Financial Markets and Institutions Test Bank (051 060)

Role of Financial Markets and Institutions  51
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) always subject to federal taxes; always exempt from state and local taxes
D) typically zero-coupon bonds; typically zero-coupon bonds
ANSWER: 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
ANSWER: C
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; much different than
C) lower; much different than
D) higher; similar to
ANSWER: D
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
ANSWER: A
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
ANSWER: A
18. A private bond placement has to be registered with the SEC.

A) True
B) False
ANSWER: B
© 2010 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
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
ANSWER: 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.
ANSWER: C
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.
ANSWER: 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
ANSWER: 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.
ANSWER: 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
ANSWER: 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.
ANSWER: 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.
ANSWER: 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.
ANSWER: 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
ANSWER: B
29. During weak economic periods, newly issued junk bonds offer _______ risk premiums.
A) true
B) false
ANSWER: B
30. _____ bonds have the most active secondary market.

A) Treasury
B) Zero-coupon corporate
C) Junk
D) Municipal
ANSWER: 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.
ANSWER: C
32. ______ are not primary purchasers of bonds.

A) Insurance companies
B) Finance companies
C) Mutual funds
D) Pension funds
ANSWER: B
33. Leveraged buyouts are commonly financed by the issuance of::

A) AAA-rated bonds.
B) Treasury bonds.
C) junk bonds.
D) municipal bonds.
ANSWER: 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
ANSWER: 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
ANSWER: 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
ANSWER: 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
ANSWER: 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
ANSWER: 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
ANSWER: E
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.
ANSWER: 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
ANSWER: 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) the amount of additional debt a firm can issue
D) a call feature
ANSWER: D
43. Bonds are issued in the primary market through a telecommunications network.
A) True
B) False
ANSWER: A
44. Corporate bonds can be placed with investors through a public offering or a private placement.
A) True
B) False
ANSWER: 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
ANSWER: 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
ANSWER: B
47. Rule 144A creates liquidity for securities that are privately placed.
A) True
B) False
ANSWER: A
48. Corporate bonds are more standardized than stocks.

A) True
B) False
ANSWER: B
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
ANSWER: 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
ANSWER: 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
ANSWER: A
52. Bond dealers do not have an inventory of bonds.

A) True
B) False
ANSWER: 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
ANSWER: B
54. Many bonds are listed on the New York Stock Exchange (NYSE).
A) True
B) False
ANSWER: 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
ANSWER: 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
ANSWER: B
57. Treasury bonds are issued by state and local governments.

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

A) True
B) False
ANSWER: B
61. Corporate bonds usually pay interest on an annual basis.

A) True
B) False
ANSWER: 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
ANSWER: 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
ANSWER: 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
ANSWER: B
65. High-risk bonds are called trash bonds.

A) True
B) False
ANSWER: B
66. Zero-coupon bonds do not pay interest. Instead, they are issued at a discount from par value.
A) True
B) False
ANSWER: 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
ANSWER: 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.
ANSWER: 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
ANSWER: B
70. (Financial calculator 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 of the above
ANSWER: D
71. 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.
ANSWER: 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.
ANSWER: 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.
ANSWER: 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.
ANSWER: D
75. 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.

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Role of Financial Markets and Institutions  51

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

20. A protective covenant may

21. A call provision normally

22. When would a firm most likely call bonds?

26. Bonds that are secured by personal property are called

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

30. _____ bonds have the most active secondary market.

31. Some bonds are “stripped,” which means that

32. ______ are not primary purchasers of bonds.

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

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

D) none of the above

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

48. Corporate bonds are more standardized than stocks.

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

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

60. Savings bonds are bonds issued by the Federal Reserve.

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

65. High-risk bonds are called trash bonds.

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

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

73. Which of the following statements is incorrect?

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