Question

1. Which of the following statements is NOT correct?

		Call Provision gives the issuing corporations the right to call the bonds for redemption. It generally occurs when interest rate declines substantially.
		Call provision is valuable to the firm but potentially hurt investors.
		Bond is a long-term contract under which a borrower agrees to make payments of interest and principal to the holders of the bond on specific dates.
		Yield to maturity is the stated interest rate on a bond. It is multiplied by par value to get dollars of interest payments every year.

2. What’s TRUE regarding long-term and short-term bonds (assume they have the same par value and coupon rate)?

		Long-term bonds have higher interest rate risk; Short-term bonds have higher reinvestment risk.
		Long-term bonds have lower interest rate risk; Short-term bonds have higher reinvestment risk.
		Long-term bonds have higher interest rate risk; Short-term bonds have lower reinvestment risk.
		Long-term bonds have lower interest rate risk; Short-term bonds have lower reinvestment risk.

3. The prices of high-coupon bonds tend to be more sensitive to a given change in interest rates than low-coupon bonds, other things held constant.

1. True
2. False

4. Which of the following statements about sinking fund is NOT true?

		Sinking fund provision facilitates the orderly retirement of the bond issue.
		A company would prefer to use sinking fund to call bond if interest rate is above the coupon rate.
		A company would use sinking fund to call bond if interest rate is well below coupon rate.
		It is a good strategy for a firm to use its sinking fund for open market purchase if bond sells at a big discount.

5. If investors become more averse to risk, the slope of the Security Market Line (SML) will decrease.

1. True
2. False

Answer 1

1. Which of the following statements is NOT correct?

Option D. Yield to maturity is the stated interest rate on a bond. It is multiplied by par value to get dollars of interest payments every year.

YTM is the rate of return the bondholder will earn if he held the bond will maturity. the information provided in this option is coupon rate. Thus Option D is correct answer.

2. What’s TRUE regarding long-term and short-term bonds (assume they have the same par value and coupon rate)?

Option A Long-term bonds have higher interest rate risk; Short-term bonds have higher reinvestment risk.

Because when interest rate changes in market, the bonds which have higher maturity will get effected the most due to long term nature of the bond. In case of short term bonds it experiences reinvestment risk because the bond will mature in short term and investor will be pressured to find a new investment at a required rate of return in market.

3. The prices of high-coupon bonds tend to be more sensitive to a given change in interest rates than low-coupon bonds, other things held constant.

false. because the effect of interest on high coupon bond and low coupon bond will be the same. the difference happens due to maturity time of the bonds. Coupon rates doesn't get affected by interest rate changes.

4. Which of the following statements about sinking fund is NOT true?

Option B A company would prefer to use sinking fund to call bond if interest rate is above the coupon rate.

because when the interest rate is higher in market than the coupon rate the borrower will not use call provision as it result in higher interest to the borrower

5. If investors become more averse to risk, the slope of the Security Market Line (SML) will decrease.

False.

the formula of slope = Market return - Risk free rate

both of the above items will change with the risk aversion of the investor