Discounted cash flows Answer: b Diff: E

i. The market value of any real or financial asset, including stocks, bonds,
or art work, may be found by determining future cash flows and then
discounting them back to the present.

a. True
b. False

Issuing bonds Answer: b Diff: E

ii. 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

Interest rate risk Answer: b Diff: E

iii. A 20-year original maturity bond with 1 year left to maturity has more
interest rate 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

Interest rate risk Answer: b Diff: E

iv. Because short-term interest rates are much more volatile than long-term
rates, you would, in the real world, be subject to much more interest
rate risk if you purchased a 30-day bond than if you bought a 30-year
bond.

a. True
b. False

Bond prices and interest rates Answer: a Diff: E

v. For bonds, price sensitivity to a given change in interest rates generally
increases as years remaining to maturity increases.

a. True
b. False

Mortgage bond Answer: a Diff: E

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

a. True
b. False

Debt coupon rate Answer: a Diff: E

vii. Other things equal, a firm will have to pay a higher coupon rate on a
subordinated debenture than on a second mortgage bond.

a. True
b. False

Call provision Answer: b Diff: E

viii. A call provision gives bondholders the right to demand, or "call for,"
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

Sinking fund Answer: a Diff: E

ix. Many bond indentures allow the company to acquire bonds for a sinking
fund either by purchasing bonds in the market or by a lottery administered
by the trustee for the purchase of a percentage of the issue through a
call at face value.

a. True
b. False

Zero coupon bond Answer: b Diff: E

x. A zero coupon bond is a bond that pays no interest and is offered (and
subsequently sells) at par, therefore providing compensation to investors
in the form of capital appreciation.

a. True
b. False

Floating rate debt Answer: a Diff: E

xi. 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
Junk bond Answer: a Diff: E
xii. A junk bond is a high risk, high yield debt instrument typically used to
finance a leveraged buyout or a merger, or to provide financing to a
company of questionable financial strength.

a. True
b. False

Bond ratings and required returns Answer: a Diff: E

xiii. 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.

a. True
b. False

Medium:
Bond value Answer: a Diff: M
xiv. If the required rate of return on a bond is greater than its coupon
interest rate (and rd remains above the coupon rate), the market value of
that bond will always be below its par value until the bond matures, at
which time its market value will equal its par value. (Accrued interest
between interest payment dates should not be considered when answering
this question.)
 a. True
b. False

Bond value - annual payment Answer: a Diff: M

xv. You have just noticed in the financial pages of the local newspaper that
you can buy a $1,000 par value bond for $800. If the coupon rate is 10
percent, with annual interest payments, and there are 10 years to
maturity, you should make the purchase if your required return on
investments of this type is 12 percent.

a. True
b. False

Prices and interest rates Answer: a Diff: M

xvi. The prices of high-coupon bonds tend to be less sensitive to a given
change in interest rates than low-coupon bonds, other things equal and
held constant.

a. True
b. False

Bond premiums and discounts Answer: a Diff: M

xvii. A bond with a $100 annual interest payment with five years to maturity
(not expected to default) would sell for a premium if interest rates were
below 9 percent and would sell for a discount if interest rates were
greater than 11 percent.

a. True
b. False

Callable bond Answer: b Diff: M

xviii. A bond that is callable has a chance of being retired earlier than its
stated term to maturity. Therefore, if the yield curve is upward sloping,
an outstanding callable bond should have a lower yield to maturity than
an otherwise identical noncallable bond.

a. True
b. False

Indexed bond Answer: b Diff: M

xix. An indexed bond has its value tied to an inflation index. As inflation
increases the value of the bond increases and the issuer is responsible
for the accumulated value which may become much greater than the original
face value.

a. True
b. False

Income bond Answer: b Diff: M

xx. Income bonds pay interest only when the amount of the interest is actually
earned by the company. Thus, these securities cannot bankrupt a company
and this makes them safer than regular bonds.

a. True
 b. False

Restrictive covenants Answer: a Diff: M

xxi. Restrictive covenants are designed so as 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

Sinking fund Answer: b Diff: M

xxii. You are considering two bonds. Both are rated double A (AA), both mature
in 20 years, both have a 10 percent coupon, and both are offered to you
at their $1,000 par value. However, Bond X has a sinking fund while Bond
Y does not. This is probably not an equilibrium situation, as Bond X,
which has the sinking fund, would generally be expected to have a higher
yield than Bond Y.

a. True
b. False

Floating rate debt Answer: b Diff: M

xxiii. Floating rate debt is advantageous to investors because the interest
rate moves up if market rates rise. Floating rate debt shifts interest
rate risk to companies and thus has no advantages for issuers.

a. True
b. False

Bond ratings Answer: a Diff: M

xxiv. A firm with a low bond rating faces a more severe penalty when the Security
Market Line (SML) is relatively steep than when it is not so steep.

a. True
b. False

Multiple Choice: Conceptual

Easy:
Interest rates Answer: e Diff: E
xxv. One of the basic relationships in interest rate theory is that, other
things held constant, for a given change in the required rate of return,
the the time to maturity, the the change in price.

a. longer; smaller.
b. shorter; larger.
c. longer; greater.
d. shorter; smaller.
e. Answers c and d are correct.

Interest rate and reinvestment risk Answer: e Diff: E

xxvi. Which of the following statements is most correct?
 a. All else equal, long-term bonds have more interest rate risk than short
term bonds.
b. All else equal, higher coupon bonds have more reinvestment risk than
low coupon bonds.
c. All else equal, short-term bonds have more reinvestment risk than do
long-term bonds.
d. Statements a and c are correct.
e. All of the statements above are correct.

Callable bond Answer: a Diff: E

xxvii. Which of the following events would make it more likely that a company
would choose to call its outstanding callable bonds?

a. A reduction in market interest rates.

b. The company's bonds are downgraded.
c. An increase in the call premium.
d. Answers a and b are correct.
e. Answers a, b, and c are correct.

Call provision Answer: b Diff: E

xxviii. Other things held constant, if a bond indenture contains a call
provision, the yield to maturity that would exist without such a call
provision will generally be _________________ the YTM with it.

a. higher than
b. lower than
c. the same as
d. either higher or lower, depending on the level of call premium, than
e. unrelated to

Bond coupon rate Answer: c Diff: E

xxix. All of the following may serve to reduce the coupon rate that would
otherwise be required on a bond issued at par, except a

a. Sinking fund.
b. Restrictive covenant.
c. Call provision.
d. Change in rating from Aa to Aaa.
e. None of the answers above (all may reduce the required coupon rate).

Bond concepts Answer: a Diff: E

xxx. Which of the following statements is most correct?

a. All else equal, if a bond’s yield to maturity increases, its price

will fall.
b. All else equal, if a bond’s yield to maturity increases, its current
yield will fall.
c. If a bond’s yield to maturity exceeds the coupon rate, the bond will
sell at a premium over par.
d. All of the answers above are correct.
e. None of the answers above is correct.

Bond concepts Answer: c Diff: E

xxxi. Which of the following statements is most correct?

a. If a bond’s yield to maturity exceeds its annual coupon, then the bond
will be trading at a premium.
 b. If interest rates increase, the relative price change of a 10-year
coupon bond will be greater than the relative price change of a 10-
year zero coupon bond.
c. If a coupon bond is selling at par, its current yield equals its yield
to maturity.
d. Both a and c are correct.
e. None of the answers above is correct.

Bond concepts Answer: e Diff: E

xxxii. A 10-year corporate bond has an annual coupon payment of 9 percent.
The bond is currently selling at par ($1,000). Which of the following
statements is most correct?

a. The bond’s yield to maturity is 9 percent.

b. The bond’s current yield is 9 percent.
c. If the bond’s yield to maturity remains constant, the bond’s price
will remain at par.
d. Both answers a and c are correct.
e. All of the answers above are correct.

Sinking fund Answer: e Diff: E

xxxiii. Which of the following statements is most correct?

a. Sinking fund provisions do not require companies to retire their debt;

they only establish “targets” for the company to reduce its debt over
time.
b. Sinking fund provisions sometimes work to the detriment of bondholders
– particularly if interest rates have declined over time.
c. If interest rates have increased since the time a company issues bonds
with a sinking fund provision, the company is more likely to retire
the bonds by buying them back in the open market, as opposed to calling
them in at the sinking fund call price.
d. Statements a and b are correct.
e. Statements b and c are correct.

Sinking fund provision Answer: d Diff: E

xxxiv. Which of the following statements is most correct?

a. Retiring bonds under a sinking fund provision is similar to calling

bonds under a call provision in the sense that bonds are repurchased
by the issuer prior to maturity.
b. Under a sinking fund, bonds will be purchased on the open market by
the issuer when the bonds are selling at a premium and bonds will be
called in for redemption when the bonds are selling at a discount.
c. The sinking fund provision makes a debt issue less risky to the
investor.
d. Both statements a and c are correct.
e. All of the statements above are correct.

Types of debt Answer: e Diff: E

xxxv. Which of the following statements is most correct?

a. Junk bonds typically have a lower yield to maturity relative to

investment grade bonds.
b. A debenture is a secured bond which is backed by some or all of the
firm’s fixed assets.
 c. Subordinated debt has less default risk than senior debt.
d. All of the statements above are correct.
e. None of the statements above is correct.

Medium:

Bond yield Answer: b Diff: M

xxxvi. Which of the following statements is most correct?

a. Rising inflation makes the actual yield to maturity on a bond greater

than the quoted yield to maturity which is based on market prices.
b. The yield to maturity for a coupon bond that sells at its par value
consists entirely of an interest yield; it has a zero expected capital
gains yield.
c. 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.
d. The market value of a bond will always approach its par value as its
maturity date approaches. This holds true even if the firm enters
bankruptcy.
e. All of the statements above are false.

Bond yield Answer: c Diff: M

xxxvii. Which of the following statements is most correct?

a. 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.
b. If a bond is selling at a discount, the yield to call is a better
measure of return than the yield to maturity.
c. If a coupon bond is selling at par, its current yield equals its yield
to maturity.
d. Both a and b are correct.
e. Both b and c are correct.

Price risk Answer: c Diff: M

xxxviii.Assume that all interest rates in the economy decline from 10 percent
to 9 percent. Which of the following bonds will have the largest
percentage increase in price?

a. A 10-year bond with a 10 percent coupon.

b. An 8-year bond with a 9 percent coupon.
c. A 10-year zero coupon bond.
d. A 1-year bond with a 15 percent coupon.
e. A 3-year bond with a 10 percent coupon.

Price risk Answer: c Diff: M

xxxix. Which of the following has the greatest price risk?

a. A 10-year, $1,000 face value, 10 percent coupon bond with semiannual

interest payments.
b. A 10-year, $1,000 face value, 10 percent coupon bond with annual
interest payments.
c. A 10-year, $1,000 face value, zero coupon bond.
d. A 10-year $100 annuity.
e. All of the above have the same price risk since they all mature in 10
 years.

Price risk Answer: c Diff: M

xl. If the yield to maturity decreased 1 percentage point, which of the
following bonds would have the largest percentage increase in value?

a. A 1-year bond with an 8 percent coupon.

b. A 1-year zero-coupon bond.
c. A 10-year zero-coupon bond.
d. A 10-year bond with an 8 percent coupon.
e. A 10-year bond with a 12 percent coupon.

Price risk Answer: a Diff: M

xli. If interest rates fall from 8 percent to 7 percent, which of the following
bonds will have the largest percentage increase in its value?

a. A 10-year zero coupon bond.

b. A 10-year bond with a 10 percent semiannual coupon.
c. A 10-year bond with a 10 percent annual coupon.
d. A 5-year zero coupon bond.
e. A 5-year bond with a 12 percent annual coupon.

Bond concepts Answer: e Diff: M

xlii. Which of the following statements is most correct?

a. Other things held constant, a callable bond would have a lower required
rate of return than a noncallable bond.
b. Other things held constant, a corporation would rather issue
noncallable bonds than callable bonds.
c. Reinvestment rate risk is worse from a typical investor's standpoint
than interest rate risk.
d. If a 10-year, $1,000 par, zero coupon bond were issued at a price which
gave investors a 10 percent rate of return, and if interest rates then
dropped to the point where rd = YTM = 5%, we could be sure that 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 which
gave investors a 10 percent rate of return, and if interest rates then
dropped to the point where rd = YTM = 5%, we could be sure that the
bond would sell at a discount below its $1,000 par value.

Bond concepts Answer: d Diff: M

xliii. Which of the following statements is most correct?

a. The market value of a bond will always approach its par value as its
maturity date approaches, provided the issuer of the bond does not go
bankrupt.
b. If the Federal Reserve unexpectedly announces that it expects inflation
to increase, then we would probably observe an immediate increase in
bond prices.
c. The total yield on a bond is derived from interest payments and changes
in the price of the bond.
d. Statements a and c are correct.
e. All of the statements above are correct.

Bond concepts Answer: b Diff: M

xliv. Which of the following statements is most correct?

a. If a bond is selling for a premium, this implies that the bond’s yield
to maturity exceeds its coupon rate.
b. If a coupon bond is selling at par, its current yield equals its yield
to maturity.
c. If rates fall after its issue, a zero coupon bond could trade for an
amount above its par value.
d. Statements b and c are correct.
e. None of the statements above is correct.

Bond concepts Answer: b Diff: M

xlv. Which of the following statements is most correct?

a. All else equal, a bond that has a coupon rate of 10 percent will sell
at a discount if the required return for a bond of similar risk is 8
percent.
b. The price of a discount bond will increase over time, assuming that
the bond’s yield to maturity remains constant over time.
c. The total return on a bond for a given year consists only of the coupon
interest payments received.
d. Both b and c are correct.
e. All of the statements above are correct.

Bond concepts Answer: e Diff: M

xlvi. Which of the following statements is most correct?

a. All else equal, a bond that has a coupon rate of 10 percent will sell
at a discount if the required return for a bond of similar risk is 8
percent.
b. Debentures generally have a higher yield to maturity relative to
mortgage bonds.
c. If there are two bonds with equal maturity and credit risk, the bond
which is callable will have a higher yield to maturity than the bond
which is noncallable.
d. Answers a and c are correct.
e. Answers b and c are correct.

Bond concepts Answer: d Diff: M

xlvii.A 10-year bond has a 10 percent annual coupon and a yield to maturity of
12 percent. The bond can be called in 5 years at a call price of $1,050
and the bond’s face value is $1,000. Which of the following statements
is most correct?

a. The bond’s current yield is greater than 10 percent.

b. The bond’s yield to call is less than 12 percent.
c. The bond is selling at a price below par.
d. Both answers a and c are correct.
e. None of the above answers is correct.
Callable bond Answer: d Diff: M
xlviii. Which of the following statements is most correct?

a. Distant cash flows are generally riskier than near-term cash flows.
Further, a 20-year bond that is callable after 5 years will have an
expected life that is probably shorter, and certainly no longer, than
an otherwise similar noncallable 20-year bond. Therefore, investors
should require a lower rate of return on the callable bond than on the
noncallable bond, assuming other characteristics are similar.
b. A noncallable 20-year bond will generally have an expected life that
is equal to or greater than that of an otherwise identical callable
20-year bond. Moreover, the interest rate risk faced by investors is
greater the longer the maturity of a bond. Therefore, callable bonds
expose investors to less interest rate risk than noncallable bonds,
other things held constant.
c. Statements a and b are correct.
d. Statements a and b are false.

Callable bond Answer: b Diff: M

xlix. Which of the following statements is most correct?

a. A callable 10-year, 10 percent bond should sell at a higher price than

an otherwise similar noncallable bond.
b. 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.
c. 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.
d. The actual life of a callable bond will be equal to or less than the
actual life of a noncallable bond with the same maturity date.
Therefore, if the yield curve is upward sloping, the required rate of
return will be lower on the callable bond.
e. 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.
Types of debt Answer: c Diff: M
l. A company is planning to raise $1,000,000 to finance a new plant. Which
of the following statements is most correct?

a. If debt is used to raise the million dollars, the cost of the debt
would be lower if the debt is in the form of a fixed rate bond rather
than a floating rate bond.
b. If debt is used to raise the million dollars, the cost of the debt
would be lower if the debt is in the form of a bond rather than a term
loan.
c. If debt is used to raise the million dollars, but $500,000 is raised
as a first mortgage bond on the new plant and $500,000 as debentures,
the interest rate on the first mortgage bond would be lower than it
would be if the entire $1 million were raised by selling first mortgage
bonds.
d. The company would be especially anxious to have a call provision
included in the indenture if its management thinks that interest rates
are almost certain to rise in the foreseeable future.
e. All of the statements above are false.

Miscellaneous concepts Answer: b Diff: M

li. Which of the following statements is most correct?

a. A firm with a sinking fund payment coming due would generally choose
to buy back bonds in the open market, if the price of the bond exceeds
the sinking fund call price.
b. Income bonds pay interest only when the amount of the interest is
actually earned by the company. Thus, these securities cannot bankrupt
a company and this makes them safer to investors than regular bonds.
c. One disadvantage of zero coupon bonds is that issuing firms cannot
realize the tax savings from issuing debt until the bonds mature.
d. Other things held constant, callable bonds should have a lower yield
to maturity than noncallable bonds.
e. All of the above statements are false.

Miscellaneous concepts Answer: b Diff: M

lii. Which of the following statements is most correct?

a. A 10-year 10 percent coupon bond has less reinvestment rate risk than
a 10-year 5 percent coupon bond (assuming all else equal).
b. The total return on a bond for a given year arises from both the coupon
interest payments received for the year and the change in the value of
the bond from the beginning to the end of the year.
c. The price of a 20-year 10 percent bond is less sensitive to changes in
interest rates (i.e., has lower interest rate price risk) than the
price of a 5-year 10 percent bond.
d. A $1,000 bond with $100 annual interest payments with five years to
maturity (not expected to default) would sell for a discount if
interest rates were below 9 percent and would sell for a premium if
interest rates were greater than 11 percent.
e. Answers a, b, and c are correct statements.

Miscellaneous concepts Answer: e Diff: M

liii. Which of the following statements is most correct?
 a. All else equal, a 1-year bond will have a higher (i.e., better) bond
rating than a 20-year bond.
b. A 20-year bond with semiannual interest payments has higher price risk
(i.e., interest rate risk) than a 5-year bond with semiannual interest
payments.
c. 10-year zero coupon bonds have higher reinvestment rate risk than 10-
year, 10 percent coupon bonds.
d. If a callable bond is trading at a premium, then you would expect to
earn the yield-to-maturity.
e. Statements a and b are correct.

Interest rate risk Answer: a Diff: M

liv. Which of the following Treasury bonds will have the largest amount of
interest rate risk (price risk)?

a. A 7 percent coupon bond which matures in 12 years.

b. A 9 percent coupon bond which matures in 10 years.
c. A 12 percent coupon bond which matures in 7 years.
d. A 7 percent coupon bond which matures in 9 years.
e. A 10 percent coupon bond which matures in 10 years.

Interest rate risk Answer: a Diff: M

lv. All treasury securities have a yield to maturity of 7 percent--so the
yield curve is flat. If the yield to maturity on all Treasuries were to
decline to 6 percent, which of the following bonds would have the largest
percentage increase in price?

a. 15-year zero coupon Treasury bond.

b. 12-year Treasury bond with a 10 percent annual coupon.
c. 15-year Treasury bond with a 12 percent annual coupon.
d. 2-year zero coupon Treasury bond.
e. 2-year Treasury bond with a 15 percent annual coupon.

Current yield and yield to maturity Answer: e Diff: M

lvi. Which of the following statements is most correct?

a. If a bond sells for less than par, then its yield to maturity is less
than its coupon rate.
b. If a bond sells at par, then its current yield will be less than its
yield to maturity.
c. Assuming that both bonds are held to maturity and are of equal risk,
a bond selling for more than par with ten years to maturity will have
a lower current yield and higher capital gain relative to a bond that
sells at par.
d. Answers a and c are correct.
e. None of the answers above is correct.
Current yield and yield to maturity Answer: a Diff: M
lvii. You just purchased a 10-year corporate bond that has an annual coupon of
10 percent. The bond sells at a premium above par. Which of the following
statements is most correct?

a. The bond’s yield to maturity is less than 10 percent.

b. The bond’s current yield is greater than 10 percent.
c. If the bond’s yield to maturity stays constant, the bond’s price will
be the same one year from now.
d. Statements a and c are correct.
e. None of the answers above is correct.

Corporate bonds and default risk Answer: c Diff: M

lviii. Which of the following statements is most correct?

a. The expected return on corporate bonds will generally exceed the yield
to maturity.
b. If a company increases its debt ratio, this is likely to reduce the
default premium on its existing bonds.
c. All else equal, senior debt will generally have a lower yield to
maturity than subordinated debt.
d. Answers a and c are correct.
e. None of the answers above is correct.

Default risk Answer: b Diff: M

lix. Which of the following statements is most correct?

a. If a company increases its debt ratio, this is likely to reduce the

default premium on its existing bonds.
b. All else equal, senior debt has less default risk than subordinated
debt.
c. An indenture is a bond that is less risky than a subordinated
debenture.
d. Statements a and c are correct.
e. All of the answers above are correct.

Default risk Answer: d Diff: M

lx. Which of the following statements is most correct?

a. The expected return on a corporate bond is always less than its

promised return when the probability of default is greater than zero.
b. All else equal, secured debt is considered to be less risky than
unsecured debt.
c. An indenture is a bond that is less risky than a subordinated
debenture.
d. Both a and b are correct.
e. All of the answers above are correct.
Sinking funds and default risk Answer: d Diff: M
lxi. Which of the following statements is correct?

a. If a company is retiring bonds for sinking fund purposes it will buy

back bonds on the open market when the coupon rate is less than the
market interest rate.
b. A bond sinking fund would be good for investors if interest rates have
declined after issuance and the investor’s bonds get called.
c. Mortgage bonds have less default risk than debentures.
d. Both a and c are correct.
e. All of the statements above are correct.

Tough:

Bond yields and prices Answer: b Diff: T

lxii. Which of the following statements is most correct?

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

current yield must also exceed its coupon rate.
b. If a bond's yield to maturity exceeds its coupon rate, the bond's price
must be less than its maturity value.
c. 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 rate.
d. Answers b and c are correct.
e. None of the answers above is correct.

Bond concepts Answer: b Diff: T

lxiii. Which of the following is not true about bonds? In all of the
statements, assume other things are held constant.

a. Price sensitivity, that is, the change in price due to a given change
in the required rate of return, increases as a bond's maturity
increases.
b. For a given bond of any maturity, a given percentage point increase in
the interest rate (rd) 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 increase in the
interest rate causes a smaller dollar capital loss than the capital
gain stemming from an identical decrease in the interest rate.
d. From a borrower's point of view, interest paid on bonds is tax-
deductible.
e. A 20-year zero coupon bond has less reinvestment rate risk than a 20-
year coupon bond.
Bond concepts Answer: e Diff: T
lxiv. Which of the following statements is most correct?

a. All else equal, an increase in interest rates will have a greater

effect on the prices of long-term bonds than it will on the prices of
short-term bonds.
b. 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.
c. An increase in interest rates will have a greater effect on a zero
coupon bond with 10 years maturity than it will have on a 9-year bond
with a 10 percent annual coupon.
d. All of the statements above are correct.
e. Answers a and c are correct.

Interest vs. reinvestment rate risk Answer: c Diff: T

lxv. Which of the following statements is most correct?

a. A 10-year bond would have more interest rate risk than a 5-year bond,
but all 10-year bonds have the same interest rate risk.
b. A 10-year bond would have more reinvestment rate risk than a 5-year
bond, but all 10-year bonds have the same reinvestment rate risk.
c. If their maturities were the same, a 5 percent coupon bond would have
more interest rate risk than a 10 percent coupon bond.
d. If their maturities were the same, a 5 percent coupon bond would have
less interest rate risk than a 10 percent coupon bond.
e. Zero coupon bonds have more interest rate risk than any other type
bond, even perpetuities.

Bond indenture Answer: d Diff: T

lxvi. Listed below are some provisions that are often contained in bond
indentures:

1. Fixed assets may be used as security.

2. The bond may be subordinated to other classes of debt.
3. The bond may be made convertible.
4. The bond may have a sinking fund.
5. The bond may have a call provision.
6. The bond may have restrictive covenants in its indenture.

Which of the above provisions, each viewed alone, would tend to reduce
the yield to maturity investors would otherwise require on a newly issued
bond?

a. 1, 2, 3, 4, 5, 6
b. 1, 2, 3, 4, 6
c. 1, 3, 4, 5, 6
d. 1, 3, 4, 6
e. 1, 4, 6
Weighted average cost of debt Answer: e Diff: T
lxvii. Suppose a new company decides to raise its initial $200 million of
capital as $100 million of common equity and $100 million of long-term
debt. By an iron-clad provision in its charter, the company can never
borrow any more money. Which of the following statements is most correct?

a. If the debt were raised by issuing $50 million of debentures and $50
million of first mortgage bonds, we could be absolutely certain that
the firm's total interest expense would be lower than if the debt were
raised by issuing $100 million of debentures.
b. If the debt were raised by issuing $50 million of debentures and $50
million of first mortgage bonds, we could be absolutely 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.
c. The higher the percentage of total debt represented by debentures, the
greater the risk of, and hence the interest rate on, the debentures.
d. The higher the percentage of total 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.
e. 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. Interest rates
on the two types of bonds would vary as their percentages were changed,
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.