ACCT 223 – Chapter 7

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1. Types of Bonds

Which of the following statements about Treasury bonds is the most accurate?

Treasury bonds are not completely risk-less, since their prices will decline when interest rates rise.

1. Types of Bonds

New York City issued a general obligation bond for a canal in 1812. It was the first formal debt instrument with a fixed repayment schedule issued by a city.

a. Who is the issuer of the bonds?

b. What type of bonds are these?

a. The New York City government b. Municipal Bonds

2. Characteristics of Bonds

a. A bond’s _____ is generally $1,000 and represents the amount borrowed from the bond’s first purchaser.

b. A bond issuer is said to be in _____ if it does not pay the interest or the principal in accordance with the terms of the indenture agreement or if it violates one or more of the issue’s restrictive covenants.

c. A bond contract feature that requires the issuer to retire a specified portion of the bond issue each year is called a _____.

d. A bond’s _____ gives the issuer the right to call, or redeem, a bond at specific time and under specific conditions.

a. face or maturity value b. default c. singing fund provision d. call provision

2. Characteristics of Bonds

Bridge Bonds Series A Dated 7-15-2005 4.375% Due 7-15-2055 @100.00

What is the issuing date of this bond?


2. Characteristics of Bonds

If the price of the bond is initially discounted and offers no coupon payments, the bond is called a _____ bond.


2. Characteristics of Bonds

Which feature of a bond contract allows the issuer to redeem bonds under specified terms prior to maturity?

call provision

2. Characteristics of Bonds

When are issuers more likely to call an outstanding bond issue?

When interest rates are lower than they were when the bonds were issued.

3. Convertible bonds, warrants, and other exotic bond features

Which of the following best describes the difference between a convertible bond and a warrant?

Convertible bonds give the investor the option to exchange bonds for shares at a certain price, whereas warrant give the investor the option to buy shares at a certain price.

3. Convertible bonds, warrants, and other exotic bond features

Scott wants to include putable bonds in his investment portfolio. Scott is likely to put the bonds when:

he is in need of cash

3. Convertible bonds, warrants, and other exotic bond features

Scott also recently bought bonds with a clause stating that interest will be paid only when the company has enough earnings to pay for it. Scott has invested in _____.

income bonds

4. Bond Valuation

Remember, a bond’s coupon rate partially determines the interest-based return that a bond _____ pay, and a bond holder’s required return reflects the return that a bondholder _____ to receive from a given investment.

will would like

4. Bond Valuation

When the bond’s coupon rate is equal to the bondholder’s required return, the bond’s intrinsic value will equal its par value, and the bond will trade at par.

a. When the bond’s coupon rate is greater to the bondholder’s required return, the bond’s intrinsic value will _____ its par value, and the bond will trade at a premium.

b. When the bond’s coupon rate is less than the bondholder’s required return, the bond’s intrinsic value will be less than its par value, and the bond will trade at _____.

a. exceed b. a discount

5. Bond Yields

Yield to maturity (YTM) is the rate of return expected from a bond held until its maturity date. However, the YTM equals the expected rate of return under certain assumptions. Which of the following is one of those assumptions?

The bond will not be called.

5. Bond Yields

Star Inc. has 9% annual coupon bonds that are callable and have 18 years left until maturity. The bonds have a par value of $1,000 and their current market price is $1,040.35. However, Star Inc. may call the bonds in eight years at the call price of $1,060. What are the YTM and the yield to call (YTC) on Star Inc.’s bonds?

YTM Value: 8.55% YTC Value: 8.82%

5. Bond Yields

If interest rates are expected to remain constant, what is the best estimate of the remaining life left for Star Inc.’s bonds?

18 years

5. Bond Yields

If Star Inc. issued new bonds today, what coupon rate must the bonds have to be issued at par?


6. Bond Yields and Prices Over Time

Smith just registered and issued its bonds, which will be sold in the bond market for the first time, bonds would be referred to as:

a new issue

7. Valuing Semiannual Coupon Bonds

a. Assume that a $1,000,000 par value, semiannual coupon U.S. Treasury note with five years to maturity (YTM) has a coupon rate of 3%. The yield to maturity of the bond is 8.80% Using this information and ignoring the other costs involved, calculate the value of the Treasury note:

b. The T-note described in the problem above is selling at a _____.

a. $769,398.74 b. discount

8. Risks of investing in bonds

An investor is concerned that a decline in interest rates might lead to _____ annual income fro her investments. If interest rates _____, the value of earnings from her investments will increase. If her goal is to save for retirement, which of the following bonds poses the biggest risk?

less increase A 20-year, 10% coupon bond that may b e called in 10 years

8. Risks of investing in bonds

Is the default spread between the corporate bonds and the Treasury securities greater for shorter or longer maturities?

Long-term maturities

8. Risks of investing in bonds

Assuming all else is equal, long-term securities are exposed to higher interest rate risk than short-term securities


8. Risks of investing in bonds

Assuming all else is equal, the shorter a bond’s maturity, the more its price changes in response to a given change in interest rates.


9. More on types of bonds

a. These bonds are collateralized securities with first claims in the event of bankruptcy.

b. These bonds have claim on assets only after senior debt has been paid in full.

c. These bonds are traded i the bond markets based on investors’ belief that the issuer will not default on the repayment. These bonds have no collateral and usually offer higher yields.

a. Senior mortgage bonds b. Subordinated debentures c. Debentures

9. More on types of bonds

Based on your understanding of bond ratings and bond-rating criteria, which of the following statements is TRUE?

An indenture is a legal document that details the rights of bondholders. If the indenture includes a sinking funds provision, the bond will have LESS default risk.

9. More on types of bonds

In May 2009, General Motors started closing 2,600 of its retail outlets and finally filed for bankruptcy in June. It emerged from the bankruptcy protection by July 2009, after it received funding from the U.S. government, the Canadian government, United Automobile Workers Union, and GM bondholders.

this is an example of:


10. Bond Ratings

Based on these ratings, bonds are classified into investment-grade bonds and junk bonds. Which of the following bonds is likely to be classified as an investment-grade bond?

A bond whose issuer has a 30% return on capital, a total debt to total capital ratio of 15%, and a 6% yield.

10. Bond Ratings

You heard that rating agencies have downgraded a bond’s rating. The yield on the bond is likely to _____, and the bond’s price will _____.

increase decrease

10. Bond Ratings

Assume you make the following investments:

-A 10,000 investment in a 10-year T-bond that yields 11%, and
-A 20,000 investment in a 10-year corporate bond with an AA rating and a yield of 14.3%

Based on this information, what is your estimate of the corporate bond’s default risk premium?


Which of the following statements is CORRECT?

If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.

A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?

The bond’s yield to maturity is greater than its coupon rate.

Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond’s face value.


As a general rule, a company’s debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.


Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength.


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