Chapter 6 TB Flashcards by Stussy Aubrey

An interest rate or a required rate of return represents the cost of money.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

A real rate of interest is the compensation paid by the borrower of funds to the lender measured in today’s dollars.

T or F?

FALSE

Real interest rate is the rate of return on an investment measured not in dollars but in the increase in purchasing power the investment provides.

How well did you know this?

Not at all

Perfectly

A nominal rate of interest is approximately equal to the sum of the real rate of interest plus the risk free rate of interest.

T or F?

FALSE

A nominal rate of interest is approximately equal to the sum of the real interest rate and the expected inflation rate.

How well did you know this?

Not at all

Perfectly

The nominal interest rate on a risk-free investment is approximately equal to the sum of the real rate of interest plus an inflation premium.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

The nominal interest rate on a risky investment equals the risk-free rate plus a risk premium.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

The nominal rate of interest on a bond is 8% and the expected inflation premium is 4%. This results in an approximate real rate of interest of 4% on the bond.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

Historically, the rate of return on U.S. Treasury bills is usually greater than the rate of inflation.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

The nominal rate of interest is the actual rate of interest charged by the supplier of funds and paid by demander.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

The term structure of interest rates is a graphical presentation of the relationship between the maturity and rate of return.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

An inverted yield curve is a downward-sloping yield curve that indicates that short-term interest rates are generally higher than long-term interest rates.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

A yield curve that reflects relatively similar borrowing costs for both short- and long-term loans is called a normal yield curve.

T or F?

FALSE

A yield curve that reflects relatively similar borrowing costs for both short- and long-term loans is called a flat yield curve.

How well did you know this?

Not at all

Perfectly

Upward-sloping yield curves result from higher future inflation expectations, lender preferences for shorter maturity loans, and greater supply of short-term as opposed to long-term loans relative to their respective demand.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

A flat yield curve means that the rates do not vary much at different maturities.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

A normal yield curve is upward-sloping and indicates generally cheaper short-term borrowing costs than long-term borrowing costs.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

A flat yield curve indicates generally cheaper long-term borrowing costs than short-term borrowing costs.

T or F?

FALSE

An inverse yield curve indicates generally cheaper long-term borrowing costs than short-term borrowing costs.

How well did you know this?

Not at all

Perfectly

The market segmentation theory suggests that the shape of the yield curve is determined by the supply and demand for funds within each maturity segment.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

The liquidity preference theory suggests that the shape of the yield curve is determined by the supply and demand for funds within each maturity segment.

T or F?

FALSE

The market segmentation theory suggests that the shape of the yield curve is determined by the supply and demand for funds within each maturity segment.

How well did you know this?

Not at all

Perfectly

The liquidity preference theory suggests that short-term interest rates should be lower than long-term interest rates most of the time.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

The expectations theory suggests that the shape of the yield curve reflects investors expectations about future interest rates.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

A downward-sloping yield curve indicates generally cheaper short-term borrowing costs than long-term borrowing costs.

T or F?

FALSE

An upward-sloping yield curve indicates generally cheaper short-term borrowing costs than long-term borrowing costs.

How well did you know this?

Not at all

Perfectly

An inverted yield curve is an upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs.

T or F?

FALSE

An normal yield curve is an upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs.

How well did you know this?

Not at all

Perfectly

The liquidity preference theory suggests that long-term interest rates tend to be higher than short-term rates (and therefore the yield curve slopes up) due to the lower liquidity and higher responsiveness to general interest rate movements of longer-term securities.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

The components of risk premium includes business risk, financial risk, interest rate risk, liquidity risk, and tax risk.

T or F?

TRUE

How well did you know this?

Not at all

Perfectly

The possibility that the issuer of a bond will not pay the contractual interest or principal payments as scheduled is called maturity risk.

T or F?

FALSE

Default risk

How well did you know this?

Not at all

Perfectly

The possibility that the issuer of a bond will not pay the contractual interest or principal payments as scheduled is called default risk. | T or F?

TRUE

The ________ rate of interest is the rate that balances the supply of savings and the demand for investment funds. A) Nominal B) Real C) Risk-free D) Equilibrium

Generally, an increase in risk will result in ________. A) a lower required return or interest rate B) a higher required return or interest rate C) a higher inflation premium D) a lower real interest rate

Although no investment is truly risk free, ________ are generally viewed as the closest thing we can come to in the real world to a risk-free investment. A) U.S. Treasury securities B) AAA-rated corporate bonds C) secured bonds D) zero-coupon bonds

Ai Lun, a management trainee at a large New York-based bank, is trying to estimate the real rate of return expected by investors. He notes that the 3-month T-bill currently yields 3 percent , and consumer prices have been rising steadily at a 2% rate for several years. What should Ai Lun's estimate of the real rate be? A) 5% B) 1% C) 3% D) 2%

Nico invested an amount a year ago and calculated his return on investment. He found that his purchasing power had increased by 15 percent as a result of his investment. If inflation during the year was 4 percent, then Nico's ________. A) real return on investment is more than 15 percent B) nominal return on investment is more than 15 percent C) nominal return on investment is less than 11 percent D) real return on investment is equal to 4 percent

The ________ rate of interest is the actual rate charged by the supplier and paid by the demander of funds. A) Nominal B) Real C) Risk-free D) Inflationary

The ________ is the compound annual rate of interest earned on a debt security purchased on a given date and held to maturity. A) risk premium B) yield curve C) risk-free rate D) yield to maturity

A(n) ________ is a graphic depiction of the relation between the maturity and rate of return for bonds with similar risks. A) yield curve B) supply function C) risk-return profile D) aggregate demand curve

According to the expectations hypothesis, a(n) ________ yield curve reflects higher expected future rates of interest. A) upward-sloping B) flat C) downward-sloping D) linear

According to the expectations hypothesis, a(n) ________ yield curve reflects lower expected future rates of interest. A) upward-sloping B) flat C) downward-sloping D) linear

The term structure of interest rates is the relationship between ________. A) the present value of principal and coupon rate of the bonds B) the general expectation of inflation and nominal rate of return for bonds C) the general expectation of inflation and real rate of return for bonds D) the maturity and rate of return for bonds with similar level of risk

A downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs is called ________. A) normal yield curve B) inverted yield curve C) flat yield curve D) linear yield curve

A yield curve that reflects relatively similar borrowing costs for both short-term and long-term loans is called as ________. A) normal yield curve B) inverted yield curve C) flat yield curve D) lognormal curve

The theory suggesting that for any given issuer, long-term interest rates tends to be higher than short-term rates is called ________. A) expectation hypothesis B) liquidity preference theory C) market segmentation theory D) interest parity theory

Which of the following explains the general shape of the yield curve? A) Expectations theory B) Perfect market theory C) Capital asset pricing theory D) Securities market theory

Assume the following returns and yields: U.S. T-bill = 8%, 5-year U.S. T-note = 7%, IBM common stock = 15%, IBM AAA Corporate Bond = 12% and 10-year U.S. T-bond = 6%. Based on this information, the shape of the yield curve is ________. A) upward sloping B) downward sloping C) flat D) normal

________ mainly explains the tendency for the yield curve to be upward sloping. A) Expectations theory B) Liquidity preference theory C) Market segmentation theory D) Investor perception theory

Which of the following affects the slope of yield curve? A) tax rates B) dividend policy C) selection of accounting standards D) liquidity preferences

Which of the following is true of the risk premium? A) T-bills have a have a higher risk premium compared with Treasury bonds. B) Government bonds have a higher risk premium compared with corporate bonds. C) Junk bonds have a lower risk premium investment-grade bonds. D) The lower-rated corporate issues have a higher risk premium than that of the higher rated corporate issues

Suppose the expectations hypothesis is true. If the yield curve is flat this means that ________. A) investors do not expect interest rates to change in the future B) investors expect interest rates to rise in the future C) investors expect interest rates to fall in the future D) investors do not require a premium for expected inflation

The coupon rate on a bond represents the percentage of the bond's par value that will be paid annually, typically in two equal semiannual payments, as interest. | T or F?

TRUE

Restrictive covenants are contractual clauses in long-term debt agreements that place certain operating and financial constraints on the borrower | T or F?

TRUE

The reason for a difference in the yield between a Aaa corporate bond and an otherwise identical Baa bond is the risk premium; other things being equal. | T or F?

TRUE

Standard debt provisions specify certain record keeping and general business practices that must be followed by the bond issuer. | T or F?

TRUE

A trustee is a paid party representing the bond issuer in the bond indenture. | T or F?

FALSE

Restrictive covenants, coupled with standard debt provisions, help the lender to monitor the borrower's activities to ensure efficient use of funds. | T or F?

TRUE

In a bond indenture, subordination is the stipulation that subsequent creditors agree to wait until all claims of the senior debt are satisfied. | T or F?

TRUE

The bond indenture identifies any collateral pledged against a bond and specifies how it is to be maintained. | T or F?

TRUE

A sinking-fund requirement requires a corporate to make semiannual or annual payments that are used to retire bonds by purchasing them in the marketplace. | T or F?

TRUE

Subordination means that subsequent creditors agree to wait until all claims of the senior debt are satisfied. | T or F?

TRUE

Restrictive covenants place operating and financial constraints on the borrower. | T or F?

TRUE

In most cases, the longer the maturity of a bond, the higher is the cost of a bond to the issuer. | T or F?

TRUE

The lower a bond's default risk, the higher is the interest rate. | T or F?

FALSE ## Footnote High risk = High returns (interest)

The legal contract setting forth the terms and provisions of a corporate bond is a(n) ________. A) indenture B) debenture C) loan document D) promissory note

A debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms is called a(n) ________. A) common stock B) corporate bond C) indenture D) preferred stock

A(n) ________ is a paid individual, corporation, or a commercial bank trust department that acts as a third party to a bond indenture. A) trustee B) investment banker C) bond issuer D) bond rating agency

A ________ is a restrictive provision in a bond indenture, providing for the systematic retirement of the bonds prior to their maturity. A) redemption clause B) sinking-fund requirement C) conversion feature D) subordination clause

Bond indentures include restrictive covenants.These provisions protect the bondholders against ________. A) increase in inflation rate B) increase in borrower's risk C) decrease in liquidity risk D) maturity risk

Which of the following is a restrictive covenant? A) to maintain satisfactory accounting records B) to pay the taxes due C) to supply audited financial statements D) to impose fixed asset restrictions

The purpose of the debt covenant that requires maintaining a minimum level of net working capital is to ________. A) protect the lender by controlling the risk and marketability of the borrower's security investment alternatives B) limit the amount of fixed-payment obligations C) ensure a cash shortage does not cause an inability to meet current obligations D) limit the annual cash dividends paid by the firm

The purpose of the debt covenant that prohibits borrowers from entering into certain types of leases is to ________. A) protect the lender by controlling the risk and marketability of the borrower's security investments alternatives B) limit the amount of fixed-payment obligations C) ensure a cash shortage does not cause an inability to meet current obligations D) limit the annual cash dividends paid by the firm

The purpose of the restrictive debt covenant that imposes fixed assets restrictions is to ________. A) protect the lender by controlling the risk and marketability of the borrower's security investment alternatives B) limit the amount of fixed-payment obligations C) ensure a cash shortage does not cause an inability to meet current obligations D) prevent the firm from liquidation and ensure its ability to repay the debt

The purpose of the restrictive debt covenant that prohibits the sale of accounts receivable is to ________. A) assure the lender that additional borrowing is constrained B) limit the amount of fixed-payment obligations C) prevent the firm from selling current assets to raise cash to pay current obligations D) limit the payment of annual cash dividends

The purpose of the restrictive debt covenant that requires that subsequent borrowing be subordinated to the original loan is to ________. A) maintain a minimum level of liquidity B) limit the amount of fixed-payment obligations C) ensure a long-run cash shortage does not cause an inability to meet current obligations D) protect the original lender in the priority of claims during liquidation

________ means that subsequent creditors agree to wait until all claims of the are senior debt satisfied before having their claims satisfied. A) Security interest B) Subordination C) Sinking fund requirement D) Bond indenture

The purpose of the restrictive debt covenant that limits the distribution of profits to shareholders is to ________. A) assure the lender that additional borrowing is constrained or may be subordinated to the original loan B) limit the amount of fixed-payment obligations C) ensure a cash shortage does not cause an inability to meet current obligations D) avoid default of payments to bondholders

An example of a standard debt provision is to ________. A) limit the corporation's annual cash dividend payments B) pay taxes and other liabilities when due C) restrict the corporation from disposing of fixed assets D) maintain a minimum level of liquidity

The cost of a long-term debt generally ________ that of a short-term debt. A) is less than B) is equal to C) is greater than D) is less than or equal to

To compensate for the uncertainty of future interest rates and the fact that the longer the term of a loan the higher the probability that the borrower will default, the lender typically ________. A) charges a higher interest rate on long-term loans B) reserves the right to change the terms of the loan at any time C) includes excessively restrictive debt provisions D) reserves the right to demand immediate payment at any time

The size of a loan and its issuance costs (as a percentage of the amount borrowed) are ________. A) not related B) inversely related C) independent D) perfectly positively correlated

A call premium is the amount by which the call price exceeds the market price of the bond. | T or F?

FALSE ## Footnote A call premium is the amount by which the call price exceeds the par value of the bond.

Stock purchase warrants are instruments that give their holder the right to purchase a certain number of shares of the firm's common stock at the market price over a certain period of time. | T or F?

FALSE ## Footnote Stock purchase warrants are instruments that give their holder the right to purchase a certain number of shares of the firm's common stock at a *specified price* over a certain period of time.

A call feature is a feature included in nearly all corporate bonds and allows the issuer to repurchase bonds at the market price prior to maturity. | T or F?

FALSE ## Footnote A call feature is a feature included in nearly all corporate bonds and allows the issuer to repurchase bonds at par prior to maturity.

Bondholders will convert their convertible bonds into shares of stock only when the conversion price is greater than the market price of the stock. | T or F?

FALSE

To sell a callable bond, the issuer must pay a higher interest rate than on an otherwise equivalent noncallable bond. | T or F?

TRUE ## Footnote In a callable bond, the issuer of the bond has the option to call the bond to his advantage. Thus, to sell a callable bond, the issuer must pay higher interest rate to the bondholder.

The conversion feature of a bond is a feature that is included in nearly all corporate bond issues that gives the issuer the opportunity to repurchase bonds at a stated price prior to maturity. | T or F?

FALSE ## Footnote The call feature of a bond is a feature that is included in nearly all corporate bond issues that gives the issuer the opportunity to repurchase bonds at a stated price prior to maturity.

A call feature in a bond allows bondholders to change each bond into a stated number of shares of common stock. | T or F?

FALSE ## Footnote A *conversion* feature in a bond allows bondholders to change each bond into a stated number of shares of common stock.

A conversion feature in a bond allows bondholders to change each bond into a stated number of shares of common stock. | T or F?

TRUE

The call option in a bond has a greater chance of being exercised (to the detriment of the bondholder) if market interest rates have fallen since the bond was issued. | T or F?

TRUE

The call option in a bond has a greater chance of being exercised (to the detriment of the bondholder) if market interest rates have fallen since the bond was issued. | T or F?

FALSE

A conversion feature in a bond has a greater chance of being exercised (to the detriment of the bondholder) if market interest rates have risen since the bond was issued. | T or F?

FALSE

IBM stock will experience greater trading activity (in terms of the number of shares traded on a given day) compared to IBM bonds. | T or F?

TRUE

A company's bonds will experience more trading activity (in terms of the number of bonds traded on a given day) compared to its stock. | T or F?

FALSE

High-quality (high-rated) bonds provide lower returns than lower-quality (low-rated) bonds. | T or F?

TRUE ## Footnote High quality bonds are low-risk. Low-risk bonds provide lower returns.

There is an inverse relationship between the quality or rating of a bond and the rate of return it must provide bondholders. | T or F?

TRUE

Any bond rated Aaa through Caa according to Moody's, would be considered investment grade debt. | T or F?

FALSE ## Footnote Investments rated Baa3 (BBB-) or better are considered "investment-grade."

An A rated bond should provide investors with a higher yield than an otherwise identical B rated bond. | T or F?

FALSE

Any Ba rated bond or lower would be considered speculative or "junk." | T or F?

TRUE

Putable bonds give the bondholders an option to sell the bond at a price higher than par value by the amount of one year interest payment when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt. | T or F?

FALSE ## Footnote Putable bonds give the bondholders an option to sell the bond at par value by the amount of one year interest payment when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt.

Since a putable bond gives its holder the right to "put the bond" at specified times or because of specified actions by the issuing firm, the bond's yield would be lower than that of an otherwise equivalent non-putable bond. | T or F?

TRUE

With subordinated debentures, payment of interest by a firm is required only when earnings are available. | T or F?

FALSE ## Footnote With income bonds, payment of interest by a firm is required only when earnings are available.

The market price of a callable bond will not generally exceed its call price, except in the case of a convertible bond. | T or F?

TRUE

Floating-rate bonds are bonds that can be redeemed at par at the option of their holder either at specific date after the date of issue and every 1 to 5 years thereafter or when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt. | T or F?

FALSE

A bond issued by an American company that is denominated in Swiss Francs and sold in Switzerland would be an example of a foreign bond. | T or F?

TRUE

A foreign bond is a bond issued by a foreign corporation or government and is denominated in the investor's home currency and sold in the investor's home market. | T or F?

TRUE

A Eurobond is a bond issued by an international borrower and sold to investors in countries with currencies other than the country in which the bond is denominated. | T or F?

TRUE

A Eurobond bond is a bond denominated in Euros. | T or F?

FALSE ## Footnote A Eurobond is a bond issued offshore by governments or corporates denominated in a *currency other than that of the issuer's country.*

The ________ feature permits the *issuer* to repurchase bonds at a stated price prior to maturity. A) call B) conversion C) put D) swap

The ________ feature allows bondholders to change each bond into stated number of shares of stock. A) call B) conversion C) put D) swap

________ allow bondholders to purchase a certain number of shares of the firm's common stock at a specified price over a certain period of time. A) Call options B) Stock purchase warrants C) Debentures D) Put options

A ________ give bondholders the right to purchase a certain number of shares of the issuer's common stock at a specified price over a certain period of time. A) stock purchase warrant B) call feature C) swap D) conversion feature

Stock purchase warrants are instruments that give their holders ________. A) the obligation to purchase a certain number of shares of the issuer's common stock at a specified price over a certain period of time B) the right to purchase a certain number of shares of the issuer's common stock at a specified price over a certain period of time C) the obligation to sell a certain number of shares of the issuer's preferred stock at a specified price over a certain period of time D) the right to sell a certain number of shares of the issuer's preferred stock at a specified price over a certain period of time

A $1,000, 8% bond sells for 980. $1,000 is called the ________. A) current value B) market value C) par value D) auction value

The current yield on a bond is measured by ________. A) the annual interest payment divided by the current price B) the annual interest payment divided by the par value C) the annual interest payment divided by the maturity value D) the annual interest payment divided by the yield to maturity

A bond rated Aaa according to Moody's, is considered ________. A) a high grade bond B) an investment grade bond C) an upper medium grade bond D) a medium grade bond

The riskiness of publicly traded bond issues is rated by independent agencies. According to Moody's rating system, an Aaa bond and a Caa bond are ________ and ________ respectively. A) speculative; investment grade B) prime quality; medium grade C) investment grade; speculative D) medium grade; lowest grade

A(n) ________ gives purchasers inflation protection. A) zero-coupon bond B) junk bond C) floating rate bond D) income bond

________ is used to finance "rolling stock"—airplanes,trucks,boats,railroad cars. A) Income bonds B) Equipment trust certificates C) Collateral trust bonds D) Subordinated debentures

A deeply discounted bond that pays no coupon interest is a ________. A) junk bond B) floating rate bond C) zero coupon bond D) subordinated debenture

The stated interest rate on ________ is adjusted periodically within stated limits in response to changes in specified money market or capital market rates. A) junk bonds B) floating rate bonds C) extendible notes D) putable bonds

A(n) ________ is secured by real estate. A) income bond B) debenture C) mortgage bond D) subordinated debenture

A(n) ________ is issued with no or very low coupon and sells significantly below its par value. A) income bond B) zero or low coupon bond C) mortgage bond D) subordinated debenture

On ________, the stated interest rate is adjusted periodically within stated limits in response to changes in specified money or capital market rates. A) a floating rate bond B) a zero coupon bond C) a mortgage bond D) an equipment trust certificate

________ are commonly issued in the reorganization of a failed or failing firm. A) Floating rate bonds B) Income bonds C) Mortgage bonds D) Equipment trust certificates

________ bonds are characterized by interest payments that are required only when earnings are available. A) Floating rate B) Income C) Mortgage D) Junk

________ are debt rated Ba or lower by Moody's or BB or lower by Standard & Poor's and are commonly used by rapidly growing firms to obtain growth capital, most often to finance mergers and takeovers. A) Subordinated debentures B) Mortgage bonds C) Junk bonds D) Equipment trust certificates

Convertible bonds are normally ________. A) debentures B) income bonds C) zero coupon bonds D) mortgage bonds

A debenture is ________. A) a bond secured by specific assets that any firm can issue B) a secured bond that is secured by unspecified assets C) a secured bond issued by startup firms D) an unsecured bond that only creditworthy firms can issue

________ are secured by stock and/or bonds that are owned by the issuer. A) Mortgage bonds B) Equipment trust certificates C) Collateral trust bonds D) Subordinated debentures

________ have a short maturities, typically one to five years, and which can be renewed for a similar period at the option of their holders. A) Floating rate bonds B) Extendible notes C) Putable bonds D) Junk bonds

Payment of interest required only when earnings are made available from which to make a payment is characteristic of a(n) ________. A) floating rate bond B) income bond C) mortgage bond D) equipment trust certificate

A putable bond gives the bondholder ________. A) the right to sell the bond back to the corporation at a discount B) the right to sell the bond back to the corporation at a stated premium C) the right to sell the bond back to the corporation at the current market value D) the right to sell the bond back to the corporation at par

A significant portion of the return on a zero coupon bond is in the form of ________. A) interest and gain in value B) interest C) gain in value D) tax reduction

________ are claims that are not satisfied until those of the creditors holding certain (senior) debts have been fully satisfied. A) Convertible debentures B) Subordinated debentures C) Mortgage bonds D) Collateral trust bonds

Bonds that can be redeemed at par at the option of their holders either at specific date after the date of issue and every 1 to 5 years thereafter or when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt are called ________. A) zero coupon bonds B) junk bonds C) floating-rate bonds D) putable bonds

A foreign bond is issued by a(n) ________. A) foreign corporation or government and is denominated in the investor's home currency and sold in the investor's home market B) corporation or government and is denominated in the investor's foreign currency and sold in the foreign market C) international borrower and sold to investors in countries with currencies other than the local currency D) international borrower and sold to investors in countries with currencies in which the bond is denominated

The primary goal of financial management is creating value by ________. A) making investments that are worth more than they cost B) making investments that pay off sooner rather than later C) taking as little risk as possible D) issuing bonds that receive investment-grade ratings

________ is a process that links risk and return to determine the worth of an asset. A) Establishing a bond rating B) The time value of money C) Valuation D) The term structure of interest rates

The value of an asset depends on the historical cash flow(s) up to the present time. | T or F?

FALSE ## Footnote The value of an asset is the present value of all th future cash flows it is expected to provide.

In the valuation process, the higher the risk, the greater is the required return | T or F?

TRUE

The level of risk associated with a given cash flow positively affects its value. | T or F?

FALSE ## Footnote The level of risk associated with a given cash flow *negatively* affects its value.

The value of an asset is determined by discounting the expected cash flows back to its present value, using an appropriate discount rate. | T or F?

TRUE

The process that links risk and return in order to determine the worth of an asset is termed ________. A) securitization B) valuation C) discounting D) compounding

The key inputs to the valuation process are ________. A) risk and risk aversion B) cash flow, cash flow timing, and risk C) cash flows and depreciation D) cash flows and taxes

The less certain a cash flow, the ________ the risk, and the ________ the present value of the cash flow. A) lower; higher B) lower; lower C) higher; lower D) higher; higher

The value of any asset is the ________. A) sum of all future cash flows it is expected to provide over the relevant time period B) sum of the present values of all future cash flows it is expected to provide over the relevant time period C) present value of the sum of all future cash flows it is expected to provide over the relevant time period D) sum of all compounded future cash flows it is expected to provide over the relevant time period

In the basic valuation model, risk is generally incorporated into the ________. A) cash flows B) timing C) discount rate D) total value

As a bond approaches maturity, the price of the bond will approach its par value until, the bond is worth its face value at maturity. | T or F?

TRUE

The longer the maturity of a Treasury security, the smaller the interest rate risk. | T or F?

FALSE ## Footnote The longer the maturity of a Treasury security, the *higher* the interest rate risk.

The value of a bond that pays semiannual interest is greater than that of an otherwise equivalent annual coupon interest paying bond. | T or F?

TRUE

Interest rate risk is the risk that results from the changes in interest rates and thereby impact the bond value. | T or F?

TRUE

When the required return is different from the coupon interest rate and is constant until maturity, the value of the bond will approach its par value as it nears maturity. | T or F?

TRUE

When a bond's required return is greater than its coupon interest rate, the bond value will be less than its par value. | T or F?

TRUE

A bond with short maturity has less "interest rate risk" than a bond with long maturity when all other features—coupon interest rate, par value, and interest payment frequency—are the same. | T or F?

TRUE

The shorter the amount of time until a bond's maturity, the more responsive is its market value to a given change in the required return. | T or F?

FALSE ## Footnote The longer the amount of time until a bond's maturity, the more responsive is its market value to a given change in the required return.

Increases in the basic cost of long-term funds or in risk will raise the required return on a bond. | T or F?

TRUE

A bond will sell at a premium when its required return rises above its coupon interest rate. | T or F?

FALSE ## Footnote A bond will sell at a *discount* when its required return rises above its coupon interest rate.

The required return on a bond is likely to differ from the stated interest rate for either of two reasons: 1) economic conditions have changed, causing a shift in the basic cost of long-term funds, or 2) the firm's risk has changed. | T or F?

TRUE

Bonds are ________. A) a series of perpetual short-term debt instruments B) a form of equity financing that pays interest C) long-term debt instruments used to raise large sums of money D) a hybrid form of financing used to raise large sums of money from a diverse group of lenders

A type of long-term financing used by both corporations and government entities is ________. A) common stocks B) bonds C) preferred stocks D) retained earnings

The value of a bond is the present value of the ________. A) dividends and maturity value B) interest and dividend payments C) maturity value D) interest payments and maturity value

The value of a bond is the present value of its interest payments plus ________. A) future value of its par value B) present value of its par value C) its face value D) present value of interest payment

If the coupon rate of a bond is equal to its required rate of return, then ________. A) the market value is less than par value B) the market value is equal to par value C) the market value is greater than par value D) the bond has just been issued

Bonds that sell at less than face value are priced at a ________, while bonds which sell at greater than face value sell at a ________. A) par; premium B) discount; par C) discount; premium D) coupon; premium

The price of a bond that pays a fixed coupon rate and the bond's required return have a relationship that is best described as ________. A) perfect positive correlation B) constant C) direct D) inverse

When the required return is constant and equal to the coupon rate, the price of a bond as it approaches its maturity date will ________. A) remain at par B) increase C) decrease D) change depending on whether it is a discount or premium bond

Interest rate risk and the time to maturity have a relationship that is best characterized as ________. A) constant B) varying C) direct D) inverse

If the required return is less than the coupon rate, a bond will sell at ________. A) par B) a discount C) a premium D) book value

When the required return is constant but different from the coupon rate, the price of a bond as it approaches its maturity date will ________. A) remain constant B) increase C) decrease D) approach par

If the required return is greater than the coupon rate, a bond will sell at ________. A) par B) a discount C) a premium D) book value

ABC company has two bonds outstanding that are the same except for the maturity date. Bond D matures in 4 years, while Bond E matures in 7 years. If the required return changes by 5 percent, then ________. A) bond D will have a greater change in price B) bond E will have a greater change in price C) the price of the bonds will be constant D) the percentage price change for the bonds will be equal

A bond will sell ________ when the stated rate of interest exceeds the required rate of return, ________ when the stated rate of interest is less than the required return, and ________ when the stated rate of interest is equal to the required return. A) at a premium; at a discount; equal to the par value B) at a premium; equal to the par value; at a discount C) at a discount; at a premium; equal to the par value D) equal to the par value; at a premium; at a discount

If a corporate bond is issued with a coupon rate that varies directly with the required return, the price of the bond will ________. A) equal the face value B) be less than the face value C) be greater than the face value D) be greater than or less than the face value depending on how interest rates vary

Yield to maturity (YTM) is the rate investors earn if they buy the bond at a specific price and hold it until maturity | T or F?

TRUE

The yield to maturity on a bond with a current price equal to its par or face value, will always be equal to the coupon interest rate. | T or F?

TRUE

If a bond's required return always equals its coupon interest rate, the bond's value will remain at par until it matures. | T or F?

TRUE

When a bond's value differs from par, its yield to maturity will differ from its coupon interest rate. | T or F?

TRUE

Yield to call represents the rate of return that investors earn if they buy a callable bond at a specific price and hold it until it is called back and they receive the call price, which would be set above the bond's par value. | T or F?

TRUE

For an investor who plans to purchase a bond maturing in one year, the primary consideration should be ________. A) retained earnings B) face value C) yield to maturity D) net income

The yield to maturity on a bond with price equal to its par value will ________. A) be less than the coupon rate B) be more than the coupon rate C) always be equal to the coupon rate D) be less than or equal to the coupon rate depending on the required return

Chapter 6 TB Flashcards

(178 cards)