Solution Manual for CFIN 5th Edition by Besley and Brigham

ISBN 1305661656 9781305661653

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brigham-isbn-1305661656-9781305661653/ Chapter 06 Bonds Debt
Characteristics and Valuation

TRUEFALSE

1. Typically, debentures have higher interest rates than mortgage bonds primarily because
mortgage bonds are backed by assets while debentures are unsecured.

(A) True (B)

False

Answer : (A)

2. A call provision gives bondholders the right to demand, or "call for," the repayment of a bond.
Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get
the principal amount back and reinvest it elsewhere at higher rates.

(A) True (B)

False

Answer : (B)

3. Issuing zero coupon bonds might appeal to a company that is considering investing in a long-term
project that will not generate positive cash flows for several years.

(A) True (B)

False

Answer : (A)

4. The motivation for floating-rate bonds arose out of the costly experience of the early 1980s when
inflation pushed interest rates to very high levels, causing sharp declines in the prices of long-term
bonds.

(A) True (B)

False

Answer : (A)
5. As junk bonds are such high-risk instruments, the returns on such bonds aren't very high.

(A) True

(B) False

Answer : (B)
6. LIBOR is the acronym for London Interbank Offer Rate, which is an average of interest rates
offered by London banks to U.S. corporations.

(A) True (B)

False

Answer : (B)

7. In general, long-term unsecured debts are less costly than long-term secured debts for a
particular firm.

(A) True (B)

False

Answer : (B)

8. Foreign debt is a debt instrument sold by a foreign borrower that is denominated in the currency
of the country in which it is sold.

(A) True (B)

False

Answer : (A)

9. Foreign debt is debt sold in a country other than the one in whose currency the debt is
denominated

(A) True (B)

False

Answer : (B)

10. Eurobonds have a higher level of required disclosure than normally applies to bonds issued in
domestic markets, particularly in the United States.

(A) True (B)

False

Answer : (B)

11. Eurobonds are typically issued as registered bonds rather than bearer bonds.

(A) True
(B) False

Answer : (B)

12. Eurocredits are bank loans that are denominated in the currency of a country other than where
the lending bank is located.

(A) True (B)

False

Answer : (A)

13. Although common stock represents a riskier investment to an individual than do bonds, bonds
represent a riskier method of financing to a corporation than does common stock.

(A) True (B)

False

Answer : (A)

14. Restrictive covenants are designed to protect both the bondholder and the issuer even though
they may constrain the actions of the firm's managers. Such covenants are contained in the bond's
indenture.

(A) True (B)

False

Answer : (A)

15. One of the disadvantages of issuing zero coupon bonds is that the tax shield associated with the
bonds' appreciation cannot be claimed until the bond matures.

(A) True (B)

False

Answer : (B)

16. Floating-rate debt is advantageous to investors because the interest rate moves up if market
rates rise.

(A) True (B)

False

Answer : (A)
17. 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 the required rate.

(A) True (B)

False

Answer : (B)

18. The financial pages of the local newspaper helped Mary in identifying that she can buy a bond
($1,000 par) for $800. If the coupon rate is 10 percent, the annual interest payments equal $80.

(A) True

(B) False

Answer : (B)

19. Call provisions on corporate bonds are generally included to protect the issuer against large
increases in interest rates. They affect the actual maturity of the bond but not its price.

(A) True (B)

False

Answer : (B)

20. If a bond is callable and if interest rates in the economy decline, then the company can sell a
new issue of low-interest-rate bonds and use the proceeds to "call" the old bonds in and have
effectively refinanced at a lower rate.

(A) True (B)

False

Answer : (A)

21. There is an inverse relationship between bond ratings and the required return on a bond. The
required return is lowest for AAA rated bonds, and required returns increase as the ratings get
lower (worse).

(A) True (B)

False

Answer : (A)

22. If there are two bonds with a simple interest rate yield of 9%, and one bond is compounded
quarterly while the other bond is compounded monthly, then the bond compounded quarterly will
have a higher effective annual yield.

(A) True

(B) False

Answer : (B)

23. A 20-year original maturity bond with 1 year left to maturity has more interest rate price risk
than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have
equal default risk and equal coupon rates.)

(A) True (B)

False

Answer : (B)

24. Regardless of the size of the coupon payment, the price of a bond moves in the opposite
direction to interest rate movements. For example, if interest rates rise, bond prices fall.

(A) True (B)

False

Answer : (A)

25. Because short-term interest rates are much more volatile than long-term rates, an investor
would, in the real world, be subject to much more interest rate price risk if he or she purchased a
30-day bond than if he or she bought a 30-year bond.

(A) True

(B) False

Answer : (B)

26. A bond's value will increase with increases in interest rate over time.

(A) True

(B) False

Answer : (B)

27. A bond with a $100 annual interest payment and $1,000 face value with five years to maturity
(not expected to default) would sell for a premium if interest rates were below 9% and would sell for
a discount if interest rates were greater than 11%.
(A) True (B)

False

Answer : (A)

28. Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10 percent
currently have a yield to maturity (YTM) equal to 8 percent. Based on this information, it is
understood that BB&C's bonds must currently be selling at a premium in the financial markets.

(A) True (B)

False

Answer : (A)

29. If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond
should be selling at a discount; i.e., the bond's market price should be less than its face (maturity)
value.

(A) True (B)

False

Answer : (B)

30. If a bond is selling for less than its face, or maturity, value and the market interest rate remains
unchanged during the life of the bond, then the price (value) of the bond will increase as the
maturity date nears.

(A) True (B)

False

Answer : (A)

31. The longer the maturity of the bond, the more significantly its price changes in response to a
given change in interest rates.

(A) True (B)

False

Answer : (A)

MULTICHOICE
32. Which of the following is generally considered an advantage of term loans over publicly issued
bonds?

(A) Higher flotation costs

(B) Speed, or how long it takes to bring the issue to the market

(C) Fixed bond terms after the bond has been issued

(D) Regular interest and principal payments on specified dates

(E) Standard terms of issue requiring no negotiation between the borrowing firm and the financial
institution

Answer : (B)

33. Other things held constant, if a bond indenture contains a call provision, the yield to maturity
(YTM) on the bond that would exist without such a call provision will be the YTM with the call
provision.

(A) higher than

(B) lower than

(C) the same as

(D) moving with

(E) unrelated to

Answer : (B)

34. The terms and conditions of a bond are set forth in its:

(A) debenture.

(B) underwriting agreement.

(C) indenture.

(D) restrictive covenants.

(E) call provision.

Answer : (C)

35. A contract that is negotiated directly with a bank and under which the borrower agrees to make
a series of interest and principal payments to the bank on specific dates is called:

(A) preferred stock.

(B) commercial paper.

(C) convertible debt.

(D) a term loan.

(E) a bond issue.

Answer : (D)

36. A bond differs from a term loan in that:

(A) a bond issue is negotiated between a financial institution and an investor.

(B) a bond is sold to a financial institution only.

(C) a bond is offered to the public at a variable coupon rate.

(D) a bond has a high issuance cost.

(E) a bond involves minimal formal documentation.

Answer : (D)

37. A debt backed by some form of specific property is known as a:

(A) debenture.

(B) mortgage bond.

(C) subordinated debt.

(D) government bond.

(E) term loan.

Answer : (B)

38. In the event of liquidation, a(n) has a claim on assets only after the senior debt has been
paid off.

(A) debenture

(B) income bond

(C) indenture

(D) subordinated debenture

(E) mortgage bond

Answer : (D)
39. A(n) can be exchanged for shares of equity at the owner's discretion.

(A) debenture

(B) indenture

(C) callable bond

(D) convertible bond

(E) putable bond

Answer : (D)

40. A bond that only pays interest if the firm has sufficient earnings to cover the interest payments
is called a(n):

(A) callable bond.

(B) putable bond.

(C) convertible bond.

(D) income bond.

(E) indexed bond.

Answer : (D)

41. A bond that can be redeemed for cash at the bondholder's option is called a(n):

(A) convertible bond.

(B) putable bond.

(C) callable bond.

(D) debenture.

(E) income bond.

Answer : (B)

42. Which of the following events would make it less likely for a company to choose to call its
outstanding callable bonds?

(A) An increase in interest rates

(B) A decrease in interest rates

(C) An increase in the price of outstanding convertible bonds

(D) A decrease in call premium

(E) An increase in the maturity value of callable bonds

Answer : (A)

43. A bond that pays no annual interest and is sold at a discount below its par value is called a:

(A) mortgage bond.

(B) callable bond.

(C) convertible bond.

(D) putable bond.

(E) zero coupon bond.

Answer : (E)

44. High-risk, high-yield bonds used to finance mergers, leveraged buyouts, and troubled companies
are referred to as:

(A) callable bonds.

(B) junk bonds.

(C) convertible bonds.

(D) floating-rate bonds.

(E) putable bonds.

Answer : (B)

45. Which of the following types of bonds protects a bondholder against increases in interest rates?

(A) Floating-rate bonds

(B) Income bonds

(C) Bonds with call provisions

(D) Municipal bonds

(E) Mortgage bonds

Answer : (A)

46. Which of the following statements is true about a zero coupon bond?
(A) A zero coupon bond is taxed as a capital gain at the time the bond matures.

(B) A zero coupon bond is issued at a substantial discount below its par value.

(C) A zero coupon bond is issued at a coupon rate that adjusts for inflation.

(D) The interest received every year on a zero coupon bond is taxed as interest income.

(E) The discount on the issue of a zero coupon bond is written off over its life in the investor's
financial statement.

Answer : (B)

47. Which of the following statements is true about foreign bonds?

(A) The interest rate on foreign bonds is annually adjusted for inflation.

(B) Foreign bonds are bonds sold in a foreign country and are denominated in the currency of the
country in which the issue is sold.

(C) Foreign bonds are bonds sold by a foreign borrower but convertible to bonds issued in the
foreign country.

(D) The term Eurobond specifically applies to any foreign bonds denominated in U.S. dollars.

(E) The interest rate on foreign bonds is adjusted annually for exchange rate fluctuations.

Answer : (B)

48. Which of the following types of investor would be most likely to purchase zero coupon bonds?

(A) Retired individuals seeking income for current consumption

(B) Individuals in high tax brackets

(C) Tax-free investors such as pension funds

(D) Risk-averse individuals anticipating increases in interest rates

(E) Individuals with no interest income

Answer : (C)

49. Which of the following bonds pays interest based on an inflation index?

(A) Floating-rate bonds

(B) Income bonds

(C) Treasury bills

(D) Purchasing power bonds

(E) Zero coupon bonds

Answer : (D)

50. The principal value of debt is:

(A) the amount added to interest payments to be repaid at the maturity date.

(B) the amount owed to the lender.

(C) the sum of all interest payments during the life of the debt.

(D) the amount of adjustment in the maturity value of the debt due to interest rate fluctuations.

(E) the sum of interest and inflation adjusted par value of debt.

Answer : (B)

51. The principal value of debt:

(A) is added to the interest payments to get the maturity value of the debt.

(B) must be repaid at some point during the life of the debt to the investors.

(C) is always half of the maturity value of the debt.

(D) is equal to the market value of the debt.

(E) always yields positive returns for investors.

Answer : (B)

52. The face value of a debt is:

(A) the principal value written on the face, or outside cover, of a debt contract.

(B) always equal to the market value of the debt.

(C) equal to the principal value minus the interest payments to investors.

(D) always greater than the maturity value of the debt.

(E) added to the interest payments to find the maturity value of the debt.

Answer : (A)

53. A debt is said to be selling at par when:

(A) investors' required rate of return from debt is equal to the coupon rate.

(B) the market rate of return is more than the coupon rate of return.
(C) the borrower pays the interest at the maturity of the debt.

(D) the current market price of the debt is more than the face value of the debt.

(E) the market value is equal to the face value of the debt.

Answer : (E)

54. The principal value is also referred to as the maturity value because:

(A) it is always repaid at maturity in one installment.

(B) it is written on the face of the debt contract.

(C) it is repaid at the maturity date.

(D) it is added to interest payments to be repaid at the maturity date.

(E) it is issued at a value below par value to generate a positive capital gain.

Answer : (C)

55. When the market value of debt is the same as its face value, it is said to be selling at the:

(A) yield value.

(B) par value.

(C) discounted value.

(D) premium value.

(E) maturity value.

Answer : (B)

56. A debt is said to be selling at par, when the of the debt is equal to the .

(A) par value; discounted value of the interest payments

(B) principal value; discount on the issue of a zero coupon bond

(C) face value; premium payment on the exercise of a call provision

(D) market value; face value of the debt

(E) maturity value; par value of the debt

Answer : (D)

57. The principal value generally is written on the outside cover of the debt contract, so it is
sometimes called the:

(A) maturity value.

(B) premium value.

(C) yield value.

(D) face value.

(E) discounted value.

Answer : (D)

58. When the market value of debt is the same as its par value, it is:

(A) refinanced at a lower interest rate.

(B) a par bond selling at its face value

(C) issued at a premium

(D) repaid at the maturity date

(E) selling at a discount

Answer : (B)

59. The date on which the principal amount of a debt is due is the:

(A) maturity date.

(B) reinvestment date.

(C) issue date.

(D) repurchase date.

(E) priority date.

Answer : (A)

60. For installment loans, the maturity date is:

(A) the date on which the last installment payment is due.

(B) the date on which the market interest rate rises above the coupon rate.

(C) the date on which the coupon rate rises above the market interest rate.

(D) the date on which the first installment payment is due.

(E) the date on which the last coupon interest payment is made to the bondholders.

Answer : (A)

61. The maturity date is the date:

(A) on which the market interest rate equals the coupon rate on a bond.

(B) the principal amount of debt is due.

(C) on which investors make no capital gain or loss on an investment.

(D) the interest payment is due.

(E) on which the market value of a bond is more than the face value of the bond.

Answer : (B)

62. On the maturity date, .

(A) the maturity value of the debt is to be repaid

(B) the first installment of the installment loan is due

(C) the interest payment is due

(D) the market interest rate rises above the coupon rate

(E) the market price of the bond rises above the face value of the debt

Answer : (A)

63. Commercial paper is a type of:

(A) promissory note.

(B) credit note.

(C) debit note.

(D) bond indenture.

(E) T-bill.

Answer : (A)

64. Which of the following statements is true about commercial paper?

(A) Commercial paper always matures in two months.

(B) Commercial paper is issued by bankrupt firms.

(C) Commercial paper pays annual interest.

(D) Commercial paper is issued at a discount.

(E) Commercial paper is issued in denominations of $100.

Answer : (D)

65. Commercial paper is issued in denominations of:

(A) $10.

(B) $100. (C)

$1,000. (D)

$100,000.

(E) $1,000,000.

Answer : (D)

66. The maturity of commercial paper varies from:

(A) six to twelve months.

(B) one to five months.

(C) one to nine months.

(D) five to ten months.

(E) four to eight months.

Answer : (C)

67. Federal funds represent:

(A) funds collected from federal tax payment by banks.

(B) loans from the federal government to banks.

(C) loans from one bank to another bank.

(D) funds with banks for the repayment of loans to the federal government.

(E) funds collected from investors for investment in federal securities.

Answer : (C)

68. Banks generally use the federal funds market to:

(A) repay loans to investors.

(B) adjust their reserves.

(C) make interest payments on loans.

(D) make security deposits with other banks.

(E) repay loans to the federal government.

Answer : (B)

69. Banks that need additional funds to meet the reserve requirements of the Federal Reserve:

(A) borrow from the state government of the state where their headquarters are located.

(B) borrow from banks with excess reserves.

(C) issue treasury bills to investors.

(D) decrease the coupon interest rate on the bonds issued to raise funds.

(E) exercise the call option on the loans extended to small businesses.

Answer : (B)

70. Which of the following statements is true about federal funds?

(A) Federal funds offer loans at a coupon rate that is two times the market interest rate.

(B) Federal funds have very long maturities, often 3 years or more.

(C) Federal funds offer loans to the state government to meet the reserve requirements of the
federal government.

(D) Federal funds are used to repay the T-bills issued by the federal government.

(E) Federal funds are used by banks to meet the reserve requirements of the Federal Reserve.

Answer : (E)

71. Which of the following is true of a traditional certificate of deposit (CD)?

(A) Money in traditional CDs must be kept at the issuing institution for a specified time period.

(B) Traditional CDs pay no periodic interest.

(C) Traditional CDs are repaid in installments by the issuing bank.

(D) Traditional CDs have a floating rate of interest.

(E) Traditional CDs are discounted when their market price is more than issue price.
Answer : (A)

72. When liquidating a traditional certificate of deposit (CD) prior to maturity, the owner:

(A) must repay the interest due on the CD.

(B) must return it to the issuing institution.

(C) must refund the difference in the face value and market value of the CD to the issuing institution.

(D) must claim the interest earned by the bank by investing the CD amount.

(E) must deposit the amount equivalent to the CD amount in a savings account with the same bank.

Answer : (B)

73. A certificate of deposit represents:

(A) a promissory note of payment by a bank borrowing reserves from another bank.

(B) a deposit in a savings account in a bank.

(C) a promissory note of payment by the issuing institution to the investor.

(D) a time deposit of a state government with the federal government.

(E) a time deposit at a bank or other financial intermediary.

Answer : (E)

74. A(n) certificate of deposit (CD) can be traded to other investors prior to maturity because it
can be redeemed by whoever owns it at maturity.

(A) exchangeable

(B) operating

(C) negotiable

(D) mature

(E) commercial

Answer : (C)

75. Municipal bonds are issued by:

(A) financial institutions.

(B) state and local governments.

(C) commercial banks.

(D) the federal government.

(E) non-governmental organizations.

Answer : (B)

76. The two principal types of municipal bonds are:

(A) general obligation bonds and income bonds.

(B) income bonds and putable bonds.

(C) revenue bonds and general obligation bonds.

(D) floating-rate bonds and indexed bonds.

(E) floating-rate bonds and revenue bonds.

Answer : (C)

77. Revenue bonds are used to:

(A) raise funds to repay loans borrowed from the federal government.

(B) raise funds for projects that will generate revenues.

(C) raise funds to pay interest on T-bills issued by the state government.

(D) raise funds to repay loans borrowed by the local government.

(E) raise funds for projects that require additional funding by increasing tax rates.

Answer : (B)

78. General obligation bonds are backed:

(A) by the revenue generated from the project in which the bond proceeds are invested.

(B) by the government's ability to tax its citizens.

(C) by the penalty collected from the earlier repayment of a certificate of deposit.

(D) by the increase in the coupon rate due to inflation adjustment.

(E) by the additional principal received from exchange rate fluctuations.

Answer : (B)

79. A is assigned to represent the bondholders and to guarantee that the terms of the
indenture are carried out.

(A) federal government agent

(B) trustee

(C) liquidator

(D) negotiator

(E) rating agency

Answer : (B)

80. The indentures for publicly traded bonds are approved by:

(A) the state government.

(B) the Securities and Exchange Commission.

(C) the federal government.

(D) the Public Company Accounting Oversight Board.

(E) the local government.

Answer : (B)

81. The Securities and Exchange Commission is required to verify that:

(A) the coupon rate of debt is more than the market interest rate.

(B) all previous indenture provisions have been met before allowing a company to sell new securities
to the public.

(C) the market price of debt is more than the principal value of debt.

(D) the face value of debt is more than the maturity value of debt.

(E) the new securities to be sold to the public have a higher coupon rate than all previous security
issues.

Answer : (B)

82. The sinking fund provision requires a firm to:

(A) issue bonds every year to finance interest payment on bonds.

(B) retire a portion of the bond issue each year.

(C) increase the coupon rate by one percent every year.

(D) use annual interest payments for the repayment of bonds.

(E) gradually reduce the face value of debt to the level of market value of debt.

Answer : (B)

83. A(n) is a provision that facilitates the orderly retirement of a bond issue.

(A) amortization fund

(B) depreciation fund

(C) redemption fund

(D) conversion fund

(E) sinking fund

Answer : (E)

84. A sinking fund call:

(A) requires the company to pay a penalty to investors.

(B) does not require the company to pay a call premium.

(C) requires the company to redeem bonds at market price.

(D) does not require the company to pay a small percentage of the issue every year.

(E) requires the company to claim back all the interest payments from the bondholders.

Answer : (B)

85. The conversion feature of a bond permits:

(A) the company to convert a high coupon rate bond into a lower rate bond.

(B) the bondholder to exchange the bonds with a company's common stock.

(C) the bondholder to redeem a small percentage of the bond every year.

(D) the company to convert the face value of the bond to the market price of the bond.

(E) the company to trade outstanding bonds with a term deposit in a financial institution.

Answer : (B)

86. Which of the following is an advantage of convertible bonds?

(A) Investors can convert the bonds into higher coupon rate bonds.
(B) Investors can choose to hold the company's bonds or convert the bonds into its stock.

(C) Investors are paid a penalty on the conversion of the bonds.

(D) Investors are redeemed for the difference between the face value and the market price on
redemption of the bonds.

(E) Investors can claim interest for the remaining life of the bonds on the bonds' early conversion.

Answer : (B)

87. The conversion ratio is:

(A) the number of new lower coupon rate bonds that the bondholder receives for old bonds.

(B) the ratio of the face value of the bond to its market value.

(C) the number of shares of stock that the bondholder receives upon conversion.

(D) the ratio of the bond's old face value to its new face value.

(E) the number of bonds in the company's new project received upon expansion.

Answer : (C)

88. A call provision for the redemption of bonds:

(A) requires an advance payment of future interest to the bondholders.

(B) allows the firm to refinance debt.

(C) allows the firm to call the bonds for redemption after one year of maturity.

(D) requires the redemption of the bonds at their market price.

(E) requires bondholders to convert their bonds into lower coupon rate bonds.

Answer : (B)

89. Which of the following ratings by Moody's represents bonds that are least investment grade?

(A) Caa

(B) Baa

(C) B

(D) Ba

(E) Aa

Answer : (B)
90. Which of the following ratings by Standard & Poor's (S&P) indicates speculative bonds?

(A) A

(B) B (C)

BB (D)

BBB (E)

CCC

Answer : (E)

91. The quality ratings assigned to bonds reflect the:

(A) probability of their face value increasing to above their market value.

(B) probabilities of their going into default.

(C) probabilities of different returns on their sinking fund investments.

(D) probabilities of their maturity value becoming lower than the principal value.

(E) probabilities of their being recalled by the exercise of a call provision.

Answer : (B)

92. A firm's rating by a rating agency is based on:

(A) the firm's ratio of debt to total assets.

(B) the dividends paid in the last year by the firm.

(C) the earnings per share of the shareholders of subsidiary firms.

(D) exchange rate fluctuations of the U.S Dollar and Euro.

(E) no precise formula.

Answer : (E)

93. As a bond's rating serves as an indicator of its default risk, the rating has a direct, measurable
influence on the firm's:

(A) earnings per share and dividend payments.

(B) cost of using such debt and the bond's interest rate.

(C) ability to procure raw material for production.

(D) tax liability to the federal government.

(E) current assets and the bond's maturity value.

Answer : (B)

94. Changes in a firm's bond rating affect its ability to:

(A) claim deductions in tax liability computation.

(B) procure raw material in sufficient quantity for manufacturing processes.

(C) increase the coupon rate on bonds issued to investors.

(D) borrow long-term capital and the cost of such funds.

(E) exercise a call provision on its bonds.

Answer : (D)

95. The greater a bond's default risk, the greater the:

(A) maturity value of the bond.

(B) risk of exercise of a call provision on the bond.

(C) interest rate stability of the bond in the long run.

(D) investment in the bond by risk-averse investors.

(E) default risk premium (DRP) associated with the bond.

Answer : (E)

96. Lower-grade bonds offer higher returns than high-grade bonds because of:

(A) their increase in coupon interest rate over the life of the bonds.

(B) their higher risk and more restricted market.

(C) their maturity value being higher than the market value.

(D) their attractive returns to risk-averse investors.

(E) their tax-free returns and no capital gain tax liability.

Answer : (B)

97. An investor just purchased a 10-year, $1,000 par value bond. The coupon rate on this bond is 8
percent annually, with interest being paid every 6 months. If the investor expects to earn a 10
percent simple rate of return on this bond, how much should she pay for it? (Round the answer to
two decimal places.)
(A) $1,122.87

(B) $1,003.42

(C) $875.38

(D) $950.75

(E) $812.15

Answer : (C)

98. Assume that an investor wishes to purchase a 20-year bond with a maturity value of $1,000 and
semiannual interest payments of $40. If the investor requires a 10 percent simple yield to maturity
on this investment, what is the maximum price she should be willing to pay for the bond? (Round the
answer to the nearest whole number.)

(A) $619

(B) $674

(C) $761

(D) $828

(E) $902

Answer : (D)

99. A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If an
investor's simple annual required rate of return is 12 percent with quarterly compounding, how
much should the investor be willing to pay for this bond? (Round the answer to two decimal places.)

(A) $941.36

(B) $1,051.25

(C) $1,115.57

(D) $1,391.00

(E) $825.49

Answer : (C)

100. Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If an
investor requires a simple annual rate of return of 12 percent with quarterly compounding, how
much should the investor be willing to pay for this bond? (Round the answer to two decimal places.)

(A) $821.92
(B) $1,207.57

(C) $986.43

(D) $1,120.71

(E) $1,358.24

Answer : (B)

101. Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has
recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to
maturity and a coupon rate of 8 percent, with interest being paid semiannually. The required simple
rate of return on this debt has now risen to 16 percent. What is the current value of this bond?
(Round the answer to the nearest whole number.)

(A) $1,273

(B) $1,000

(C) $7,783

(D) $550

(E) $450

Answer : (D)

102. An investor is contemplating the purchase of a 20-year bond that pays $50 interest every six
months. The investor plans to hold the bond only for 10 years, at which time she will sell it in the
marketplace. She requires a 12 percent annual return but believes the market will require only an 8
percent return when she sells the bond 10 years from now. Assuming she is a rational investor, how
much should she be willing to pay for the bond today? (Round the answer to two decimal places.)

(A) $1,126.85

(B) $1,081.43

(C) $737.50

(D) $927.68

(E) $856.91

Answer : (D)

103. JRJ Corporation issued 10-year bonds at a price of $1,000. These bonds pay $60 interest every
six months. Their price has remained the same since they were issued; that is, the bonds still sell for
$1,000. Due to additional financing needs, the firm wishes to issue new bonds that would have a
maturity of 10 years and a par value of $1,000 and pay $40 interest every six months. If both bonds
have the same yield, how many new bonds must JRJ issue to raise $2,000,000 cash? (Round the
value of the bond to two decimal places and the number of bonds to the nearest whole number.)

(A) 2,400

(B) 2,596

(C) 3,000

(D) 5,000

(E) 4,275

Answer : (B)

104. Cold Boxes Corporation has 100 bonds outstanding with a maturity value of $1,000. The
required rate of return on these bonds is currently 10 percent, and interest is paid semiannually.
The bonds mature in 5 years, and their current market value is $768 per bond. The annual coupon
interest rate is: (Round the answer to the nearest whole number.)

(A) 8%.

(B) 6%.

(C) 4%.

(D) 2%.

(E) 0%.

Answer : (C)

105. The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond is
paid every six months, and the simple annual yield is 14 percent. Given this information, the annual
coupon rate on the bond is: (Round the answer to the nearest whole number.)

(A) 10%.

(B) 12%.

(C) 14%.

(D) 17%.

(E) 21%.

Answer : (D)

106. Rick bought a bond when it was issued by Macroflex Corporation 14 years ago. The bond,
which has a $1,000 face value and a coupon rate equal to 10 percent, matures in six years. Interest
is paid every six months; the next interest payment is scheduled for six months from today. If the
yield on similar risk investments is 14 percent, the current market value (price) of the bond is:
(Round the answer to two decimal places.)

(A) $841.15.

(B) $1,238.28.

(C) $904.67.

(D) $757.26.

(E) $844.45.

Answer : (A)

107. Devine Divots issued a bond a few years ago. The bond has a face value equal to $1,000 and
pays investors $30 interest every six months. The bond has eight years remaining until maturity. If
an investor requires a 7 percent rate of return to invest in this bond, what is the maximum price the
investor should be willing to pay to purchase the bond? (Round the answer to two decimal places.)

(A) $761.15

(B) $939.53

(C) $940.29

(D) $965.63

(E) $1,062.81

Answer : (B)

108. Recently, Ohio Hospitals Inc. filed for bankruptcy. The firm was reorganized as American
Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue to be put into
effect. The issue has 10 years to maturity and a coupon rate of 10 percent, paid annually. The new
agreement allows the firm to pay no interest for 5 years. Then, interest payments will be resumed
for the next 5 years. Finally, at maturity (Year 10), the principal plus the interest that was not paid
during the first 5 years will be paid. However, no interest will be paid on the deferred interest. If the
required return is 20 percent, what should the bonds sell for in the market today? (Round the
answer to two decimal places.)

(A) $242.26

(B) $281.69

(C) $578.31

(D) $362.44

(E) $813.69

Answer : (D)
109. Tony's Pizzeria plans to issue bonds with a par value of $1,000 and 10 years to maturity. These
bonds will pay $45 interest every 6 months. Current market conditions are such that the bonds will
be sold at net $937.79. What is the yield to maturity (YTM) of the issue as a broker would quote it to
an investor? (Round the answer to the nearest whole number.)

(A) 11%

(B) 10%

(C) 9%

(D) 8%

(E) 7%

Answer : (B)

110. The current market price of Smith Corporation's 10 percent, 10-year bonds is $1,297.58. A 10
percent coupon interest rate is paid semiannually, and the par value is equal to $1,000. What is the
yield to maturity (YTM), (stated on a simple, or annual, basis) if the bonds mature 10 years from
today? (Round the answer to the nearest whole number.)

(A) 8%

(B) 6%

(C) 4%

(D) 2%

(E) 1%

Answer : (B)

111. A $1,000 par value bond sells for $1,216. It matures in 20 years, has a 14 percent coupon, pays
interest semiannually, and can be called in 5 years at a price of $1,100. The bond's yield to maturity
is: (Round the answer to two decimal places.)

(A) 6.05%.

(B) 10.00%.

(C) 10.06%.

(D) 8.59%.

(E) 11.26%.

Answer : (E)

112. Which of the following statements is true of a bond?

(A) The maturity value of a bond is always more than the market value of the bond.

(B) Interest payments increase throughout the duration of a bond.

(C) The maturity date of a bond is contractually fixed.

(D) The call provision of a bond is exercised in the last year of the bond.

(E) The market value of a bond is mentioned in the bond indenture.

Answer : (C)

113. The of a bond fluctuates continuously during its life.

(A) principal value

(B) face value

(C) maturity value

(D) coupon rate

(E) market value

Answer : (E)

114. bonds are often called by the firm prior to maturity.

(A) Floating rate

(B) Mortgage

(C) Callable

(D) Municipal

(E) Corporate

Answer : (C)

115. The computation for the yield to call (YTC) is the same as that for the yield to maturity (YTM),
except that we substitute the of the bond for the maturity (par) value.

(A) market price

(B) face value

(C) call price

(D) principal value

(E) issue price

Answer : (C)

116. The average rate of return earned on a bond if it is held until the first call date is the:

(A) yield to call.

(B) yield to market.

(C) yield to principal price.

(D) yield to issue price.

(E) yield to discount.

Answer : (A)

117. If an investor buys a bond and holds it until it matures, the average rate of return the investor
will earn per year is called the bond's:

(A) coupon rate.

(B) yield to maturity.

(C) yield to call.

(D) current yield.

(E) capital gains yield.

Answer : (B)

118. Which of the following is a result of setting the coupon rate on a bond immediately before it is
issued?

(A) The coupon rate is equal to the yield to maturity on the bond.

(B) The market interest rate is equal to the coupon rate of the bond.

(C) The yield to maturity is equal to the market yield on the bond.

(D) The issuing price equals the face (par) value of the bond.

(E) The market value is equal to the maturity value of the bond.

Answer : (D)

119. A change in market conditions causes the market price of a bond to change because of changes
in the bond's:

(A) coupon rate.

(B) yield to call.

(C) yield to maturity.

(D) principal value.

(E) maturity value.

Answer : (C)

120. Rolling Coast Inc. issued BBB bonds two years ago. These bonds provided a yield to maturity
(YTM) of 11.5 percent. Long-term risk-free government bonds were yielding 8.7 percent at the time.
The current risk premium on BBB bonds versus government bonds is half of what it was two years
ago. If the risk-free long-term government bonds are currently yielding 7.8 percent, then at what
interest rate should Rolling Coast expect to issue new bonds?

(A) 7.8%

(B) 8.7%

(C) 9.2%

(D) 10.2%

(E) 12.9%

Answer : (C)

121. GP&L sold $1,000,000 of 12 percent, 30-year, semiannual payment bonds 15 years ago. The
bonds are not callable, but they do have a sinking fund which requires GP&L to redeem 5 percent of
the original face value of the issue each year ($50,000), beginning in Year 11. To date, 25 percent of
the issue has been retired. The company can either call bonds at par for sinking fund purposes or
purchase bonds in the open market, spending sufficient money to redeem 5 percent of the original
face value each year. If the yield to maturity (15 years remaining) on the bonds is currently 14
percent, what is the least amount of money GP&L must put in to satisfy the sinking fund provision
for the next redemption? (Round the answer to the nearest whole number.)

(A) $43,856

(B) $50,000

(C) $37,500

(D) $43,796

(E) $39,422

Answer : (D)

122. Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10.65
percent currently have a yield to maturity (YTM) equal to 15.25 percent. Based on this information,
it is understood that BB&C's bonds must currently be selling at in the financial markets.

(A) par value

(B) a discount

(C) a premium

(D) the inflation adjusted interest rate

(E) a floating interest rate

Answer : (B)

123. If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the
bond should be:

(A) selling at a discount; i.e., the bond's market price should be less than its face (maturity) value.

(B) selling at a premium; i.e., the bond's market price should be greater than its face value.

(C) selling at par; i.e., the bond's market price should be the same as its face value.

(D) a floating-rate bond yielding market adjusted interest.

(E) an indexed bond that adjusts interest payments on the basis of an inflation index.

Answer : (B)

124. Omega Inc. holds a 12-year bond that has a 12 percent coupon rate and a marginal tax rate of
40 percent. It is currently selling for $1,000, which is the bond's face value. If interest is paid
semiannually, the bond's yield to maturity is:

(A) equal to 12 percent.

(B) greater than 12 percent.

(C) less than 12 percent.

(D) equal to 7.2 percent.

(E) greater than 16.8 percent.

Answer : (A)

125. Which of the following statements is true of a zero coupon bond?

(A) If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10
percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, the
borrower would exercise the call option and call in the bonds.
(B) If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10
percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, the
bond's maturity value would be more than its par value.

(C) If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10
percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, the
bond's maturity would increase from 10 years to 15 years.

(D) If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10
percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, the
bond would sell at a premium over its $1,000 par value.

(E) If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10
percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, the
bond's coupon rate would decrease from 10 percent to 5 percent.

Answer : (D)

126. Which of the following statements is true of the yield to maturity for a bond?

(A) The yield to maturity for a bond that sells at its par value comprises a capital gains yield equal to
the face value of the bond.

(B) The yield to maturity for a bond that sells at its par value entirely comprises an interest yield and
has a zero expected capital gains yield.

(C) The yield to maturity for a bond that sells at its par value comprises an interest yield equal to the
capital yield on the bond.

(D) The yield to maturity for a bond that sells at its par value is equal to the present value of interest
payments received from the bond.

(E) The yield to maturity for a bond that sells at its par value is equal to the future value of interest
payments received from the bond.

Answer : (B)

127. The percentage rate of return that investors earn on a bond consists of a(n):

(A) interest yield plus a capital gains yield.

(B) interest yield plus the maturity value of the bond.

(C) expected interest yield plus the principal value of the bond.

(D) expected capital gains yield plus the future value of coupon payments.

(E) market interest rate plus the coupon interest rate.

Answer : (A)
128. Which of the following statements is true of the price of a bond that is less than the bond's face
value?

(A) As the coupon rates remain constant, the market value of the bond remains unchanged.

(B) The price of the bond will decrease further below the bond's face value when the rates in the
market are too high

(C) The price of the bond will increase as the bond gets closer to its maturity because the bond's
value has to equal its face value at maturity.

(D) The market value of the bond will increase with the interest received at the maturity of the bond.

(E) The par value of the bond will increase with an increase in the bond price in the market until
maturity.

Answer : (C)

129. Omega Software Corporation's bond with a face value of $1,000 is currently selling at a
premium in the financial markets. If the bond's yield to maturity is 11.5 percent, then the bond's:

(A) coupon rate of interest will be less than 11.5 percent.

(B) coupon rate of interest will be greater than 11.5 percent.

(C) coupon rate of interest will be equal to 11.5 percent.

(D) maturity value will be greater than $1,000.

(E) maturity value will be less than $1,000.

Answer : (B)

130. Stephanie purchased a corporate bond that matures in three years. The bond has a coupon
interest rate of 9 percent and its yield to maturity is 6 percent. If market interest rates remain
constant and Stephanie sells the bond in 12 months, her capital gain from holding the bond will be:

(A) positive because she purchased the bond at a discount and the bond price will approach its face
value as it nears its maturity.

(B) negative because she purchased the bond at a discount and the bond price will approach its face
value as it nears its maturity.

(C) positive because she purchased the bond at a premium and the bond price will approach its
market price as it nears its maturity.

(D) negative because she purchased the bond at a premium and the bond price will approach its face
value as it nears its maturity.

(E) positive because she purchased the bond at a discount and the bond price will approach its
market price as it nears its maturity.
Answer : (D)

131. Assuming other things are held constant, which of the following is true of bonds?

(A) A bond's sensitivity to the change in price from a change in the interest rate increases as its
maturity increases.

(B) For a given bond of any maturity, a given percentage point increase in the interest rate causes a
larger dollar capital loss than the capital gain stemming from an identical decrease in the interest
rate.

(C) For any given maturity, a given percentage point decrease in the interest rate causes a smaller
dollar capital loss than the capital gain stemming from an identical decrease in the interest rate.

(D) In the year of purchase of bonds, an investor gets a deduction for the difference in the market
value of bonds purchased at a premium and the face value of the bonds.

(E) A 20-year bond has more interest rate reinvestment risk than a 2-year bond.

Answer : (A)

132. The interest rate on a 10 percent, 10-year zero-coupon bond with a $1,000 face value falls from
8 percent to 7 percent. Which of the following is true of the value of the bond? (Round the answer to
two decimal places.)

(A) The present value of the bond at 8 percent is $508.34.

(B) The present value of the bond at 7 percent is $463.19.

(C) The maturity value of the bond at 8 percent is $508.34.

(D) The maturity value of the bond at 7 percent is $508.34.

(E) The present value of the bond at 7 percent is $508.34.

Answer : (E)

133. If a bond's yield to maturity exceeds its coupon rate, the bond's:

(A) current yield is equal to the coupon rate.

(B) price must be less than its par value.

(C) maturity value is more than its face value.

(D) current yield is equal to the capital gain on the maturity of the bond.

(E) maturity value is less than the bond's market value.

Answer : (B)
134. All else being equal, an increase in the yield to maturity of a bond will result in:

(A) an increase in the market price of the bond.

(B) a greater interest rate price risk on a long-term bond than on a short-term bond.

(C) an increase in the maturity value of the bond.

(D) a decrease in the rate of return at which the cash flows from the portfolios can be reinvested.

(E) a lower risk of suffering losses in the market values of the bond portfolios.

Answer : (B)

135. Which of the following mathematical expressions is used to compute the percentage rate of
return on a bond?

(A) Current Yield + Coupon Rate of Interest

(B) Current Yield + Capital Gains Yield

(C) Market Return + Maturity Value

(D) Market Yield + Current Yield

(E) Market Yield + Capital Gains Yield

Answer : (B)

136. If interest rates decline, bondholders will earn:

(A) a lower rate of return on reinvested cash flows.

(B) a higher current yield.

(C) no capital gain on the bond's maturity.

(D) a lower coupon interest on the bond.

(E) a higher maturity value on the maturity date.

Answer : (A)

137. The risk that income from a bond portfolio will vary because cash flows must be reinvested at
current market rates is called:

(A) interest rate price risk.

(B) market yield risk.

(C) interest rate reinvestment risk.

(D) capital gain yield risk.

(E) yield to maturity risk.

Answer : (C)

138. An increase in interest rates will increase the future value of a portfolio because the cash flows
produced by the portfolio:

(A) will increase the maturity value of the bond.

(B) can be reinvested at higher rates of return.

(C) can be used to recall high-rate bonds.

(D) will generate cash to pay future coupon interest.

(E) will decrease the yield to maturity of the bond.

Answer : (B)

139. The current market interest rate declines from 10 percent to 8 percent. Due to interest rate
reinvestment risk, the bondholders will:

(A) receive a lower market value for the bond.

(B) receive a higher principal at the maturity of the bond.

(C) call back the bond before its maturity.

(D) earn a lower return on the reinvested cash flows.

(E) receive a lower coupon interest than mentioned in the bond indenture.

Answer : (D)