Question 1. Under normal conditions, which of the following would be most likely to in

1. Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?

a. Adding additional restrictive covenants that limit management’s actions.

b. Adding a call provision.

c. The rating agencies change the bond’s rating from Baa to Aaa.

d. Making the bond a first mortgage bond rather than a debenture.

e. Adding a sinking fund.

2. Which of the following statements is CORRECT?

a. Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued.

b. Most sinking funds require the issuer to provide funds to a trustee, who holds the money so that it will be available to pay off bondholders when the bonds mature.

c. A sinking fund provision makes a bond more risky to investors at the time of issuance.

d. Sinking fund provisions never require companies to retire their debt; they only establish “targets” for the company to reduce its debt over time.

e. If interest rates increase after a company has issued bonds with a sinking fund, the company will be less likely to buy bonds on the open market to meet its sinking fund obligation and more likely to call them in at the sinking fund call price.

3. Amram Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not convertible, not callable, and has no sinking fund. Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the second bond, the convertible,callable bond with the sinking fund, to have it sell initially at par?

a. The coupon rate should be exactly equal to 6%.

b. The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%.

c. The rate should be slightly greater than 6%.

d. The rate should be over 7%.

e. The rate should be over 8%.

4. Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return?

a. Because of the call premium, the required rate of return would decline.

b. There is no reason to expect a change in the required rate of return.

c. The required rate of return would decline because the bond would then be less risky to a bondholder.

d. The required rate of return would increase because the bond would then be more risky to a bondholder.

e. It is impossible to say without more information.

5. Which of the following statements is CORRECT?

a. A zero coupon bond’s current yield is equal to its yield to maturity.

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

c. All else equal, if a bond’s yield to maturity increases, its price will fall.

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

e. All else equal, if a bond’s yield to maturity increases, its current yield will fall.

6. A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?

a. The bond’s current yield is less than 8%.

b. If the yield to maturity remains at 8%, then the bond’s price will decline over the next year.

c. The bond’s coupon rate is less than 8%.

d. If the yield to maturity increases, then the bond’s price will increase.

e. If the yield to maturity remains at 8%, then the bond’s price will remain constant over the next year.

7. Which of the following statements is CORRECT?

a. If a bond is selling at a discount, the yield to call is a better measure of return than is the yield to maturity.

b. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.

c. On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest.

d. If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield is zero.

e. The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B.

8. Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

a. Bond 8’s current yield will increase each year.

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