Miscellaneous concepts [i]. Which of the following statements is most correct? a. Once a firm declares bankruptcy it is liquidated by the trustee who uses the proceeds to pay bondholders unpaid wages taxes and lawyer fees. b. 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. c. 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. d. One disadvantage of zero coupon bonds is that issuing firms cannot realize the tax savings from issuing debt until the bonds mature. e. Other things held constant callable bonds should have a lower yield to maturity than noncallable bonds. Miscellaneous concepts [ii]. 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 (that is has lower interest rate 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. Statements a b and c are correct. Miscellaneous concepts [iii]. Which of the following statements is most correct? a. All else equal a 1-year bond will have a higher (that is better) bond rating than a 20-year bond. b. A 20-year bond with semiannual interest payments has higher price risk (that is 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 were trading at a premium then you would expect to earn the yield to maturity. e. Statements a and b are correct. Current yield and yield to maturity [iv]. 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 10 years to maturity will have a lower current yield and higher capital gain relative to a bond that sells at par. d. Statements a and c are correct. e. None of the statements above is correct. Current yield and yield to maturity [v]. 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 statements above is correct. Corporate bonds and default risk [vi]. Which of the following statements is most correct? a. The expected return on corporate bonds will generally exceed the yield to maturity. b. Firmsthatare in financial distress are forced to declare bankruptcy. c. All else equal senior debt will generally have a lower yield to maturity than subordinated debt. d. Statements a and c are correct. e. None of the statements above is correct. Default risk and bankruptcy [vii]. Which of the following statements is incorrect? a. Firms will often voluntarily enter bankruptcy before they are forced into bankruptcy by their creditors. b. An indenture is a bond that is less risky than a subordinated debenture. c. When a firm files for Chapter 11 bankruptcy it may attempt to restructure its existing debt by changing (subject to creditor approval) the interest payments maturity and/or principal amount. d. All else equal mortgage bonds are less risky than debentures because mortgage bonds provide investors with a lien (that is a claim) against specific property. e. A company’s bond rating is affected by financial performance and provisions in the bond contract. Default risk and bankruptcy [viii]. 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. When companies enter Chapter 11 their assets are immediately liquidated and the firm no longer continues to operate. d. Statements a and c are correct. e. All of the statements above are correct. Default risk and bankruptcy [ix]. 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. Under Chapter 11 Bankruptcy the firm’s assets are sold and debts are paid off according to the seniority of the debt claim. d. Statements a and b are correct. e. All of the statements above are correct.
