Question 1

What is a credit default swap? Briefly explain.

Accepted Answer

A credit default swap (CDS)is an arrangement by which investors can insure corporate bonds. If an investor buys a credit default swap, he or she commits to pay a regular insurance premium or spread. In return, if the firm subsequently defaults on its debt, the seller of the swap pays the investor the difference between the face value of the debt and its market value. Credit default swaps have proved very popular, particularly with banks that need to reduce the risk of their loan portfolios.

Question 2

A corporate bond matures in one year. The bond promises a $50 coupon and a principal payment of $1,000 at maturity. If an investor buys the bond for $938.10, calculate the promised yield on the bond.

Accepted Answer

A) 6.60 percent 
B) 11.93 percent 
C) 5 percent 
D) 5.33 percent 
A) 6.60 percent 
B) 11.93 percent 
C) 5 percent 
D) 5.33 percent B

Question 3

If the discount rate on a bond is 8 percent and the expected payment in year 1 is $952.50, calculate the price of the bond.

Accepted Answer

A) $1,050 
B) $985 
C) $907.14 
D) $881.94 
A) $1,050 
B) $985 
C) $907.14 
D) $881.94 D

Question 4

Define the term credit risk.

Accepted Answer

Credit risk or default risk is

Question 5

Briefly describe bond ratings.

Accepted Answer

Bond ratings are a qualitative measure o

Question 6

The value of a firm's right to default on a bond generally increases with the maturity of the bond.

Accepted Answer

A) True 
 B)False

Question 7

Investors can insure corporate bonds through an arrangement called a credit default swap.

Accepted Answer

A) True 
 B)False

Question 8

The value of a risky bond equals asset value - value of call option on assets.

Accepted Answer

A) True 
 B)False

Question 9

Generally, a corporate bond has a higher promised yield than the yield on a similar government bond.

Accepted Answer

A) True 
 B)False

Question 10

The average yield spread based on promised yield on Aaa bonds rated by Moody's and the yield on Treasuries is about

Accepted Answer

A) 1 percent. 
B) 2 percent. 
C) 3 percent. 
D) 4 percent. 
A) 1 percent. 
B) 2 percent. 
C) 3 percent. 
D) 4 percent.

Question 11

The default rate on B rated bonds 10 years after issue is less than (choose best response)

Accepted Answer

A) 5 percent. 
B) 10 percent. 
C) 20 percent. 
D) 45 percent. 
A) 5 percent. 
B) 10 percent. 
C) 20 percent. 
D) 45 percent.

Question 12

The value of a corporate bond can be thought of as

Accepted Answer

A) asset value - value of call option on assets. 
B) asset value + value of call option on assets. 
C) asset value + value of a default-free bond. 
D) asset value - value of put option on assets. 
A) asset value - value of call option on assets. 
B) asset value + value of call option on assets. 
C) asset value + value of a default-free bond. 
D) asset value - value of put option on assets.

Question 13

The value of a bond is given by
I.bond value = asset value - value of call option on assets
II.bond value = value of an equivalent default-free bond + value of put option on assets
III.bond value = value of an equivalent default-free bond + value of put option on the stock
IV.bond value = asset value + value of call option on the stock

Accepted Answer

A) I only. 
B) I and II only. 
C) III and IV only. 
D) IV only. 
A) I only. 
B) I and II only. 
C) III and IV only. 
D) IV only.

Question 14

Investment-grade bonds can usually be entered at face value on the books of banks and life insurance companies.

Accepted Answer

A) True 
 B)False

Question 15

The U.S. government agrees to guarantee a bond issue planned by Demurrage Associates (DA). The value of this guarantee
I.equals the value of the guaranteed loan minus the value of the loan without a guarantee;
II.is a subsidy to DA's equity investors;
III.is a windfall gain to the buyers of the bonds;
IV.equals the value of a put option on the firm's assets with an exercise price equal to the bond's promised payments

Accepted Answer

A) II only 
B) I, II, and IV 
C) I only 
D) III only 
A) II only 
B) I, II, and IV 
C) I only 
D) III only

Question 16

A corporate bond matures in one year. The bond promises a $50 coupon and a principal payment of $1,000 at maturity.
If the bond has a 15% probability of default and payment under default is $400, calculate the expected payment from the bond.

Accepted Answer

A) $1,050.00 
B) $400.00 
C) $952.50 
D) $892.50 
A) $1,050.00 
B) $400.00 
C) $952.50 
D) $892.50

Question 17

Suppose that a bond with one-year maturity, a coupon rate of 5 percent, and face value of $1,000 sells for $881.94. Calculate the promised yield on the bond.

Accepted Answer

A) 5.42 percent 
B) 8.07 percent 
C) 19.06 percent 
D) 5.67 percent 
A) 5.42 percent 
B) 8.07 percent 
C) 19.06 percent 
D) 5.67 percent

Question 18

Commercial banks and several other financial institutions are not permitted to invest in bonds unless they are investment grade. What is the definition of an investment-grade bond?

Accepted Answer

A) One with a triple-A rating. 
B) One with a rating of Baa or better. 
C) One with a rating of B or better. 
D) One with a rating of C or better. 
A) One with a triple-A rating. 
B) One with a rating of Baa or better. 
C) One with a rating of B or better. 
D) One with a rating of C or better.

Question 19

Generally, promised yields are at least as great as expected yields.

Accepted Answer

A) True 
 B)False

Question 20

Bonds rated BBB (Baa)and above are called junk bonds.

Accepted Answer

A) True 
 B)False

Exam 23: Credit Risk and the Value of Corporate Debt

What is a credit default swap? Briefly explain.

A corporate bond matures in one year. The bond promises a $50 coupon and a principal payment of $1,000 at maturity. If an investor buys the bond for $938.10, calculate the promised yield on the bond.

If the discount rate on a bond is 8 percent and the expected payment in year 1 is $952.50, calculate the price of the bond.

Define the term credit risk.

Briefly describe bond ratings.

The value of a firm's right to default on a bond generally increases with the maturity of the bond.

Investors can insure corporate bonds through an arrangement called a credit default swap.

The value of a risky bond equals asset value - value of call option on assets.

Generally, a corporate bond has a higher promised yield than the yield on a similar government bond.

The average yield spread based on promised yield on Aaa bonds rated by Moody's and the yield on Treasuries is about

The default rate on B rated bonds 10 years after issue is less than (choose best response)

The value of a corporate bond can be thought of as

Investment-grade bonds can usually be entered at face value on the books of banks and life insurance companies.

A corporate bond matures in one year. The bond promises a $50 coupon and a principal payment of $1,000 at maturity. If the bond has a 15% probability of default and payment under default is $400, calculate the expected payment from the bond.

Suppose that a bond with one-year maturity, a coupon rate of 5 percent, and face value of $1,000 sells for $881.94. Calculate the promised yield on the bond.

Commercial banks and several other financial institutions are not permitted to invest in bonds unless they are investment grade. What is the definition of an investment-grade bond?

Generally, promised yields are at least as great as expected yields.

Bonds rated BBB (Baa)and above are called junk bonds.

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Making Investment Decisions With the Net Present Value Rule

Introduction to Risk and Return

Portfolio Theory and the Capital Asset Pricing Model

Risk and the Cost of Capital

Project Analysis

How to Ensure That Projects Truly Have Positive Npvs

Agency Problems and Investment

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

Does Debt Policy Matter

How Much Should a Corporation Borrow

Financing and Valuation

Understanding Options

Valuing Options

Real Options

The Many Different Kinds of Debt

Leasing

Managing Risk

Managing International Risks

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

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