# Multiple choice questions on bonds

1. 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. Statements c and d are correct.

2. Assume that a 10-year Treasury bond has a 12 percent annual coupon, while a 15-year Treasury bond has an 8 percent annual coupon. The yield curve is flat; all Treasury securities have a 10 percent yield to maturity. Which of the following statements is most correct?

a. The 10-year bond is selling at a discount, while the 15-year bond is selling at a premium.

b. The 10-year bond is selling at a premium, while the 15-year bond is selling at par.

c. If interest rates decline, the price of both bonds will increase, but the 15-year bond will have a larger percentage increase in price.

d. If the yield to maturity on both bonds remains at 10 percent over the next year, the price of the 10-year bond will increase, but the price of the 15-year bond will fall.

e. Statements c and d are correct.

3. Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If you require a nominal annual rate of return of 12 percent, with quarterly compounding, how much should you be willing to pay for this bond? (Hint: The PVIFA and PVIF for 3 percent, 60 periods are 27.6748 and 0.1697, respectively.)

a. $ 821.92 b. $1,207.57 c. $ 986.43 d. $1,120.71 e. $1,358.24

4. You just purchased a 15-year bond with an 11 percent annual coupon. The bond has a face value of $1,000 and a current yield of 10 percent. Assuming that the yield to maturity of 9.7072 percent remains constant, what will be the price of the bond one year from now?

a. $1,000 b. $1,064 c. $1,097 d. $1,100 $1,150

5. Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest paid semiannually. The required nominal rate on this debt has now risen to 16 percent. What is the current value of this bond?

a. $1,273

b. $1,000

c. $7,783

d. $ 550

e. $ 450

6. A corporate bond with 12 years to maturity has a 9 percent semiannual coupon and a face value of $1,000. (That is, the semiannual coupon payments are $45.) The bond has a nominal yield to maturity of 7 percent. The bond can be called in three years at a call price of $1,045. What is the bond's nominal yield to call?

a. 4.62%

b. 10.32%

c. 17.22%

d. 5.16%

e. 2.31%

7. A 10-year bond has a face value of $1,000. The bond has a 7 percent semiannual coupon. The bond is callable in 7 years at a call price of $1,040. The bond has a nominal yield to call of 6.5 percent. What is the bond's nominal yield to maturity?

a. 3.14%

b. 6.05%

c. 7.62%

d. 6.27%

e. 6.55%

8. Meade Corporation bonds mature in 6 years and have a yield to maturity of 8.5 percent. The par value of the bonds is $1,000. The bonds have a 10 percent coupon rate and pay interest on a semiannual basis. What are the current yield and capital gains yield on the bonds for this year? (Assume that interest rates do not change over the course of the year).

a. Current yield = 8.50%; capital gains yield = 1.50%

b. Current yield = 9.35%; capital gains yield = 0.65%

c. Current yield = 9.35%; capital gains yield = -0.85%

d. Current yield = 10.00%; capital gains yield = 0.00%

e. Current yield = 10.50%; capital gains yield = -1.50%

9. A 16-year bond with a 10 percent annual coupon has a current yield of 8 percent. What is the bond's yield to maturity (YTM)?

a. 6.9%

b. 7.1%

c. 7.3%

d. 7.5%

e. 7.7%

10. 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 that gave investors a 10 percent rate of return, and if interest rates then dropped to the point where kd = 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 that gave investors a 10 percent rate of return, and if interest rates then dropped to the point where kd = YTM = 5%, we could be sure that the bond would sell at a discount below its $1,000 par value.

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#### Solution Preview

1. 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. Statements c and d are correct.

The longer the time to maturity the more the volatility in price. Hence c and d are correct. (Answer e)

2. Assume that a 10-year Treasury bond has a 12 percent annual coupon, while a 15-year Treasury bond has an 8 percent annual coupon. The yield curve is flat; all Treasury securities have a 10 percent yield to maturity. Which of the following statements is most correct?

a. The 10-year bond is selling at a discount, while the 15-year bond is selling at a premium.

b. The 10-year bond is selling at a premium, while the 15-year bond is selling at par.

c. If interest rates decline, the price of both bonds will increase, but the 15-year bond will have a larger percentage increase in price.

d. If the yield to maturity on both bonds remains at 10 percent over the next year, the price of the 10-year bond will increase, but the price of the 15-year bond will fall.

e. Statements c and d are correct.

The 10 year bond will sell at a premium because the coupon payment is more than the yield on treasury securities.

The 15 year bond will sell at a discount because the coupon payment is less than the yield on treasury securities.

Hence a and b are incorrect.

C is correct (Explanation in answer 1 above)

D is incorrect (As the time to maturity approaches the value will move towards the face value. Hence the price of 10 yr bond which is selling at a premium will decline and the price of 15 yr bond which is selling at a discount will rise.)

(Answer C)

3. Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If you require a nominal annual rate of return of 12 percent, with quarterly ...

#### Solution Summary

The solution provides answers and explanations to 10 multiple choice questions on bonds.

Finance Multiple choice questions: Bonds, WACC, current ratio, EBIT, growth rate, beta

When interest rates in the general market place fall below what a bond's original issued coupon payment was:

a) the price of the bond remains the same, but the interest payments are lowered to adjust for the fall in rates.

b) the price of the bond falls, and interest payments of the bond are lowered to adjust for the fall in rates.

c) the price of the bond rises, and interest payments of the bond are lowered to adjust for the fall in rates.

d) the price of the bond remains the same, and interest payments of the bond do not change.

e) the price of the bond rises, and interest payments of the bond do not change.

A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept?

a. Project A requires an up-front expenditure of $1,000,000 and generates a net present value of $3,200.

b. Project B has a modified internal rate of return of 9.5 percent.

c. Project C requires an up-front expenditure of $1,000,000 and generates a positive internal rate of return of 9.7 percent.

d. Project D has an internal rate of return of 9.5 percent.

e. None of the projects above should be accepted.

Securities that do not line up on the Security Market Line, whether above or below, are known as:

a. betas

b. deviations

c. alphas

d. variances

e. omegas

Other things held constant, which of the following will not affect the current ratio, assuming an initial current ratio greater than 1.0?

a. Fixed assets are sold for cash.

b. Long-term debt is issued to pay off current liabilities.

c. Accounts receivable are collected.

d. Cash is used to pay off accounts payable.

e. A bank loan is obtained, and the proceeds are credited to the firm's checking account.

If a company increases its debt ratio, but leaves its operating income (EBIT) and total assets unchanged, which of the following is most likely to occur:

a. The company's stock price will rise.

b. The company's net income will rise.

c. The company's basic earning power will fall.

d. The company's tax liability will fall.

e. None of the answers above is correct.

Which of the following would best describe a situation where the bond you are currently holding would be considered a premium bond?

a. Rates in the market are the same today as when you purchased the bond.

b. Rates in the market today are higher than when you purchased the bond.

c. Rates in the market today are lower than when you purchased the bond.

d. All of the above describe possible scenarios where a bond could be a premium bond.

e. None of the above are correct.

Grant Corporation's stock is selling for $40 in the market. The company's beta is 0.8, the market risk premium is 6 percent, and the risk-free rate is 9 percent. The previous dividend was $2 (i.e., D0 = $2) and dividends are expected to grow at a constant rate. What is the growth rate for this stock?

a. 3.00%

b. 4.68%

c. 6.00%

d. 8.38%

e. 13.80%

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 1-year bond with a 15 percent coupon.

b. A 3-year bond with a 10 percent coupon.

c. An 8-year non-callable bond with a 9 percent coupon.

d. A 10-year bond with a 10 percent coupon, callable in 5 years.

e. A 10-year zero coupon bond.

You are holding a stock with a beta of 2.0 that is currently in equilibrium. The required rate of return on the stock is 15% versus a required return on an average stock of 10%. Now the required return on an average stock increases by 30.0% (not percentage points, rather a 3% increase from the previous 10%). The risk-free rate remains unchanged. By what percentage (not percentage points, again) would the required return on your stock increase as a result of this event?

a. 38.00%

b. 40.00%

c. 42.00%

d. 45.00%

e. 50.00%

The expected rate of return on the common stock of Northwest Corporation is 14 percent. The stock's dividend is expected to grow at a constant rate of 8 percent a year. The stock currently sells for $50 a share with a beta of 1.25. Which of the following statements is correct?

a. The stock price is expected to be $54 a share in one year.

b. The stock price is expected to be $57 a share in one year.

c. The stock's dividend yield is 7 percent.

d. The stock's dividend yield is 8 percent.

e. The current dividend per share is $4.00.

Ignoring cost and other effects on the firm, which of the following measures would tend to reduce the cash conversion cycle?

a. Maintain the level of receivables as sales decrease.

b. Buy more raw materials to take advantage of price breaks.

c. Take discounts when offered.

d. Forgo discounts that are currently being taken.

e. Offer a longer deferral period to customers.

If the expected rate of return on a stock exceeds the required rate,

a. The stock is experiencing supernormal growth.

b. The stock should be sold.

c. The stock is a good buy.

d. The company is probably not trying to maximize price per share.

e. Dividends are not being declared.

Which of the following statement completions is most correct? If the yield curve is upward sloping, then a firm's marketable securities portfolio, assumed to be held for liquidity purposes, should be

a. Balanced between long- and short-term securities to minimize the effects of either an upward or a downward trend in interest rates.

b. Weighted toward U.S. Treasury securities to avoid interest rate risk.

c. Weighted toward long-term securities because they pay higher rates.

d. Weighted toward short-term securities because they pay higher rates.

e. Weighted toward short-term securities to avoid interest rate risk.

Which of the following would be considered the highest rate that one could expect on a premium bond?

a. Yield to maturity.

b. Yield to call.

c. Coupon rate.

d. Current yield.

e. There is no difference, the bond will return the same in all cases.

A company's balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 million. The balance sheets also show that that the company has 10 million shares of stock; the total of common stock and retained earnings is $30 million. The current stock price is $7.5 per share. The current return required by stockholders, rS, is 12 percent. The company has a target capital structure of 40 percent debt and 60 percent equity. The tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects?

a. 8.55%

b. 9.33%

c. 9.36%

d. 9.87%

e. 10.67%