FINA 351 – Managerial Finance, Chapter 6, (Ref. 6a)
Use Ch. 6 and the instructor notes to answer the questions below about bond definitions and terminology.
DEBT VS. EQUITY SECURITIES (see instructor notes)
1.
For each of the following, determine if you acquired a debt or equity security, or both:
(A) You purchased one share of General Motors common stock.
(B) You bought a General Motors corporate bond.
(C) You opened a saving account at Blue Mtn. Credit Union by buying shares (members own the credit union)
(D) You opened a saving account at the Umpqua Bank down the street.
(E) You became a partner in a small local business by buying a 50% stake
2.
(A) What are the two types of future cash flows that bond investors expect to receive? (See Figure 6.1)
(B) What are the two types of future cash flows that stock investors may (or may not) receive? (See teacher notes)
(C) Why are the future cash flows for bond investors considered less risky than those for stock investors?
(D) If the value of an investment today is the present value of the future cash flows, which do you think is easier to
value correctly: a bond or in a stock?
3.
(A) T or F: Stock investors usually face significantly more risk than bond investors do because stock investors can
only guess what their future cash flows might be, whereas bond investments know the timing and amount of future
cash flows, which are guaranteed by the investee.
(B) T or F: When a company declares bankruptcy, the bondholders and other creditors have first claim to the
company assets but the stockholders, who have a residual interest, often end up with nothing.
(C) Circuit City (the nation’s second largest electronic retailer at the time) declared bankruptcy in late 2008. Based on
the stock chart below, what amounts, if any, do you think the equity owners got from the leftovers assets?
4.
(A) See lines A & B (blue and red lines) on the next page. Which is more risky, A or B? Why?
(B) See the “Risk & Return Over Time” graph on the next page. If $1 had been invested in L/T Gov’t Bonds in 1925,
what would the investment be worth in 2014? How about for Small Company Stocks?
(C) Did the L/T Gov’t Bonds or Small-Company Stocks have a higher standard deviation (wiggled more)? Why do
you think this is the case?
(D) T or F: Stock investments take on the risks and rewards of ownership while bond investments settle for a
potentially lower but a more certain reward.
BASIC BOND TERMINOLOGY/CONCEPTS
From the instructor notes and textbook Ch. 6, determine if each statement is true or false:
5.
T or F: The entity selling bonds is borrowing money and the entity buying bonds is lending money.
6.
T or F: The typical face value or par value of a corporate bond is $1,000 each. (See Section 6.1)
7.
T or F: The typical maturity of a corporate bond is 30 years. (See Section 6.1)
8.
T or F: The market interest rate is also called the yield-to-maturity (YTM) or just “yield.” (See Section 6.1)
9.
T or F: An investor buying a bond gets a discount when the fixed coupon interest rate offered by the bond is inferior to
the rate the investor could get elsewhere for a similar bond. (See Section 6.1)
10. T or F: An investor is willing to pay a premium for a bond when the bond offers superior fixed interest payments
compared to other bonds of similar risk. (See Section 6.1)
11. T or F: The value of a bond can be approximated by summing the present value of the coupon payments (annuity) with
the present value of the face amount (single sum). (See Section 6.1)
12. T or F: In practice, bonds issued in the U.S. usually make coupon payments for interest only once a year. (See Ex. 6.1)
13. T or F: Bond prices and interest rates move in the same direction (e.g. if interest rates increase, so would the price of
the bonds.) (See Section 6.1)
14. T or F: Without the use of a financial calculator/spreadsheet, finding YTM is a trial-and-error process. (See Sect. 6.1)
15. T or F: Bonds whose ownership is registered with the corporation are called bearer bonds. (See Section 6.2)
16. T or F: Most corporate bonds today are bearer bonds. (See Section 6.2)
17. T or F: An indenture is the formal bond contract, a debenture is an unsecured bond, and a denture is false teeth. (See
Sect.6.2)
18. T or F: Most corporate bonds, with the exception of railroads & utilities, are debentures. (See Section 6.2)
19. T or F: In the event of default, senior bondholders get paid before junior bondholders. (See Section 6.2)
20. T or F: A sinking fund is an arrangement made to pay-off a portion of the bonds each year so that the borrower isn’t
faced with a huge balloon payment at maturity which it can’t pay. (See Section 6.2)
21. T or F: In essence, a call provision allows the corporation to refinance bonds at a lower interest rate.
22. T or F: A bond rated AAA will offer a higher interest rate than a bond rated BBB. (See Section 6.3)
23. T or F: Junk bonds are non-investment-grade bonds. (See Section 6.3)
24. T or F: When state and local governments issue bonds (municipal bonds), the lenders do not have to pay federal
income tax on the interest. (See Section 6.4)
25. T or F: A zero coupon bond pays interest in regular intervals during the life of the bond. (See Section 6.4)
WEBAPP
26. Go to http://screener.finance.yahoo.com/bonds.html.
(A) Check the corporate bonds box and find the bond listing for “3M CO” that mature in 2022 (Hint: sort by issue;
should be close to top of the list). Record the following: price, coupon, maturity date, YTM, current yield, rating, and
callable.
(B) Is this corporate bond a discount or premium bond? Why do you think it is selling at a discount or premium?
(C) Is this a junk bond? (See instructor’s notes for Fitch’s rating system. Junk bonds are often called high-yield
bonds because they promise higher interest rates to compensate for the added risk. They are also called noninvestment grade bonds).
(D) Is this bond callable? What does callable mean?