Chapter 9

Debt Valuation and Interest Rates

Multiple Choice Questions
Instructions: For each question there are several answers. Clearly mark the best
answer.
1.
A.
B.
C.
D.

The par value of a bond:

Never equals its market value.
Is determined by the investor.
Generally is $1,000.
Is never returned to the bondholder.

2.
A.
B.
C.
D.

The interest on corporate bonds is typically paid:

Semiannually.
Annually.
Quarterly.
Monthly.

3.
A.
B.
C.
D.

On any given day, a bond can be issued at:

A discount.
A premium.
Par.
All of the above.

4.
A.
B.
C.
D.

Mortgage bonds:
Is a type of debenture?
Are secured by a lien on real property.
Usually pay little or no interest.
Can only be issued by financial institutions.

5.
A.
B.
C.
D.

Bondholders have a priority claim on assets ahead of:

Common stockholders.
Preferred stockholders.
Both A and B.
None of the above.

6. Which type of value is shown on the firm's balance sheet?

A. Book value
B. Liquidation value

C. Market value
D. Intrinsic value
7.
A.
B.
C.
D.

Which of the following is generally NOT a characteristic of a bond?

Voting rights
Par value
Claims on assets and income
Indenture

8.
A.
B.
C.
D.

Common indenture provisions include:

Restrictions on the issuance of common stock dividends.
Restrictions on the sale or purchase of fixed assets.
Constraints on additional borrowing.
All of the above.

9.
A.
B.
C.
D.
E.

The issuance of bonds to raise capital for a corporation:

Magnifies the returns to the stockholders.
Increases risk to the stockholders.
Is a cheaper form of capital than the issuance of common stock?
All of the above.
None of the above.

10.A (n) ________ is used to outline the issuing company's contractual obligations to
bondholders.
A. mortgage
B. debenture
C. bond rating
D. indenture
11.Junk bonds:
A. Are high yield bonds.
B. Have higher default risk.
C. Were used to finance "fallen angels."
D. All of the above.
12.Which of the following investors incurs the least risk?
A. Bondholders
B. Preferred stockholders
C. Common stockholders
D. All of the above bear equal risk
13.The yield to maturity on a bond:
A. Is fixed in the indenture.
B. Is lower for higher-risk bonds.

C. Is the required return on the bond?

D. Is generally equal to the coupon interest rate.
14.All of the following affect the value of a bond EXCEPT:
A. Investors' required rate of return.
B. The recorded value of the firm's assets.
C. The coupon rate of interest.
D. The maturity date of the bond.
15.A $1,000 par value 10-year bond with a 10% coupon rate recently sold for $900. The yield
to maturity:
A. Is 10%.
B. Is greater than 10%.
C. Is less than 10%.
D. Cannot be determined.
16.Sterling Corp. bonds pay 10% annual interest and are selling at 97. The market rate of
interest:
A. Is less than 10%.
B. Is greater than 10%.
C. Equals 10%.
D. Cannot be determined.
17.The Blackburn Group has recently issued 20-year; unsecured bonds rated BB by Moody's.
These bonds are:
A. Low-risk bonds.
B. Debentures.
C. Premium bonds.
D. Mortgage bonds.
18.Bond ratings are usually not affected by:
A. The company's fiscal year end.
B. Profitable operations.
C. Variability in earnings.
D. Firm size.
19.The discount rate used to value a bond is:
A. The coupon interest rate.
B. Determined by the issuing company.
C. Fixed for the life of the bond.
D. The market rate of interest.
20.As interest rates, and consequently investors' required rates of return, change over time, the
________ of outstanding bonds will also change.

A.
B.
C.
D.

maturity date
coupon interest payment
par value
price

21.Bond ratings are favorably affected by:

A. A greater reliance on equity in financing the firm.
B. High variability in past earnings.
C. Large firm size.
D. Both A and C.
22.If the market price of a bond increases, then:
A. The yield to maturity decreases.
B. The coupon rate increases.
C. The yield to maturity increases.
D. None of the above.
23.If current market interest rates rise, what will happen to the value of outstanding bonds?
A. It will rise.
B. It will fall.
C. It will remain unchanged.
D. There is no connection between current market interest rates and the value of outstanding
bonds.
24.If current market interest rates fall, what will happen to the value of outstanding bonds?
A. It will rise.
B. It will fall.
C. It will remain unchanged.
D. There is no connection between current market interest rates and the value of outstanding
bonds.
25.Cassel Corp. bonds pay an annual coupon rate of 10%. If investors' required rate of return is
now 8% on these bonds, they will be priced at:
A. Par value.
B. A premium to par value.
C. A discount to par value.
D. Cannot be determined from information given.
26.Which of the following statements is true?
A. A bond that has a rating of AA is considered to be a junk bond.
B. A bond will sell at a premium if the prevailing required rate of return is less than the bond's
coupon rate.
C. A zero coupon is a bond that is secured by a lien on real property.
D. The legal document that describes all of the terms and conditions of a bond issue is called a

debenture agreement.
27.Quirk Drugs sold an issue of 30-year, $1,000 par value bonds to the public that carry a
10.85% coupon rate, payable semiannually. It is now 10 years later, and the current market
rate of interest is 9.00%. If interest rates remain at 9.00% until Quirk's bonds mature, what
will happen to the value of the bonds over time?
A. The bonds will sell at a premium and decline in value until maturity.
B. The bonds will sell at a discount and rise in value until maturity.
C. The bonds will sell at a premium and rise in value until maturity.
D. The bonds will sell at a discount and fall in value until maturity.
28.Which of the following statements is true?
A. When investors' required rate of return equals the bond's coupon rate, then the market value
of the bond may be selling at par value.
B. When investors' required rate of return exceeds the bond's coupon rate, then the market value
of the bond will be greater than par value.
C. When investors' required rate of return is less than the bond's coupon rate, then market value
of the bond will be greater than par value.
D. When investors' required rate of return is less than the bond's coupon rate, then the market
value of the bond will be less than par value.
29.A bond with a face value of $1,000 has annual coupon payments of $100 and was issued
seven years ago. The bond currently sells for a premium and has eight years left to maturity.
This bond's ________ must be less than 10%.
A. yield to maturity
B. current yield
C. coupon rate
D. current yield and coupon rate
E. yield to maturity and current yield
30.A bond has a coupon rate of 10% and yield to maturity of 12%. Which of the following must
be true?
A. The bond is selling at a discount.
B. The bond is selling at a premium.
C. The bond's current yield is less than the coupon rate.
D. Both A and C.
E. Both B and C.
31.Which of the following statements about bonds is true?
A. Bond prices move in the same direction as market interest rates.
B. If market interest rates change, long-term bonds will fluctuate more in value than short-term
bonds.
C. Long-term bonds are less risky than short-term bonds.
D. If market interest rates are higher than a bond's coupon interest rate, then the bond will sell

above its par value.

E. None of the above.
32.Which of the following statements about bonds is true?
A. As the maturity date of a bond approaches, the market value of a bond will become more
volatile.
B. Long-term bonds have less interest rate risk than do short-term bonds.
C. Bond prices move in the same direction as market interest rates.
D. If market interest rates are above a bond's coupon interest rate, then the bond will sell below
its par value.
E. None of the above.
33.Which of the following statements about bonds is true?
A. The market value of a bond moves in the opposite direction of market interest rates.
B. As the maturity date of a bond approaches, the market value of a bond will become more
volatile.
C. Long-term bonds are less risky than short-term bonds.
D. If market interest rates are higher than a bond's coupon interest rate, then the bond will sell
above its par value.
E. None of the above.
34.Which of the following statements is FALSE?
A. A debenture would usually be more risky than a mortgage bond that is issued by the same
firm.
B. A bond will sell at a discount if the prevailing required rate of return is more than the bond's
coupon rate.
C. A short-term bond will fluctuate less in value than a long-term bond if interest rates
fluctuate.
D. Interest rates and bond prices usually move in the same direction.
35.Which of the following statements about bonds is true?
A. If market interest rates are below a bond's coupon interest rate, then the bond will sell above
its par value.
B. Long-term bonds have less interest rate risk than do short-term bonds.
C. Bond prices move in the same direction as market interest rates.
D. As the maturity date of a bond approaches, the market value of a bond will become more
volatile.
E. None of the above.
36.Eurobonds are:
A. Issued in a country different from the one in whose currency the bond is denominated.
B. Issued only in Europe.
C. The European equivalent of a junk bond.
D. None of the above.

37.Which of the following statements about zero coupon bonds is FALSE?

A. When the bonds mature, the issuing firm is faced with a small cash outflow relative to the
cash inflow the firm receives when the bonds are initially issued.
B. Zero coupon bonds are disadvantageous to the issuing firm if interest rates fall.
C. Yields tend to be bid down on zero coupon bonds due to investor demand for the bonds.
D. Zero coupon bonds provide a positive annual cash flow to the issuing firm over the life of
the bonds.
38.Eurobonds:
A. Are registered with the SEC.
B. Are frequently offered to U.S. citizens and residents during their initial distribution.
C. Take relatively longer periods of time to issue.
D. Have none of the above characteristics.
39.Which of the following bonds is sold by a corporation at a discount and pays no interest?
A. An indenture bond
B. A zero coupon bond
C. A junk bond
D. A Eurobond
40.Which of the following is an advantage of zero coupon bonds?
A. Small cash outflow at maturity
B. Lower yield due to low demand
C. Ability to deduct annual amortization of discount
D. Both A and C
E. All of the above
41.Which of the following statements about debentures is FALSE?
A. The earning ability of the issuing corporation is of great concern to the bondholder.
B. Debentures are viewed as less risky than secured bonds.
C. Debentures must provide investors with a higher yield than secured bonds.
D. Debentures allow the firm to issue debt and still preserve some future borrowing power.
42.Government bonds have lower yield to maturity than do corporate bonds of the same
maturity because the ________ premium is lower for government bonds.
A. interest rate risk
B. inflation
C. default
D. maturity
43.Shafer Corporation issued callable bonds. The bonds are most likely to be called if
A. Interest rates decrease.
B. Interest rates increase.

C. Shafer Corporation needs additional financing.

D. Shafer Corporation's stock price increases dramatically.
44.Which of the following statements concerning junk bonds is most correct?
A. A rational investor will always prefer an AAA-rated bond to a junk bond.
B. Junk bonds have higher interest rates than AAA-rated bonds because of the higher risk.
C. Junk bonds may also be called low-yielding securities.
D. Junk bonds are priced higher than AAA-rated bonds because junk bonds are more risky.
45.Which of the following statements is true regarding convertible bonds?
A. The holder has the right to sell these bonds back to the issuer if the bonds don't perform well.
B. The holder can convert these bonds into an equal number of new bonds if they choose to do
so.
C. These bonds are convertible into common stock of the issuing firm at a prespecified price.
D. These bonds have a variable interest rate.
46.If a corporation were to choose between issuing a debenture, a mortgage bond, or a
subordinated debenture, which would have the highest yield to maturity, everything else
equal?
A. the debenture
B. the mortgage bond
C. the subordinated debenture
D. all of the above
47.Which of the following is true of a zero coupon bond?
A. The bond makes no coupon payments.
B. The bond sells at a premium prior to maturity.
C. The bond has a zero par value.
D. The bond has no value until the year it matures because there are no positive cash flows until
then.
48.If a firm were to experience financial insolvency, the legal system provides an order of
hierarchy for the payment of claims. Assume that a firm has the following outstanding
securities: mortgage bonds, common stock, debentures, and preferred stock. Rank the order
in which investors that own mortgage bonds would have their claim paid?
A. First
B. Second
C. Third
D. Fourth
49.Put the following in order of their claim on assets of a firm, starting with the LAST to have a
claim:
A. Subordinated debentures

B. Debentures (unsubordinated)

A.
B.
C.
D.
E.

C. Common Stock
C, B, A, D
C, D, A, B
B, A, C, D
D, C, B, A
D, C, A, B

D. Preferred stock

50.Other things being equal, investors will value which of the following bonds the highest?
A. Callable bonds
B. Convertible bonds
C. Bonds that are both callable and convertible
D. Unsecured, callable bonds