) The issuance of bonds to raise capital for a corporation: A) magnifies the ret
ID: 2771517 • Letter: #
Question
) The issuance of bonds to raise capital for a corporation:
A) magnifies the returns to the stockholders.
B) increases risk to the stockholders.
C) is a cheaper form of capital than the issuance of common stock.
D) all of the above.
E) none of the above.
The discount rate used to value a bond is:
A) the coupon interest rate.
B) determined by the issuing company.
C) fixed for the life of the bond.
D) the market rate of interest.
If the market price of a bond increases, then:
A) the yield to maturity decreases.
B) the coupon rate increases.
C) the yield to maturity increases.
D) none of the above.
Government bonds have lower yield to maturity than do corporate bonds of the same
maturity because the ________ premium is lower for government bonds.
A) interest rate risk
B) inflation
C) default
D) maturity
Explanation / Answer
1) D . It magnifies the return to stock holders because firm has more amount of capital to invest in positive NPV projects with the same amount of investors to distribute dividends to. It increases risk to common stockholders because in case of bankruptcy, bondholders have superiority over equity holders over the claims on company's assets during liquidation. It is a cheaper form of capital because bond interest rate is lesser than requred rate of return on equity.
2) D. The discount rate used to value a bond is the market rate of interest.
3) A. If the market price of a bond increases, then the yield to maturity decreases. This is because market price is inversely proportional to bond yield.
4) C. default premium is lower for goverment bonds compared to corporate bonds because government can repay their bonds by increasing taxes
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