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Bond Valuation - Test Bank 1

Bond Valuation - Test Bank 1

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Published by: drde321 on Mar 26, 2013
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09/22/2013

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CHAPTER 6BONDS AND THEIR VALUATION
(Difficulty: E = Easy, M = Medium, and T = Tough)
True-False
 Easy:
Discounted cash flowsAnswer: b Diff: E
1
.The market value of any real or financial asset, including stocks,bonds, or art work, may be found by determining future cash flows andthen discounting them back to the present.a.Trueb.False
Issuing bondsAnswer: b Diff: E
2
.If a firm raises capital by selling new bonds, the buyer is called the"issuing firm," and the coupon rate is generally set equal to therequired rate.a.Trueb.False
Interest rate riskAnswer: b Diff: E
3
.A 20-year original maturity bond with 1 year left to maturity has moreinterest rate risk than a 10-year original maturity bond with 1 yearleft to maturity. (Assume that the bonds have equal default risk andequal coupon rates.)a.Trueb.False
Interest rate riskAnswer: b Diff: E
4
.Because short-term interest rates are much more volatile than long-termrates, you would, in the real world, be subject to much more interestrate risk if you purchased a 30-day bond than if you bought a 30-yearbond.a.Trueb.False
Bond prices and interest ratesAnswer: a Diff: E
5
.For bonds, price sensitivity to a given change in interest ratesgenerally
increases
as years remaining to maturity increases.a.Trueb.False
 
 Mortgage bondAnswer: a Diff: E
6
.Typically, debentures have higher interest rates than mortgage bondsprimarily because the mortgage bonds are backed by assets whiledebentures are unsecured.a.Trueb.False
Debt coupon rateAnswer: a Diff: E
7
.Other things equal, a firm will have to pay a higher coupon rate on asubordinated debenture than on a second mortgage bond.a.Trueb.False
Call provisionAnswer: b Diff: E
8
.A call provision gives bondholders the right to demand, or "call for,"repayment of a bond. Typically, calls are exercised if interest ratesrise, because when rates rise the bondholder can get the principalamount back and reinvest it elsewhere at higher rates.a.Trueb.False
Sinking fundAnswer: a Diff: E
9
.Many bond indentures allow the company to acquire bonds for a sinkingfund either by purchasing bonds in the market or by a lotteryadministered by the trustee for the purchase of a percentage of theissue through a call at face value.a.Trueb.False
Zero coupon bondAnswer: b Diff: E
.A zero coupon bond is a bond that pays no interest and is offered (andsubsequently sells) at par, therefore providing compensation toinvestors in the form of capital appreciation.a.Trueb.False
Floating rate debtAnswer: a Diff: E
.The motivation for floating rate bonds arose out of the costlyexperience of the early 1980s when inflation pushed interest rates tovery high levels causing sharp declines in the prices of long-termbonds.a.Trueb.False
 
Junk bondAnswer: a Diff: E
.A junk bond is a high risk, high yield debt instrument typically usedto finance a leveraged buyout or a merger, or to provide financing to acompany of questionable financial strength.a.Trueb.False
Bond ratings and required returnsAnswer: a Diff: E
.There is an inverse relationship between bond ratings and the requiredreturn on a bond. The required return is lowest for AAA-rated bonds,and required returns increase as the ratings get lower.a.Trueb.False
 Medium:
Bond valueAnswer: a Diff:
.If the required rate of return on a bond is
greater than
its couponinterest rate (and r
d
remains above the coupon rate), the market valueof that bond will always be
below 
its par value until the bond matures,at which time its market value will equal its par value. (Accruedinterest between interest payment dates should not be considered whenanswering this question.)a.Trueb.False
Bond value - annual paymentAnswer: a Diff:
.You have just noticed in the financial pages of the local newspaperthat you can buy a $1,000 par value bond for $800. If the coupon rateis 10 percent, with annual interest payments, and there are 10 years tomaturity, you should make the purchase if your required return oninvestments of this type is 12 percent.a.Trueb.False
Prices and interest ratesAnswer: a Diff:
.The prices of high-coupon bonds tend to be less sensitive to a givenchange in interest rates than low-coupon bonds, other things equal andheld constant.a.Trueb.False

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