Chapter 5: 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) Corporate
D) Treasury

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

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) 5 years or more; less than 5 years
D) less than 5 years; 5 years or more
4. Investors in Treasury notes and bonds receive interest payments from the
Treasury.
A) annual
B) semiannual
C) monthly
D) quarterly
5. Since 2001, the Treasury has relied heavily on -year bonds to finance the U.S.
budget deficit.
A) 50
B) 2
C) 10
D) 5

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.
7. Treasury bond auctions are normally conducted only at the beginning of each
year.
A) True
B) False

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) Non-negotiable
D) Negotiable
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.

10. Under the STRIP program created by the Treasury, stripped securities are
created and sold by the Treasury.
A) True
B) False

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

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

A) the Treasury
B) AAA-rated corporations
C) city governments
D) state governments

13. Municipal general obligation bonds are . 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) typically zero-coupon bonds; typically zero-coupon bonds
D) always subject to federal taxes; always exempt from state and local taxes
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

15. The municipal yield curve is typically than the Treasury yield curve, and
the shape of the municipal yield curve is the shape of the Treasury yield
curve.
A) lower; similar to
B) higher; similar to
C) higher; much different than
D) lower; much different than

16. The yield curve for corporate bonds is normally affected by interest rate
expectations, a liquidity premium, and the specific maturity preferences by
corporations issuing bonds.
A) True
B) False

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

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

A) True
B) False

19. Which of the following institutions is most likely to purchase a private bond
placement?
A) commercial bank
B) mutual fund
C) savings institution
D) insurance company
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
21. A call provision normally
A) allows the firm to call bonds at par value.
B) gives the firm the option to call bonds at market value.
C) allows the firm to call bonds at a price below par value.
D) requires the firm to call bonds at a price above par value.

22. When would a firm most likely call bonds?

A) after interest rates have declined
B) if interest rates do not change
C) just before the time at which interest rates are expected to decline
D) after interest rates increase

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.

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

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.

26. Bonds that are secured by personal property are called

A) chattel mortgage bonds.
B) first mortgage bonds.
C) second mortgage bonds.
D) debentures.
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.

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 unaffected
D) be zero
29. During weak economic periods, newly issued junk bonds offer risk premiums.
A) true
B) false

30. bonds have the most active secondary market.

A) Treasury
B) Municipal
C) Zero-coupon corporate
D) Junk

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.

32. are not primary purchasers of bonds.

A) Insurance companies
B) Finance companies
C) Mutual funds
D) Pension funds
33. Leveraged buyouts are commonly financed by the issuance of::
A) AAA-rated bonds.
B) Treasury bonds.
C) junk bonds.
D) municipal bonds.

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) stripped securities
C) structured notes
D) leveraged notes

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

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

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

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
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 are true

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.

41. If interest rates suddenly , those existing bonds that have a call feature
are likely to be called.
A) decline; more
B) decline; less
A) increase; more
B) none

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

43. Bonds are issued in the primary market through a telecommunications network.
A) true
B) false
44. Corporate bonds can be placed with investors through a public offering or a
private placement.
A) true
B) false

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

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

47. Rule 144A creates liquidity for securities that are privately placed.
A) true
B) false

48. Corporate bonds are more standardized than stocks.

A) True
B) False

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

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

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
52. Bond dealers do not have an inventory of bonds.
A) True
B) False
53. Bond dealers specialize in small transactions (less than $100,000) in order to
enable small investors to trade bonds.
A) True
B) False
54. Many bonds are listed on the New York Stock Exchange (NYSE).
A) True
B) False

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

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

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

A) True
B) False

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

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
60. Savings bonds are bonds issued by the Federal Reserve.
A) True
B) False

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

A) True
B) False

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
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

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

65. High-riskbonds are called trash bonds.

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

67. Ifinterest rates suddenly decline, those existing bonds that have a call
feature are less likely to be called.
A) True
B) False
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

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
70. (Financialcalculator required.) Ed Wood, 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. Mr. Wood’s yield to
maturity is percent.
A) 9.96
B) 10.00
C) 10.33
D) 10.24
E) none

Jim, a private investor, 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.

71. 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.

72. 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.

73. 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.

74. 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.

75. 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

76. Ifa 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

77. 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.

78. 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.

79. Everything else being equal, which of the following bond ratings is associated
with the highest yield?
A) Baa
B) A
C) Aa
D) Aaa