Chapter 7—Bond Markets

1. _____ require the owner to clip coupons attached to the bonds and send them to the issuer to receive
coupon payments.
a. Bearer
b. Registered
c. Treasury
d. Corporate

Ans: A

2. The yield to maturity is the annualized discount rate that equates the future coupon and principal payments
to the initial proceeds received from the bond offering
a. True
b. False

Ans: A

3. Note maturities are usually ____, while bond maturities are ____.
a. less than 10 years; 10 years or more
b. 10 years or more; less than 10 years
c. less than 5 years; 5 years or more
d. 5 years or more; less than 5 years

Ans: A

4. Investors in Treasury notes and bonds receive ____ interest payments from the Treasury.
a. annual
b. semiannual
c. quarterly
d. monthly

Ans: B

5. The Treasury has relied heavily on _____ -year bonds to finance the U.S. budget deficit.
a. 50
b. 70
c. 10
d. 5

Ans: C

6. Interest earned from Treasury bonds is

a. exempt from all income tax.
b. exempt from federal income tax.
c. exempt from state and local taxes.
d. subject to all income taxes.

Ans: C
7. Treasury bond auctions are normally conducted only at the beginning of each year.
a. True
b. False

Ans: B

8. ____ bids for Treasury bonds specify a price that the bidder is willing to pay and a dollar amount of securities
to be purchased.
a. Competitive
b. Noncompetitive
c. Negotiable
d. Non-negotiable

Ans: A

9. Treasury bond dealers ____.

a. quote an ask price for customers who want to sell existing Treasury bonds to the dealers.
b profit from a very wide spread between bid and ask prices in the Treasury securities market.
c. may trade Treasury bonds among themselves.
d. make a primary market for Treasury bonds.

Ans: C

10. Under the STRIP program created by the Treasury, stripped securities are created and sold by the Treasury.
a. True
b. False

Ans: B

11. A ten-year, inflation-indexed bond has a par value of $10,000 and a coupon rate of 5 percent. During the
first six months since the bond was issued, the inflation rate was 2 percent. Based on this information, the
coupon payment after six months will be $____.
a. 250
b. 255
c. 500
d. 510

Ans: B

12. Bonds issued by ____ are backed by the federal government.

a. the Treasury
b. AAA-rated corporations
c. state governments
d. city governments

Ans: A
13. Municipal general obligation bonds are ____. No Municipal revenue bonds are ____.
a. supported by the municipal government's ability to tax; supported by the municipal government's ability to
tax
b. supported by the municipal government's ability to tax; supported by revenue generated from the project
c. always subject to federal taxes; always exempt from state and local taxes
d. typically zero-coupon bonds; typically zero-coupon bonds

Ans: B

14. In general, variable-rate municipal bonds are desirable to investors who expect that interest rates will
____.
a. remain unchanged
b. fall
c. rise
d. none of the above

Ans: C

15. Which of the following statements is not true regarding zero-coupon bonds?
a. They are issued at a deep discount from par value.
b. Investors are taxed on the total amount of interest earned at maturity.
c. The issuing firm is permitted to deduct the amortized discount as interest expense for federal income tax
purposes, even though it does not pay interest until maturity.
d. Zero-coupon bonds are purchased mainly for tax-exempt investment accounts, such as pension funds and
individual retirement accounts.
e. All of the above are true.

Ans: A

16. A variable rate bond allows

a. investors to benefit from declining rates over time.
b. issuers to benefit from rising market interest rates over time.
c. investors to benefit from rising market interest rates over time.
d. none of the above.

Ans: C

17. Corporate bonds that receive a ____ rating from credit rating agencies are normally placed at yields.
a. higher; lower
b. lower; lower
c. higher; higher
d. none of the above

Ans: A

18. A private bond placement has to be registered with the SEC.

a. True
b. False

Ans: B
19. Which of the following institutions is most likely to purchase a private bond placement?
a. commercial bank
b. mutual fund
c. insurance company
d. savings institution

Ans: C

20. A protective covenant may

a. specify all the rights and obligations of the issuing firm and the bondholders.
b. require the firm to retire a certain amount of the bond issue each year.
c. restrict the amount of additional debt the firm can issue.
d. none of the above

Ans: C

21. A call provision on bonds normally

a. allows the firm to sell new bonds at par value.
b. gives the firm to sell new bonds above market value.
c. allows the firm to sell bonds to the Treasury.
d. allows the firm to buy back bonds that it previously issued.

Ans: D

22. When would a firm most likely call bonds?

a. after interest rates have declined
b. if interest rates do not change
c. after interest rates increase
d. just before the time at which interest rates are expected to decline

Ans: A

23. Assume U.S. interest rates are significantly higher than German rates. A U.S. firm with a German subsidiary
could achieve a lower financing rate, without exchange rate risk by denominating the bonds in
a. dollars.
b. euros and making payments from U.S. headquarters.
c. euros and making payments from its German subsidiary.
d. dollars and making payments from its German subsidiary.

Ans: C

24. Many bonds have different call prices: a higher price for calling the bonds to meet sinking-fund
requirements and a lower price if the bonds are called for any other reason.
a. True
b. False

Ans: B
25. Bonds that are not secured by specific property are called
a. a chattel mortgage.
b. open-end mortgage bonds.
c. debentures.
d. blanket mortgage bonds.

Ans: C

26. Bonds that are secured by personal property are called

a. chattel mortgage bonds.
b. first mortgage bonds.
c. second mortgage bonds.
d. debentures.

Ans: A

27. The coupon rate of most variable-rate bonds is tied to

a. the prime rate.
b. the discount rate.
c. LIBOR.
d. the federal funds rate.

Ans: C

28. Assume that you purchased corporate bonds one year ago that have no protective covenants. Today, it is
announced that the firm that issued the bonds plans a leveraged buyout. The market value of your bonds will
likely ____ as a result.
a. rise
b. decline
c. be zero
d. be unaffected

Ans: B

29. During weak economic periods, newly issued junk bonds require lower risk premiums than in strong
economic periods.
a. True
b. False

Ans: B

30. ____ bonds have the most active secondary market.

a. Treasury
b. Zero-coupon corporate
c. Junk
d. Municipal

Ans: A
31. Some bonds are "stripped," which means that
a. they have defaulted.
b. the call provision has been eliminated.
c. they are transferred into principal-only and interest-only securities.
d. their maturities have been reduced.

Ans: C

32. ____ are not primary purchasers of bonds.

a. Insurance companies
b. Finance companies
c. Mutual funds
d. Pension funds

Ans: B

33. Leveraged buyouts are commonly financed by the issuance of:

a. money market securities.
b. Treasury bonds.
c. corporate bonds.
d. municipal bonds.

Ans: C

34. When firms issue ____, the amount of interest and principal to be paid is based on specified market
conditions. The amount of the repayment may be tied to a Treasury bond price index or even to a stock index.
a. auction-rate securities
b. structured notes
c. leveraged notes
d. stripped securities

Ans: B

35. Which of the following statements is true regarding STRIPS?

a. they are issued by the Treasury
b. they are created and sold by various financial institutions
c. they are not backed by the U.S. government
d. they have to be held until maturity
e. all of the above are true regarding STRIPS

Ans: B

36. (Financial calculator required.) Lisa can purchase bonds with 15 years until maturity, a par value of $1,000,
and a 9 percent annualized coupon rate for $1,100. Lisa's yield to maturity is ____ percent.
a. 9.33
b. 7.84
c. 9.00
d. none of the above

Ans: B
37. (Financial calculator required.) Erin is, a private investor, who can purchase $1,000 par value bonds for
$980. The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until
maturity. Erin's yield to maturity is ____ percent.
a. 9.96
b. 10.00
c. 10.33
d. 10.24
e. none of the above

Ans: D

38. Devin is, a private investor, purchases $1,000 par value bonds with a 12 percent coupon rate and a 9
percent yield to maturity. Devin will hold the bonds until maturity. Thus, he will earn a return of ____ percent.
a. 12
b. 9
c. 10.5
d. more information is needed to answer this question

Ans: B

39. Which of the following is not true regarding zero-coupon bonds?

a. They are issued at a deep discount from par value.
b. Investors are taxed annually on the amount of interest earned, even though the interest will not be received
until maturity.
c. The issuing firm is permitted to deduct the amortized discount as interest expense
for federal income tax purposes, even though it does not pay interest.
d. Zero-coupon bonds are purchased mainly for tax-exempt investment account, such as pension funds and
individual retirement accounts.
e. all of the above are true

Ans: A

40. Which of the following is not true regarding the call provision?
a. It typically requires a firm to pay a price above par value when it calls its bonds.
b. The difference between the market value of the bond and the par value is called the call premium.
c. A principal use of the call provision is to lower future interest payments.
d. A principal use of the call provision is to retire bonds as required by a sinking fund provision
e. A call provision is normally viewed as a disadvantage to bondholders.

Ans: B

41. If interest rates suddenly ____, those existing bonds that have a call feature are ____ likely to be called
a. decline; more
b. decline; less
c. increase; more
d. none of the above

Ans: A
42. Which of the following would not be a likely example of a protective covenant provision?
a. a limit on the amount of dividends a firm can pay
b. a limit on the corporate officers' salaries a firm can pay
c. a call feature
d. the amount of additional debt a firm can issue

Ans: C

43. Bonds are issued in the primary market through a telecommunications network.
a. True
b. False

Ans: A

44. Corporate bonds can be placed with investors through a public offering or a private placement.
a. True
b. False

Ans: A

45. When a corporation issues bonds, it normally hires a securities firm that targets large institutional investors
such as pension funds, bond mutual funds, and insurance companies.
a. True
b. False

Ans: A

46. Rule 144A, which allows small individual investors to trade privately-placed bonds (and some other
securities) with each other without requiring that the firms that issued the securities to register them with
the SEC.
a. True
b. False

Ans: B

47. Rule 144A creates liquidity for securities that are privately placed.
a. True
b. False

Ans: A

48. Corporate bonds are more standardized than stocks.

a. True
b. False

Ans: A
49. Structured notes are issued by firms to borrow funds, and the repayment of interest and principal is based
on specified market conditions.
a. True
b. False

Ans: A

50. Bonds issued by large well-known corporations in large volume are illiquid because most buyers hold these
bonds until maturity.
a. True
b. False

Ans: B

51. The bond market is served by bond dealers, who can play a broker role by matching up buyers and sellers.
a. True
b. False

Ans: A

52. Bond dealers do not have an inventory of bonds.

a. True
b. False

Ans: B

53. Bond dealers specialize in small transactions (less than $100,000) in order to enable small investors to
trade bonds.
a. True
b. False

Ans: B

54. Many bonds are listed on the New York Stock Exchange (NYSE).
a. True
b. False

Ans: A

55. The primary investors in bond markets are institutional investors such as commercial banks, bond mutual
funds, pension funds, and insurance companies.
a. True
b. False

Ans: A
56. The key difference between a note and a bond is that note maturities are usually less than one year, while
bond maturities are one year or more.
a. True
b. False

Ans: B

57. Treasury bonds are issued by state and local governments.

a. True
b. False

Ans: B

58. Stripped bonds are bonds whose cash flows have been transformed into a security representing the
principal payment only and a security representing interest payments only.
a. True
b. False

Ans: A

59. Inflation-indexed Treasury bonds are intended for investors who wish to ensure that the returns on their
investments keep up with the increase in prices over time.
a. True
b. False

Ans: A
60. Savings bonds are bonds issued by the Federal Reserve.
a. True
b. False

Ans: B

61. Corporate bonds usually pay interest on an annual basis.

a. True
b. False

Ans: B

62. The bond debenture is a legal document specifying the rights and obligations of both the issuing firm and
the bondholders.
a. True
b. False

Ans: B

63. A sinking-fund provision is a requirement that the issuing firm retire a certain amount of the bond issue
each year.
a. True
b. False

Ans: A
64. Subordinated indentures are debentures that have claims against the firm's assets that are junior to the
claims of both mortgage bonds and regular debentures.
a. True
b. False

Ans: B

65. High-risk bonds are called trash bonds.

a. True
b. False

Ans: B

66. Zero-coupon bonds do not pay interest. Instead, they are issued at a discount from par value.
a. True
b. False

Ans: A

67. If interest rates suddenly decline, those existing bonds that have a call feature are less likely to be called.
a. True
b. False

Ans: B

68. Which of the following statements is not true regarding STRIPS?

a. They are not issued by the Treasury.
b. They are created and sold by various financial institutions.
c. They are backed by the U.S. government.
d. They have to be held until maturity.
e. All of the above are true regarding STRIPS.

Ans: D

69. (Financial calculator required.) Paul can purchase bonds with 15 years remaining until maturity, a par
value of $1,000, and a 9 percent annual coupon rate for $1,100. Paul's yield to maturity is ____ percent.
a. 9.33
b. 7.84
c. 9.00
d. none of the above

Ans: B
70. (Financial calculator required.) Steven, a private investor, can purchase $1,000 par value bonds for $980.
The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until maturity.
Steven's yield to maturity is ____ percent.
a. 9.96
b. 10.00
c. 10.33
d. 10.24
e. none of the above

Ans: D

71. Jim purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity.
Jim will hold the bonds until maturity. Thus, he will earn a return of ____ percent.
a. 12.00
b. 9.00
c. 10.50
d. More information is needed to answer this question.

Ans: B

72. Which of the following is not an example of a municipal bond?

a. general obligation bond
b. revenue bond
c. Treasury bond
d. All of the above are examples of municipal bonds.

Ans: C

73. Which of the following statements is incorrect?

a. The municipal bond must pay a risk premium to compensate for the possibility of default risk.
b. The Treasury bond must pay a slight premium to compensate for being less liquid than municipal bonds.
c. The income earned from municipal bonds is exempt from federal taxes.
d. All of the above are true.

Ans: B

74. Which of the following is not mentioned in your text as a protective covenant?
a. a limit on the amount of dividends a firm can pay
b. a limit on the corporate officers' salaries a firm can pay
c. the amount of additional debt a firm can issue
d. the appointment of a trustee in all bond indentures
e. All of the above are mentioned in the text as protective covenants.

Ans: D
75. Everything else being equal, which of the following bond ratings is associated with the highest yield?
a. Baa
b. А
c. Aa
d. Aaa

Ans: A

76. A ____ has first claim on specified assets, while a ____ is a debenture that has claims against a firm's
assets that are junior to the claims of mortgage bonds and regular debentures.
a. first mortgage bond, second mortgage bond
b. first mortgage bond; debenture
c. first mortgage bond; subordinated debenture
d. chattel mortgage bond; subordinated debenture
e. none of the above

Ans: C

77. If a firm believes that it will have sufficient cash flows to cover interest payments, it may consider using
____ debt and ____ equity, which implies a ____ degree of financial leverage.
a. more; less; lower
b. more; less; higher
c. less; more; higher
d. none of the above

Ans: B

78. The yield to investors on Treasury bonds reflects the risk-free rate because these bonds are virtually free
from credit (default) risk.
a. True
b. False

Ans: A

79. The issuance of municipal securities is regulated by:

a. the Securities and Exchange Commission.
b. the Consumer Financial Protection Bureau.
c. their respective state governments.
d. the Federal Reserve.

Ans: C

80. For bonds issued under a ____ arrangement, the underwriter guarantees the issuer that the bonds will be
sold at a specified price.
a. specific value
b. fixed proceeds
c. best efforts
d. firm commitment

Ans: D
81. For bonds issued under a ____ arrangement, the underwriter attempts to sell the bonds at a specified
price but makes no guarantee to the issuer.
a. floating value
b. variable proceeds
c. best efforts
d. firm commitment

Ans: C

82. Which of the following eurozone countries has not recently experienced debt repayment problems?
a. Finland
b. Greece
c. Portugal
d. Spain

Ans: A

83. The Financial Reform Act of 2010 established the ____ to provide oversight for credit rating agencies.
a. Federal Ratings Bureau
b. Office of Credit Ratings
c. Office of Agency Supervision
d. Ratings Oversight Commission

Ans: B

84. A credit rating agency is paid by:

a. the purchasers of the bonds that the agency rates.
b. the issuers of the bonds that the agency rates.
c. the taxpayers, because the rating agencies are government agencies.
d. the New York Stock Exchange or the over-the-counter market where the bonds are listed.

Ans: B

85. All of the bonds issued by a particular company will have the same maturity, price, and credit rating.
a. True
b. False

Ans: B

86. When purchasing bonds, individual investors can use a ____ to specify the maximum price they are willing
to pay for a bond.
a. limit order
b. market order
c. stop order
d. price order

Ans: A
87. Online bond brokerage services offer several advantages including:
a. pricing is more transparent because investors can easily compare bid and ask spreads.
b. some services charge commissions, which may be more easily understood than bid and ask spreads.
c. some brokers have narrowed their spreads so that they do not lose business to competitors.
d. all of the above

Ans: D

88. Jim purchases $10,000 par value bonds with a 10 percent coupon rate and a 7 percent yield to maturity.
Jim will hold the bonds until maturity. Thus, he will earn a return of ____ percent.
a. 7.00
b. 8.00
c. 10.00
d. More information is needed to answer this question.

Ans: A

89. Which of the following is not an advantage of online bond brokerage services?
a. Some services charge commissions, which may be more easily understood than bid and ask spreads.
b. Pricing is more transparent because investors can easily compare bid and ask spreads.
c. All of the above are advantages of online bond brokerage services.
d. Some brokers have narrowed their spreads so that they do not lose business to competitors.

Ans: C

90. Treasury bond auctions are normally conducted only at the beginning of each year.
a. True
b. False

Ans: B

91. Corporate bonds are sometimes packaged by commercial banks into ___________, in which investors
receive the interest or principal payments generated by the debt securities.
a. inverted bonds
b. reverse loans
c. collateralized debt obligations (CDOs)
d. credit default swaps

Ans: C