Question 1

XYZ company issued callable bonds three years ago with a 7% coupon rate.Today,the market rate of interest was lowered to 4%.What most likely will happen next?

Accepted Answer

When market rates decrease, bond prices increase. Thus, XYZ company is likely to call their bonds and refinance at a lower interest rate to save money on interest payments. They have the option to do so since they issued callable bonds. Lowering the par value or raising the coupon rate would not make financial sense in this situation.

Question 2

An unsecured long-term bond is known as a(n)

Accepted Answer

An unsecured long-term bond is known as a debenture. A debenture is backed only by the creditworthiness and reputation of the issuer, not by any collateral.

Question 3

Which of the following determines what the annual interest payment on a bond will be?

Accepted Answer

The annual interest payment on a bond is determined by the coupon rate, which is the percentage of the bond's par value. Therefore, both the par value and the coupon rate (options A and C) are correct determinants. The maturity date (option B) does not directly determine the annual interest payment but rather the overall payment at the maturity of the bond. Hence, option D is incorrect, and the best choice is E.

Question 4

Bonds that do not pay interest are known as no-load bonds.

Accepted Answer

Bonds that do not pay interest are known as zero-coupon bonds or discount bonds. No-load bonds refer to mutual funds that do not charge a sales commission when bought or sold.

Question 5

What is the purpose of the sinking fund?

Accepted Answer

The purpose of a sinking fund is to force the issuing company to save money to retire the bonds at maturity. By requiring the issuer to set aside money each year, they are able to reduce their risk and increase the likelihood that they will be able to pay off the bonds at maturity. This provides additional security to investors and can help to increase demand for the bonds.

Question 6

Any bond that is backed by the pledge of collateral is known as what type of bond?

Accepted Answer

A secured bond is backed by collateral, which means that if the bond issuer defaults on their payments, the bondholders have the right to claim the collateral as compensation. This provides an added layer of protection for investors compared to unsecured bonds. Collateralized and recalled bonds are not standard bond categories, while sinking bonds are repaid over time using a sinking fund, and agency bonds are issued by government agencies.

Question 7

Why might you consider investing in bonds?

Accepted Answer

Bonds can provide diversification, a steady income stream, and safety if held to maturity. Investing in bonds may be attractive to those seeking a more conservative investment strategy or looking to balance out riskier investments in their portfolio.

Question 8

The ________ is the face value of a bond,and the amount that is returned to the bondholder at maturity.

Accepted Answer

Par value is the face value of a bond and represents the amount that will be returned to the bondholder at maturity. The other options do not accurately describe the face value of a bond.

Question 9

The par value of the bond is the rate at which payments will be made to the bondholder annually,in the form of interest.

Accepted Answer

The par value of a bond is the face value of the bond, usually set at $1,000. It represents the amount that the issuer promises to repay the bondholder at the bond's maturity date. The interest rate or coupon rate is the rate at which payments will be made to the bondholder annually, not the par value.

Question 10

If you are already retired and seek additional income,then bonds as an investment choice would be wise.

Accepted Answer

Bonds are typically considered a conservative investment choice, providing a steady and predictable stream of income through interest payments. As such, they can be a good option for retirees looking to supplement their existing income, particularly if they prioritize capital preservation over growth.

Question 11

The issuer of the bond is effectively loaning money to the bondholder when the bond is purchased.

Accepted Answer

The issuer of the bond is borrowing money from the bondholder when the bond is purchased.

Question 12

Bonds enjoy all but one of the following advantages.Which is it?

Accepted Answer

Bonds may be called when interest rates drop, which means the issuer can pay off the bond early, leaving the investor with the reinvestment risk of finding a new investment with a potentially lower interest rate. This is a disadvantage, not an advantage. The other options listed are all advantages of investing in bonds.

Question 13

You hold in your hands a legal document that provides the specific terms of the loan agreement,including a description of the bond,as well as the rights of the bondholder.You have a(n)

Accepted Answer

An indenture is a legal document that spells out the terms of a bond and the rights of bondholders. It is a contract between the issuer of the bond and the bondholders. The other options do not accurately describe a bond document.

Question 14

Bonds reduce risk through diversification.

Accepted Answer

Bonds can be used as part of a diversified investment portfolio to reduce overall risk. When stocks and other high-risk investments are performing poorly, the stability and lower risk of bonds can help offset losses and provide more stable returns.

Question 15

State or municipal bonds that have interest and par value paid for with funds from a designated project or specific tax are known as ________ bonds.

Accepted Answer

Revenue bonds are issued to finance a particular project, such as a toll road, bridge or public facility. The interest and principal payments on revenue bonds are paid from the revenue generated by the project rather than from other tax sources.

Question 16

What could happen if you sell a bond before its maturity date?

Accepted Answer

Selling a bond before its maturity date could result in a capital gain, capital loss, or breaking even with the price paid for the bond. Therefore, all of the answer choices are correct.

Question 17

Herman Melville never thought of a bond as being a ________ and that he would be a ________ when securing one until he read about it in his personal finance text.

Accepted Answer

The question mentions securing a bond, which typically means being a lender. The options that include "lien" refer to a type of legal claim on property, not a role in a financial transaction. Option B ("loan; borrower") doesn't make sense because the sentence says "securing one," which implies the person is the one providing the funds, not the one borrowing them. "Debenture" doesn't fit because it's a type of bond, not a role in a transaction. Therefore, the correct answer is C, "loan; lender."

Question 18

The face value of a bond,or the amount that is returned to the bondholder at maturity is also known as the bond's denomination.

Accepted Answer

The face value of a bond is also known as the bond's denomination, and it is the amount that is returned to the bondholder at maturity.

Question 19

Bonds which are very low rated,yet high yielding bonds are known as junk bonds.

Accepted Answer

Junk bonds are also known as high-yield bonds because they offer higher returns to investors due to their low credit ratings and increased risk of default.

Question 20

Bond issuers may do something very important for the bondholder that increases the probability the debt will be successfully paid off at maturity.The issuer

Accepted Answer

Establishing a sinking fund is a common strategy used by bond issuers to increase the probability that the debt will be paid off at maturity. A sinking fund is a reserve account funded with regular contributions by the issuer that is used to retire the bonds when they mature. This reduces the risk of default and provides added assurance to bondholders that their investment will be repaid.

B, C, and D are not correct choices as setting a fixed interest rate, having the bond indentured, and having the bond deferred do not necessarily increase the probability that the debt will be successfully paid off at maturity. While setting a fixed interest rate can provide predictability to bondholders, it does not directly impact the issuer's ability to repay the debt. Indenturing the bond simply means that the terms of the bond are legally binding, but this does not necessarily ensure that the issuer will make timely payments. Deferring a bond means delaying payment until a later date, which would not be beneficial to bondholders who are expecting payment at maturity.

Quiz 13: Investing in Bonds and Other Alternatives