TBCh09
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Chapter 9 The Capital Markets
9.1 Multiple Choice
1)(I) Securities that have an original maturity that is greater than one year are traded in capital markets. (II) The best known capital market securities are stocks and bonds.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
2)(I) Securities that have an original maturity that is greater than one year are traded in money markets. (II) The best known money market securities are stocks and bonds.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: D
3)(I) Firms and individuals use the capital markets for long-term investments. (II) The capital markets provide an alternative to investment in assets such as real estate and gold.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
4)The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will
A)rise before they pay off their debt.
B)fall before they pay off their debt.
C)become more volatile before they pay off their debt.
D)become more stable before they pay off their debt.
Answer: A
5)A firm that chooses to finance a new plant by issuing money market securities
A)must incur the cost of issuing new securities to roll over its debt.
B)runs the risk of having to pay higher interest rates when it rolls over its debt.
C)incurs both the cost of reissuing securities and the risk of having to pay higher interest rates on the new debt.
D)is more likely to profit if interest rates rise while the plant is being constructed.
Answer: C
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6)The primary reason that individuals and firms choose to borrow long-term is to
A)reduce the risk that interest rates will fall before they pay off their debt.
B)reduce the risk that interest rates will rise before they pay off their debt.
C)reduce monthly interest payments, as interest rates tend to be higher on shortterm than long-term debt instruments.
D)reduce total interest payments over the life of the debt.
Answer: B
7)A firm will borrow long-term
A)if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates before it retires its debt.
B)if the extra interest cost of borrowing short-term due to rising interest rates does not exceed the expected premium that is paid for borrowing long term.
C)if short-term interest rates are expected to decline during the term of the debt.
D)if long-term interest rates are expected to decline during the term of the debt.
Answer: A
8)The primary issuers of capital market securities include
A)the federal and local governments.
B)the federal and local governments, and corporations.
C)the federal and local governments, corporations, and financial institutions.
D)local governments and corporations.
Answer: B
9)Governments never issue stock because
A)they cannot sell ownership claims.
B)the Constitution expressly forbids it.
C)of both (A) and (B) of the above.
D)of neither (A) nor (B) of the above.
Answer: A
10)(I) The primary issuers of capital market securities are federal and local governments, and corporations. (II) Governments never issue stock because they cannot sell ownership claims.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
11)(I) The primary issuers of capital market securities are financial institutions. (II) The largest purchasers of capital market securities are corporations.
A)(I) is true, (II) false.
B)(I) is false, (II) true
C)Both are true.
D)Both are false.
Answer: D
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12)The distribution of a firm’s capital between debt and equity is its
A)leverage ratio.
B)liability structure
C)acid ratio.
D)capital structure.
Answer: D
13)The largest purchasers of capital market securities are
A)households.
B)corporations
C)governments.
D)central banks.
Answer: A
14)Although individuals and households are the largest purchasers of capital market securities, they frequently purchase these securities through financial institutions such as
A)mutual funds.
B)pension funds.
C)money market mutual funds.
D)all of the above.
E)only (A) and (B) of the above.
Answer: E
15)(I) There are two types of exchanges in the secondary market for capital securities: organized exchanges and over-the-counter exchanges. (II) When firms sell securities for the very first time, the issue is an initial public offering.
A)(I) is true, (II) false.
B)(I) is false, (II) true
C)Both are true.
D)Both are false.
Answer: C
16)Organized exchanges account for about _____ percent of the total dollar volume of domestic stock shares traded.
A)30
B)45
C)60
D)70
Answer: D
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17)Organized exchanges account for about _____ percent of the total dollar volume of domestic stocks traded.
A)60
B)70
C)80
D)90
Answer: B
18)(I) The largest of the organized stock exchanges in the United States is the New York Stock Exchange. (II) To be listed on the NYSE, a firm must have a minimum of 10 million shares traded publicly.
A)(I) is true, (II) false.
B)(I) is false, (II) true
C)Both are true.
D)Both are false.
Answer: A
19)To list on the NYSE, a firm must
A)have at least 2000 stockholders, each owning 100 shares or more.
B)have pretax earnings of at least $1 million per year.
C)have a total of $100 million in market value of publicly traded shares.
D)meet all of the above requirements.
E)meet (A) and (B) of the above requirements.
Answer: E
Securities not listed on one of the exchanges trade in the over-the-counter market. In this exchange, dealers “make a market” by
F)buying stocks for inventory when investors want to sell.
G)selling stocks from inventory when investors want to buy.
H)doing both of the above.
I)doing neither of the above.
Answer: C
20)(I) Capital market securities fall into two categories: bonds and stocks. (II) Longterm bonds include government bonds and long-term notes, municipal bonds, and corporate bonds.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: B
21)The _____ value of a bond is the amount that the issuer must pay at maturity.
A)market
B)present
C)face
D)amortized
Answer: C
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22)The _____ rate is the rate of interest that the issuer must pay.
A)market
B)coupon
C)discount
D)funds
Answer: B
23)(I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate is usually fixed for the duration of the bond and does not fluctuate with market interest rates.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
24)Federal government bonds are subject to _____ risk but are free of _____ risk.
A)default; interest rate
B)default; underwriting
C)interest rate; default
D)interest rate; underwriting
Answer: C
25)The prices of Treasury notes, bonds, and bills are quoted as a percentage of
A)the coupon rate.
B)the previous day’s closing value.
C)$100 face value.
D)$1000 face value.
Answer: C
26)(I) To sell an old bond when interest rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate. (II) The risk that the value of a bond will fall when market interest rates rise is called interest rate risk.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
27)To sell an old bond when interest rates have _____, the holder will have to ______
the price of the bond until the yield to the buyer is the same as the market rate.
A)risen; lower
B)risen; raise
C)fallen; lower
D)risen; inflate
Answer: A
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28)Most of the time, the interest rate on Treasury notes and bonds is
A)above that on money market securities because of interest rate risk.
B)above that on money market securities because of default risk.
C)below that on money market securities because of interest rate risk.
D)below that on money market securities because of default risk.
Answer: A
29)(I) In most years the rate of return on short-term Treasury bills is below that on the 20-year Treasury bond. (II) Interest rates on Treasury bills are more volatile than rates on long-term Treasury securities.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
30)(I) Because interest rates on Treasury bills are more volatile than rates on long-term securities, the return on short-term Treasury securities is usually above that on longer-term Treasury securities. (II) A STRIP separates the periodic interest payments from the final principal repayment.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: B
31)Which of the following statements about Treasury inflation-indexed bonds is not true?
A)The principal amount used to compute the interest payment varies with the consumer price index.
B)The interest payment rises when inflation occurs.
C)The interest rate rises when inflation occurs.
D)At maturity the securities pay the greater of face-value or inflation-adjusted principal.
Answer: C
32)The interest rates on government agency bonds are
A)are almost identical to those available on Treasury securities since it is unlikely that the federal government would permit its agencies to default on their obligations.
B)are significantly higher than those available on Treasury securities due to their low liquidity.
C)are significantly lower than those available on Treasury securities because agency interest payments are tax exempt.
D)are significantly lower than those available on Treasury securities because the interest rate risk on agency securities is lower than that on Treasury securities.
Answer: B
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33)(I) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation. (II) General obligation bonds do not have specific assets pledged as security or a specific source of revenue allocated for their repayment.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
34)(I) Most corporate bonds have a face value of $1000, pay interest semi-annually, and can be redeemed anytime the issuer wishes. (II) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: A
35)The bond contract that states the lender’s rights and privileges and the borrower’s obligations is called the
A)bond syndicate.
B)restrictive covenant.
C)bond covenant.
D)bond indenture.
Answer: D
36)Policies that limit the discretion of managers as a way of protecting bondholders’ interests are called
A)restrictive covenants.
B)debentures.
C)sinking funds.
D)bond indentures.
Answer: A
37)Typically, the interest rate on corporate bonds will be
A)higher the more restrictions are placed on management through restrictive covenants, because corporate earnings will be limited by the restrictions.
B)higher the more restrictions are placed on management through restrictive covenants, because the bonds will be considered safer by bondholders.
C)lower the more restrictions are placed on management through restrictive covenants, because the bonds will be considered safer by buyers.
D)lower the fewer restrictive covenants are placed on management, because corporate earnings will be higher the fewer the restrictions.
Answer: C
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38)Restrictive covenants can
A)limit the amount of dividends the firm can pay.
B)limit the ability of the firm to issue additional debt.
C)restrict the ability of the firm to enter into a merger agreement.
D)do all of the above.
E)do only (A) and (B) of the above.
Answer: D
39)(I) Restrictive covenants often limit the amount of dividends that firms can pay the stockholders. (II) Most corporate indentures include a call provision, which states that the issuer has the right to force the holder to sell the bond back.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
40)Call provisions will be exercised when
A)interest rates and bond values rise.
B)interest rates rise and bond values fall.
C)interest rates fall and bond values rise.
D)interest rates and bond values fall.
Answer: C
41)A requirement in the bond indenture that the firm pay off a portion of the bond issue each year is called
A)a call provision.
B)a restrictive covenant.
C)a sinking fund.
D)a shelf registration.
Answer: C
42)(I) Callable bonds must have a higher yield than comparable noncallable bonds. (II) Convertible bonds are attractive to bondholders and sell for a higher price than comparable nonconvertible bonds.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
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43)Long-term unsecured bonds that are backed only by the general creditworthiness of the issuer are called
A)junk bonds.
B)callable bonds.
C)convertible bonds.
D)debentures.
Answer: D
44)Financial guarantees
A)are insurance policies to back bond issues.
B)are purchased by financially weaker security issuers.
C)lower the risk of the bonds covered by the guarantee.
D)do all of the above.
E)do only (A) and (B) of the above.
Answer: D
45)(I) A share of common stock in a firm represents an ownership interest in that firm. (II) A share of preferred stock is as much like a bond as it is like common stock.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
46)Preferred stockholders hold a claim on assets
A)that has priority over the claims of both common stockholders and bondholders.
B)that has priority over the claims of neither common stockholders nor bondholders.
C)that has priority over the claims of common stockholders, but after that of bondholders.
D)that has priority over the claims of bondholders but after that of common stockholders.
Answer: C
47)(I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders, but after that of bondholders. (II) Firms issue preferred stock in far greater amounts than common stock.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: A
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48)(I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders. (II) Bondholders hold a claim on assets that has priority over the claims of preferred stockholders.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
49)(I) Firms issue common stock in far greater amounts than preferred. (II) The total volume of stock issued is much less than the volume of bonds issued.
A)(I) is true, (II) false.
B)(I) is false, (II) true.
C)Both are true.
D)Both are false.
Answer: C
9.2 True/False
1)The primary issuers of capital market securities are local governments and corporations.
Answer: FALSE
2)Governments never issue stock because they cannot sell ownership claims. Answer: TRUE
3)Dealers “make a market” in over-the-counter stock by buying for inventory when investors want to sell and selling from inventory when investors want to buy. Answer: TRUE
4)To sell an old bond when rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate.
Answer: TRUE
5)Most of the time, the interest rate on Treasury notes is below that on money market securities because of their low default risk.
Answer: FALSE
6)Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation.
Answer: TRUE
7)Most corporate bonds have a face value of $1000, are sold at a discount, and can only be redeemed at the maturity date.
Answer: FALSE
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8)Registered bonds have now been largely replaced by bearer bonds, which do not have coupons.
Answer: FALSE
9)A sinking fund is a requirement in the bond indenture that the firm pay off a portion of the bond issue each year.
Answer: TRUE
10)Debentures are long-term unsecured bonds that are backed only by the general creditworthiness of the issuer.
Answer: TRUE
11)In a leveraged buy out, a firm greatly increases its debt level by issuing junk bonds to finance the purchase of another firm’s stock.
Answer: TRUE
12)A financial guarantee ensures that the lender (bond purchaser) will be paid both principal and interest in the event the issuer defaults.
Answer: TRUE
13)Common stockholders hold a claim on assets that has priority over claims of bondholders, but after that of preferred stockholders.
Answer: FALSE
9.3Essay
1)What is a bond indenture?
2)What role do restrictive covenants play in bond markets?
3)What is the basic difference between common and preferred stock?
4)What is difference between a general obligation and a revenue bond?
5)What are STRIPS?
6)What is a convertible bond? How does the convertibility feature affect the bond’s price and interest rate?
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