Question

True or False?

5. In general, if interest rates rise, the prices of existing bonds rise.

6. If a company defaults on its bonds, interest continues to accrue but may not be paid.

7. Current yield provides the best measure of a bond’s investment return.

8. Preferred stock dividends are usually fixed.

9. If a cumulative preferred stock’s dividend is in arrears, the dividend is not being paid.

10. Corporations are obligated to pay cash dividends if they generate earnings.

11. The value of a preferred stock rises when interest rates rise.

12. The shorter the term of a preferred stock, the less volatile should be its price.

13. An increase in the required return will tend to increase the value of a stock.

14. Corporations that pay common stock dividends apply less to retained earnings than if they didn’t pay dividends.

15. The shares of mutual funds are readily bought and sold in efficient, secondary markets.

Answer 1

5] False

The price of a bond is calculated as the present value of its cash flows. The cash flows of a bond are its coupon payments and maturity value. The present value of these cash flows is calculated by discounting them at the current interest rates.

If the interest rates rise, the present value of these cash flows will fall (as per the time value of money concept). Hence, the prices of bonds will fall

6] True

If a company defaults on its bonds, it does not automatically absolve the company of its interest obligations. Interest will continue to accrue, and the company will remain liable to pay the accrued interest even if it is not in a position to pay.

7] False

Current yield is not the best measure of a return because it does not take into account that the coupon payments are received over the life of the bond. YTM takes this into consideration, and therefore is a better measure of a bond's investment return

8] True

Preferred stock dividend is usually fixed at the time of their issue, and does not change over their life.