7.81%

B) 15.36%

C) 15.61%

D) 16.22%

 

12) What is the expected rate of return on a bond that pays a coupon rate of 9% paid semi-annually, has a par value of $1,000, matures in five years, and is currently selling for $1071?

A) 7.28%

B) 8.40%

C) 3.64%

D) 4.21%

13) What is the value of a bond that has a par value of $1,000, a coupon rate of $80 (annually), and matures in 11 years? Assume a required rate of return of 11%, and round your answer to the nearest $10.

A) $320.66

B) $1,011.00

C) $813.80

D) $790.79

14) What is the value of a bond that matures in three years, has an annual coupon payment of $110, and a par value of $1,000? Assume a required rate of return of 11%, and round your answer to the nearest $10.

A) $970

B) $1,330

C) $330

D) $1,000

 

 

15) Bond ratings directly affect a bond's

A) spread over the Treasury yield.

B) coupon rate.

C) maturity date.

D) call provisions.

16) The discount rate used to value a bond is

A) the coupon interest rate.

B) determined by the issuing company.

C) fixed for the life of the bond.

D) the market rate of interest.

17) As interest rates, and consequently investors' required rates of return, change over time, the ________ of outstanding bonds will also change.

A) maturity date

B) coupon interest payment

C) par value

D) price

18) Mango Company bonds pay a semiannual coupon rate of 6.4%. They have eight years to maturity and face value, or par, of $1,000. Compute the value of Mango bonds if investors' required rate of return is 5%.

A) $1,090.48

B) $883.66

C) $1,006.83

D) $950.00

 

19) Terminator Bug Company bonds have a 14% coupon rate. Interest is paid semiannually. The bonds have a par value of $1,000 and will mature 10 years from now. Compute the value of Terminator bonds if investors' required rate of return is 12%.

A) $1,114.70

B) $1,149.39

C) $894.06

D) $1,000.00

20) Brookline, Inc. just sold an issue of 30-year bonds for $1,107.20. Investors require a rate of return on these bonds of 7.75%. The bonds pay interest semiannually. What is the coupon rate of the bonds?

A) 7.750%

B) 11.072%

C) 9.375%

D) 8.675%

21) Applebee sold an issue of 30-year, $1,000 par value bonds to the public. The coupon rate of 8.75% is payable annually. It is now five years later, and the current market rate of interest is 7.25%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.

A) $715

B) $1,171

C) $1,225

D) $697

22) Six years ago, Colt, Inc. sold an issue of 30-year, $1,000 par value bonds. The coupon rate of 5.25% is payable annually. Investors presently require a rate of return of 8.375%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.

A) $1,050

B) $932

C) $681

D) $1,111

 

23) Blue's Chips Inc. has a $1,000 par value bond that is currently selling for $1,300. It has an annual coupon rate of 7%, paid semiannually, and has nine years remaining until maturity. What is the annual yield to maturity on the bond? (Round to the nearest whole percentage.)

A) 3.15%

B) 1.57%

C) 3.12%

D) 6.24%

 

24) You are considering the purchase of Hytec bonds that were issued 14 years ago. When the bonds were originally sold, they had a 30-year maturity and a 14.375% coupon interest rate that is payable semiannually. The bond is currently selling for $1,508.72. What is the yield to maturity on the bonds?

A) 8.50%

B) 14.38%

C) 11.11%

D) 7.67%

 

25) Aurand, Inc. has outstanding bonds with an 8% annual coupon rate paid semiannually. The bonds have a par value of $1,000, a current price of $904, and will mature in 14 years. What is the annual yield to maturity on the bond?

A) 15.80%

B) 10.47%

C) 9.24%

D) 7.90%

E) 4.62%

 

26) Marshall Manufacturing has a bond outstanding that was issued 20 years ago at a coupon rate of 9%. The $1,000 par value bond pays interest semiannually and was originally issued with a term of 30 years. If today's interest rate is 14%, what is the value of the bond today?

A) $654.98

B) $735.15

C) $814.42

D) $941.87

 

27) A $1,000 par value bond is currently listed as selling at 92 1/8. This means

A) that you can buy the bond for $92.125.

B) that you can buy the bond for $921.25.

C) that if you purchase the bond today, you will receive $921.25 when the bond matures.

D) none of the above.

28) You paid $865.50 for a corporate bond that has a 6.75% coupon rate. What is the bond's current yield?

A) 8.375%

B) 7.800%

C) 15.001%

D) 6.667%

29) A $1,000 par value bond with a 12% coupon rate currently selling for $825 has a current yield of

A) 14.55%.

B) 12.44%.

C) 7.27%.

D) 5.61%.

 

30) When a bond's coupon rate is higher than the required rate of return, the bond

A) will sell at a discount from par.

B) will sell at a premium over par.

C) may sell at either a discount or a premium.

D) will sell at par value.

31) Miller Motorworks has a $1,000 par value, 8% annual coupon bond with interest payable semiannually with a remaining term of 15 years. The annual market yield on similar bonds is 6%.  This bond will at a discount from par.

 

32) Lambda Co. has bonds outstanding that mature in 10 years. The bonds have $1,000 par value, pay interest annually at a rate of 9%, and have a current selling price of $1,125. The yield to maturity on the bonds is less than 9%.

33) Generic, Inc. has bonds outstanding that mature in 20 years. The bonds have $1,000 par value, pay interest annually at a rate of 10%, and have a current selling price of $875.25. The current yield on the bonds is 11.63%.

34) A basis point is equal to one hundredth of a percentage point.

 

35) A bond's "spread" refers to the difference between it's Moody's rating and its Standard & Poors rating.

 

36) A bond issued by Pomme Computers has a coupon rate of #5 paid semi-annually.  If the market's required rate of return on this bond is also 3%, the bond will sell at par value.

37) Dry Seal plans to issue bonds to expand operations. The bonds will have a par value of $1,000, a 10-year maturity, and a coupon interest rate of 9%, paid semiannually. Current market conditions are such that the bonds will be sold to net $937.79.  The yield-to-maturity of these bonds is 10%.

38) You purchased Photon, Inc. bonds exactly one year ago today for $875. During the latest year, you received $65 in interest on the bonds. The current yield on these bonds is 6.5%.

39) A AAA rated bond's yield to maturity will be very close to it's expected yield.

40) The longer the time to maturity, the more sensitive a bond's price to changes in market interest rates.

41) A bond's value equals the present value of interest and principal the owner will receive.

 

42) The higher the bond rating, the more default risk associated with the bond.

 

43) Bond ratings measure the interest rate risk of a given bond issue.

 

44) When referring to bonds, expected rate of return and yield to maturity are often used interchangeably.

45) Investment grade bonds are rated BB or lower.

46) The current yield of a bond will equal its coupon rate when the bond is selling at par value.

47) The better the bond rating, the lower the rate of return demanded in the capital markets.

48) The sensitivity of a bond's value to changing interest rates depends on both the bond's time to maturity and its pattern of cash flows.

 

49) Compare and contrast current yield and yield to maturity.

50) BCD's $1,000 par value bonds currently sell for $798.50. The coupon rate is 10%, paid semiannually. If the bonds have five years before maturity, what is the yield to maturity or expected rate of return?

51) If you are willing to pay $1,392.05 for a 15-year, $1,000 par value bond that pays 10% interest semiannually, what is your expected rate of return?

52) DAH, Inc. has issued a 12% bond that is to mature in nine years. The bond had a $1,000 par value, and interest is due to be paid semiannually. If your required rate of return is 10%, what price would you be willing to pay for the bond?

53) The market price of a 20-year, $1,000 bond that pays 9% interest semiannually is $774.31. What is the bond's yield to maturity?

54) Calculate the value of a bond that is expected to mature in 13 years with a $1,000 face value. The interest coupon rate is 8%, and the required rate of return is 10%. Interest is paid annually.

55) Garvin, Inc.'s bonds have a par value of $1,000. The bonds pay semiannual interest of $40 and mature in five years.

a.     How much would you pay for Garvin bonds if your required rate of return is 10%?

b.     How much would you pay if your required rate of return is 8%?

56) Given the following information, determine the market value of EAO Company bonds.

Par value                        $1,000

Coupon rate                    10%

Years to maturity              6

Market rate                       8%

Interest paid           semiannually

9.3   Bond Valuation: Four Key Relationships

 

1) If the market price of a bond increases, then

A) the yield to maturity decreases.

B) the coupon rate increases.

C) the yield to maturity increases.

D) none of the above.

2) If current market interest rates rise, what will happen to the value of outstanding bonds?

A) It will rise.

B) It will fall.

C) It will remain unchanged.

D) There is no connection between current market interest rates and the value of outstanding bonds.

3) If current market interest rates fall, what will happen to the value of outstanding bonds?

A) It will rise.

B) It will fall.

C) It will remain unchanged.

D) There is no connection between current market interest rates and the value of outstanding bonds.

 

 

4) Cassel Corp. bonds pay an annual coupon rate of 10%. If investors' required rate of return is now 8% on these bonds, they will be priced at

A) par value.

B) a premium to par value.

C) a discount to par value.

D) cannot be determined from information given.

5) Which of the following statements is true?

A) A bond that has a rating of AA is considered to be a junk bond.

B) A bond will sell at a premium if the prevailing required rate of return is less than the bond's coupon rate.

C) A zero coupon is a bond that is secured by a lien on real property.

D) The legal document that describes all of the terms and conditions of a bond issue is called a debenture agreement.

6) Quirk Drugs sold an issue of 30-year, $1,000 par value bonds to the public that carry a 10.85% coupon rate, payable semiannually. It is now 10 years later, and the current market rate of interest is 9.00%. If interest rates remain at 9.00% until Quirk's bonds mature, what will happen to the value of the bonds over time?

A) The bonds will sell at a premium and decline in value until maturity.

B) The bonds will sell at a discount and rise in value until maturity.

C) The bonds will sell at a premium and rise in value until maturity.

D) The bonds will sell at a discount and fall in value until maturity.

 

 

7) Which of the following statements is true?

A) When investors' required rate of return equals the bond's coupon rate, then the market value of the bond may be selling at par value.

B) When investors' required rate of return exceeds the bond's coupon rate, then the market value of the bond will be greater than par value.

C) When investors' required rate of return is less than the bond's coupon rate, then market value of the bond will be greater than par value.

D) When investors' required rate of return is less than the bond's coupon rate, then the market value of the bond will be less than par value.

8) A bond with a face value of $1,000 has annual coupon payments of $100 and was issued seven years ago. The bond currently sells for $1,085, has eight years left to maturity. This bond's ________ must be less than 10%.

A) current yield

B) coupon rate

C) current yield and coupon rate

D) yield to maturity and current yield

 

9) A bond has a coupon rate of 6% paid semi-annually, a par value of $1,000, and matures tomorrow.  The bond will sell for

A) approximately $1,030 .

B) approximately $1,000.

C) approximately $1,060.

D) The price cannot be estimated without knowing the market rate of interest.

 

10) Which of the following statements about bonds is true?

A) Bond prices move in the same direction as market interest rates.

B) If market interest rates change, long-term bonds will fluctuate more in value than short-term bonds.

C) Long-term bonds are less risky than short-term bonds.

D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value.

E) None of the above.

11) Which of the following statements about bonds is true?

A) As the maturity date of a bond approaches, the market value of a bond will become more volatile.

B) Long-term bonds have less interest rate risk than do short-term bonds.

C) Bond prices move in the same direction as market interest rates.

D) If market interest rates are above a bond's coupon interest rate, then the bond will sell below its par value.

12) Which of the following statements about bonds is true?

A) The market value of a bond moves in the opposite direction of market interest rates.

B) As the maturity date of a bond approaches, the market value of a bond will become more volatile.

C) Long-term bonds are less risky than short-term bonds.

D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value.

E) None of the above.

13) A bond investor seeking capital gains should purchase

A) bonds with short maturity dates when interest rates are expected to rise.

B) bonds with distant maturity dates when interest rates are expected to rise.

C) bonds with short maturity dates when interest rates are expected to decline.

D) bonds with distant maturity dates when interest rates are expected to decline.

14) Which of the following statements about bonds is true?

A) If market interest rates are below a bond's coupon interest rate, then the bond will sell above its par value.

B) Long-term bonds have less interest rate risk than do short-term bonds.

C) Bond prices move in the same direction as market interest rates.

D) As the maturity date of a bond approaches, the market value of a bond will become more volatile.

15) Bonds cannot be worth less than their book value.

16) So long as a bond sells for an amount above its par value, the coupon interest rate and yield to maturity remain equal.

 

17) As market interest rates increase, bond prices decrease.

18) Bonds that sell at a discount have a coupon rate lower than the market interest rate.

19) Bonds with a longer time to maturity have less interest rate risk.

 

20) As investors' required rate of return on a bond increases, the value of the bond increases also.

21) As the maturity date of a bond approaches, the bond's market value approaches its par value.

22) Shorter-term bonds have greater interest rate risk than do longer-term bonds.

 

23) Why are longer-term bonds more sensitive to changes in interest rates than shorter-term bonds?

9.4   Types of Bonds

 

1) Eurobonds are

A) issued in a country different from the one in whose currency the bond is denominated.

B) issued only in Europe.

C) the European equivalent of a junk bond.

D) none of the above.

 

2) Which of the following statements about zero coupon bonds is FALSE?

A) When the bonds mature, the issuing firm is faced with a small cash outflow relative to the cash inflow the firm receives when the bonds are initially issued.

B) Zero coupon bonds have lower interest rate risk than bonds with high coupons.

C) Zero coupon bonds are an extremely popular way for corporations to borrow money.

D) Most zero coupon bonds in the U.S. are government issues.

3) Which of the following bond types has the greatest risk for investors?

A) Debentures

B) Mortgage bonds

C) Floating rate bonds

D) Subordinated debentures

 

4) The holder of a non-amortizing bonds

A) receives no periodic interest payments.

B) receives the full par value of the bond when it matures.

C) receives shares of common stock rather than cash interest payments.

D) receives periodic payments that consist of both interest and principal.

5) Junk bonds

A) pay little or no interest.

B) are commonly used to finance municipal waste disposal facilities.

C) are issued by the U. S. Treasury Department.

D) have yields that are considerably higher than those of the highest rated bonds.

6) Debentures are unsecured long-term debt.

7) Zero coupon bonds are disadvantageous to the issuing firm if interest rates fall.

 

 

8) Eurobonds are bonds issued in a country different from the one in whose currency the bond is denominated.

9) Convertible bonds can be exchanged for the issuing firm's common stock at a price specified at the time of issue.

9.5   Determinants of Interest

 

1) The nominal interest rate

A) does not include inflation.

B) includes inflation and the real rate of interest.

C) ignores the Fisher effect.

D) is the rate at which banks lend money to other banks.

2) Government bonds have lower yield to maturity than do corporate bonds of the same maturity because the ________ premium is lower for government bonds.

A) interest rate risk

B) inflation

C) default

D) maturity

3) The Fisher effect can be expressed mathematically as

A) ( nominal rate)= (the real rate of interest) ( the inflation rate).

B) (1+ the nominal rate)= (1+the real rate of interest) (1 + the inflation rate).

C)  the nominal rate)= the real rate of interest + the inflation rate).

D) the real rate of interest= the nominal rate - the inflation rate).

4) The yield on a corporate bond with a 20 year maturity would include

A) only the real rate of interest and expected inflation.

B) the risk-free rate multiplied by 1+ default rate.

C) the risk-free rate plus a default risk premium, a liquidity risk premium and a maturity risk premium.

D) the real rate of interest, the expected inflation rate and a default risk premium.

 

5) Pursuant to the Fisher Effect, the real interest rate is exactly equal to the nominal interest rate less the rate of inflation.

6) When inflation rates go up, bond prices go up as well.

 

7) As the time to maturity increases, the maturity premium increases.

8) Maturity risk and liquidity risk are equivalent terms.

9) Maturity risk and liquidity risk are equivalent terms.

10) Long-term government bonds are not without maturity risk.

 

11) Explain why an increase in the inflation rate will cause the yield to maturity on a bond to increase.

12) What elements determine what the yield to maturity will be for a bond?

13) Given the anticipated rate of inflation (i) of 6.3% and the real rate of interest (R) of 4.7%, find the nominal rate of interest (r).

 

14) If provided the nominal rate of interest (r) of 14.2% and the anticipated rate of inflation (i) of 5.5%, what is the real rate of interest (R)?

15) Given the anticipated rate of inflation (i) of 6.13% and the real rate of interest (R) of 7.56%, what is the true inflation premium?