finance data bank

31. Which of the following statements is CORRECT?

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. The expected capital gains yield on a bond will always be zero or positive because no investor would purchase a bond with an expected capital loss.

32. Which of the following statements is CORRECT?

a. If a coupon bond is selling at a premium, then the bond's current yield is zero.

b. If a coupon bond is selling at a discount, then the bond's expected capital gains yield is negative.

c. If a bond is selling at a discount, the yield to call is a better measure of the expected return than the yield to maturity.

d. The current yield on Bond A exceeds the current yield on Bond B. Therefore, Bond A must have a higher yield to maturity than Bond B.

e. If a coupon bond is selling at par, its current yield equals its yield to maturity.

33. Which of the following statements is CORRECT?

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 their 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.

34. Which of the following statements is CORRECT?

a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.

b. If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.

c. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.

d. If the maturity risk premium (MRP) equals zero, the yield curve must be flat.

e. The yield curve can never be downward sloping.

35. Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that

a. Inflation is expected to decline in the future.

b. The economy is not in a recession.

c. Long-term bonds are a better buy than short-term bonds.

d. Maturity risk premiums could help to explain the yield curve’s upward slope.

e. Long-term interest rates are more volatile than short-term rates.

36. Which of the following statements is CORRECT?

a. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.

b. The most likely explanation for an inverted yield curve is that investors expect inflation to increase.

c. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.

d. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.

e. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.

37. Short Corp. just issued bonds that will mature in 10 years, and Long Corp. issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further, assume that the Treasury yield curve is based only on expectations about future inflation, i.e., that the maturity risk premium is zero for T-bonds but not necessarily for corporate bonds. Under these conditions, which of the following statements is correct?

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.

38. Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, an 8% yield to maturity, and are noncallable. Which of the following statements is CORRECT?

a. Bond A’s capital gains yield is greater than Bond B’s capital gains yield.

b. Bond A trades at a discount, whereas Bond B trades at a premium.

c. If the yield to maturity for both bonds remains at 8%, Bond A’s price one year from now will be higher than it is today, but Bond B’s price one year from now will be lower than it is today.

d. If the yield to maturity for both bonds immediately decreases to 6%, Bond A’s bond will have a larger percentage increase in value.

e. Bond A’s current yield is greater than that of Bond B.

39. Which of the following statements is CORRECT?

a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.

b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.

c. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.

d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.

e. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.

40. Which of the following statements is CORRECT?

a. Senior debt is debt that has been more recently issued, and in bankruptcy it is paid off after junior debt because the junior debt was issued first.

b. A company's subordinated debt has less default risk than its senior debt.

c. Convertible bonds generally have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.

d. Junk bonds typically provide a lower yield to maturity than investment-grade bonds.

e. A debenture is a secured bond that is backed by some or all of the firm’s fixed assets.

41. Which of the following statements is CORRECT?

a. One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the use of debt until the bonds mature.

b. Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.

c. Once a firm declares bankruptcy, it must be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and legal fees.

d. Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds.

e. A firm with a sinking fund that gives it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.

42. Which of the following statements is CORRECT?

a. The total return on a bond during a given year is based only on the coupon interest payments received.

b. All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required return for bonds of similar risk is 8%.

c. The price of a discount bond will increase over time, assuming that the bond’s yield to maturity remains constant.

d. For a given firm, its debentures are likely to have a lower yield to maturity than its mortgage bonds.

e. When large firms are in financial distress, they are almost always liquidated, whereas smaller firms are generally reorganized.

43. Which of the following statements is CORRECT?

a. All else equal, secured debt is more risky than unsecured debt.

b. The expected return on a corporate bond must be greater than its promised return if the probability of default is greater than zero.

c. All else equal, senior debt has more default risk than subordinated debt.

d. A company’s bond rating is affected by its financial ratios but not by provisions in its indenture.

e. Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off claims against it according to the priority of the claims as spelled out in the Act.

44. Grossnickle Corporation issued 20-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity?

a. $1,113.48

b. $1,142.03

c. $1,171.32

d. $1,201.35

e. $1,232.15

45. A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now?

a. $884.19

b. $906.86

c. $930.11

d. $953.36

e. $977.20

46. Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going interest rate (r_d) is 6.20%, based on semiannual compounding. What is the bond’s price?

a. $1,047.19

b. $1,074.05

c. $1,101.58

d. $1,129.12

e. $1,157.35

47. In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures from historical book values to market values. KJM Corporation's balance sheet (book values) as of today is as follows:

Long-term debt (bonds, at par) $23,500,000

Preferred stock 2,000,000

Common stock ($10 par) 10,000,000

Retained earnings 4,000,000

Total debt and equity $39,500,000

The bonds have a 7.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 11%, so the bonds now sell below par. What is the current market value of the firm's debt?

a. $17,436,237

b. $17,883,320

c. $18,330,403

d. $7,706,000

e. $7,898,650