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Chapter 07 - Valuing Bonds
Chapter 07
Valuing Bonds
Multiple Choice Questions
1. Which of these statements is false?

A. Bonds are more important capital sources than stocks for companies and governments.
B. Some bonds offer high potential for rewards and, consequently, higher risk.
C. The bond market is larger than the stock market.
D. Bonds are always less risky than stocks.
2. Bonds are issued by which of the following?

A. corporations
B. federal government or its agencies
C. state and local governments
D. all of these
3. Which of these statements answers why bonds are known as fixed income securities?
A. Many investors on fixed incomes buy them.
B. Investors know how much they will receive in interest payments.
C. Investors will not receive their principal when the bond's term is up.
D. All of these
4. Which of the following is a legal contract that outlines the precise terms between the issuer
and the bondholder?
A. debenture
B. enforcement codes
C. indenture
D. prospectus
7-1
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5. Regarding a bond's characteristics, which of the following is the principal loan amount that
the borrower must repay?
A. call premium
B. maturity date
C. par or face value
D. time to maturity value
6. To compensate the bondholders for getting the bond called, the issuer pays which of the
following?
A. call feature
B. call premium
C. coupon rate
D. original issue premium
7. This determines the dollar amount of interest paid to bondholders.

A. original issue discount
B. call premium
C. coupon rate
D. market rate
8. Bond prices are quoted in terms of which of the following?

B. percent of par value
C. coupon rate in dollars
D. market rate in dollars
9. Which of the following are main issuers of bonds?

A. U.S. Treasury bonds
B. Corporate bonds
C. Municipal bonds
D. All of these
7-2
10. Which of the following statements is true?

A. Interest payments paid to U.S. Treasury bond holders are not taxed at the federal level.
B. Interest payments paid to corporate bond holders are not taxed at the federal level.
C. Interest payments paid to corporate bond holders are not taxed at the state level.
D. Interest payments paid to municipal bond holders are not taxed at the federal level, or by
the state for which the bond is issued.
11. Which of the following issues Treasury Inflation Protected Securities (TIPS)?
A. U.S. Treasury
B. Corporations
C. Municipalities
D. Nonprofits
12. Which of the following is true regarding U.S. Government Agency Securities?
A. They carry the federal government's full faith and credit guarantee.
B. They do not carry the federal government's full faith and credit guarantee.
C. They are insured by the FDIC.
D. They are treated the same as U.S. Treasury bonds with regard to the federal government's
full faith and credit guarantee.
13. Which of the following is a debt security whose payments originate from other loans, such
as credit card debt, auto loans, and home equity loans?
A. asset-backed securities
B. credit quality securities
C. debentures
D. junk bonds
14. Which of the following is NOT a factor that determines the coupon rate of a company's
bonds?
A. The amount of uncertainty about whether the company will be able to make all the
payments.
B. The term of the loan.
C. The level of interest rates in the overall economy at the time.
D. All of these are factors that determine the coupon rate of a company's bonds.
7-3
15. Which of the following bonds makes no interest payments?

A. a bond whose coupon rate is equal to the market interest rates
B. a bond whose coupon rates are greater than market interest rates
C. a bond whose coupon rates are less than the market interest rates
D. zero coupon bond
16. Which of the following is a true statement?

A. If interest rates fall, U.S. Treasury bonds will have decreasing values.
B. If interest rates fall, corporate bonds will have decreasing values.
C. If interest rates fall, no bonds will enjoy rising values.
D. If interest rates fall, all bonds will enjoy rising values.
17. Which of the following terms means that during periods when interest rates change
substantially, bondholders experience distinct gains and losses in their bond investments?
A. credit quality risk
B. interest rate risk
C. liquidity rate risk
D. reinvestment rate risk
18. Which of the following terms means the chance that future interest payments will have to
be reinvested at a lower interest rate?
19. Which of the following terms is a comparison of market yields on securities, assuming all
characteristics except maturity are the same?
C. liquidity of interest rate risk
D. term structure of interest rates
7-4
20. A bond's current yield is defined as

A. the bond's annual coupon rate divided by the bond's par value.
B. the bond's annual coupon rate divided by the market interest rate.
C. the bond's annual coupon rate divided by the bond's current market price.
D. the bond's annual coupon rate divided by the bond's original issue price.
21. Which of the following is an important advantage to the issuer of a bond with a call
provision?
A. They are able to avoid interest rate risk.
B. They are able to avoid reinvestment rate risk.
C. They are able to reduce their credit risk.
D. They allow for refinancing opportunities.
22. Which of the following is a reason municipal bonds offer lower rates of interest income
for their investors?
C. They are able to offer reduced credit risk as they are backed by the federal government.
D. They are tax exempt—at least at the federal level.
23. Which of the following terms is the chance that the bond issuer will not be able to make
timely payments?
24. Which of the following bonds carry significant risk that the issuer will not make current or
future payments?
A. credit quality risk bonds
B. interest rate risk bonds
C. liquidity rate risk bonds
D. junk bonds
7-5
25. Interest Payments Determine the interest payment for the following three bonds: 5½
percent coupon corporate bond (paid semi-annually), 6.45 percent coupon Treasury note, and
a corporate zero coupon bond maturing in 10 years. (Assume a $1,000 par value.)
A. $5.50, $6.45, $0, respectively
B. $27.50, $32.25, $0, respectively
C. $27.50, $32.25, $100, respectively
D. $55.00, $64.50, $0, respectively
A. $2.50, $3.15, $0, respectively
B. $12.50, $15.75, $0, respectively
C. $12.50, $15.75, $100, respectively
D. $25.00, $31.50, $0, respectively
27. Interest Payments Determine the interest payment for the following three bonds: 4
A. $4.00, $4.75, $0, respectively
B. $20.00, $23.75, $0, respectively
C. $20.00, $23.75, $150, respectively
D. $40.00, $47.50, $0, respectively
28. Time to Maturity A bond issued by a corporation on June 15, 2007, is scheduled to
mature on June 15, 2017. If today is December 16, 2008, what is this bond's time to maturity?
(Assume annual interest payments.)
A. 1 year, 6 months
B. 8 years
C. 8 years, 6 months
D. 10 years
7-6
29. Time to Maturity A bond issued by a corporation on May 1, 1999, is scheduled to mature
on May 1, 2019. If today is May 2, 2009, what is this bond's time to maturity? (Assume
annual interest payments.)
A. 9 years
B. 10 years
C. 19 years
D. 20 years
30. Time to Maturity A bond issued by a corporation on October 1, 2007, is scheduled to

mature on October 1, 3007. If today is October 2, 2009, what is this bond's time to maturity?
A. 2 years
B. 50 years
C. 998 years
D. 100 years
31. Call Premium A 5.5 percent corporate coupon bond is callable in four years for a call
premium of one year of coupon payments. Assuming a par value of $1,000, what is the price
paid to the bondholder if the issuer calls the bond? (Assume annual interest payments.)
A. $55
B. $220
C. $1000
D. $1055
32. Call Premium A 6 percent corporate coupon bond is callable in ten years for a call
paid to the bondholder if the issuer calls the bond?
A. $60
B. $600
C. $1000
D. $1060
7-7
33. Call Premium A 4.5 percent corporate coupon bond is callable in five years for a call
A. $45
B. $225
C. $1000
D. $1045
34. TIPS Interest and Par Value A 2½ percent TIPS has an original reference CPI of 170.4.
If the current CPI is 205.7, what is the current interest payment and par value of the TIPS?
(Assume semi-annual interest payments and $1,000 par value.)
A. $1000, $7.16, respectively
B. $1000, $15.09, respectively
C. $1207.16, $7.16, respectively
D. $1207.16, $15.09, respectively
35. TIPS Interest and Par Value A 3 3/4 percent TIPS has an original reference CPI of
175.8. If the current CPI is 207.7, what is the current interest payment and par value of the
TIPS? (Assume semi-annual interest payments and $1,000 par value.)
A. $1000, $18.75, respectively
B. $1000, $37.50, respectively
C. $1181.46, $22.15, respectively
D. $1181.46, $37.50, respectively
36. Bond Quotes Consider the following three bond quotes; a Treasury note quoted at 87:25,
and a corporate bond quoted at 102.42, and a municipal bond quoted at 101.45. If the
Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par
value of $5,000, what is the price of these three bonds in dollars?
A. $872.50, $1000, $1000, respectively
B. $1000, $1000, $1000, respectively
C. $877.81, $1024.20, $5072.50, respectively
D. $1000, $1024.20, $1001.45, respectively
7-8
37. Bond Quotes Consider the following three bond quotes; a Treasury note quoted at
102:30, and a corporate bond quoted at 99.45, and a municipal bond quoted at 102.45. If the
Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par
value of $5,000, what is the price of these three bonds in dollars?
A. $1002.30, $1000, $1000, respectively
B. $1000, $1000, $5000, respectively
C. $1002.30, $994.50, $5012.25 respectively
D. $1029.38, $994.50, $5122.50, respectively
38. Zero Coupon Bond Price Calculate the price of a zero coupon bond that matures in 10
years if the market interest rate is 6 percent. (Assume semi-annual compounding and $1,000
par value.)
A. $553.68
B. $558.66
C. $940.00
D. $1000.00
39. Zero Coupon Bond Price Calculate the price of a zero coupon bond that matures in 5
years if the market interest rate is 7.50 percent. (Assume semi-annual compounding and
$1,000 par value.)
A. $692.02
B. $696.57
C. $962.50
D. $1000.00
40. Current Yield What's the current yield of a 6 percent coupon corporate bond quoted at a
price of 101.70?
A. 5.9%
B. 6.0%
C. 6.1%
D. 10.2%
7-9
41. Current Yield What's the current yield of a 5.75 percent coupon corporate bond quoted at
a price of 103.05?
A. 5.58%
B. 5.75%
C. 5.93%
D. 17.54%
42. Current Yield What's the current yield of an 8.15 percent coupon corporate bond quoted
at a price of 94.30?
A. 4.30%
B. 8.01%
C. 8.15%
D. 8.64%
43. Taxable Equivalent Yield What's the taxable equivalent yield on a municipal bond with
a yield to maturity of 3.9 percent for an investor in the 35 percent marginal tax bracket?
A. 1.09%
B. 3.90%
C. 6.00%
D. 11.14%
44. Taxable Equivalent Yield What's the taxable equivalent yield on a municipal bond with
a yield to maturity of 4.5 percent for an investor in the 39 percent marginal tax bracket?
A. 1.76%
B. 4.50%
C. 7.38%
D. 11.54%
7-10
45. Credit Risk and Yield Rank the following bonds in order from lowest credit risk to
highest risk all with the same time to maturity, by their yield to maturity: JM Corporate bond
with yield of 12.25 percent, IB Corporate bond with yield of 4.49 percent, TC Corporate bond
with yield of 8.76 percent, and B&O Corporate bond with a yield of 5.99 percent.
A. JM bond, TC bond, B&O bond, IB bond
B. IB bond, B&O bond, TC bond, JM bond
C. TC bond, B&O bond, IB bond, JM bond
D. JM bond, IB bond, B&O bond, TC bond
46. TIPS Capital Return Consider a 2.75% TIPS with an issue CPI reference of 184.2. At
the beginning of this year, the CPI was 195.4 and was at 200.5 at the end of the year. What
was the capital gain of the TIPS in dollars?
A. $5.10
B. $11.20
C. $16.30
D. $27.69
was the capital gain of the TIPS in dollars? (Assume semi-annual interest payments and
$1,000 par value.)
A. $4.90
B. $10.80
C. $15.70
D. $26.25
was the capital gain of the TIPS in percentage terms? (Assume semi-annual interest payments
and $1,000 par value.)
A. 3.75%
B. 4.62%
C. 7.10%
D. 8.80%
7-11
49. Compute Bond Price Compute the price of a 4.75 percent coupon bond with 15 years left
to maturity and a market interest rate of 6.25 percent. (Assume interest payments are semi-
annual and par value is $1,000.) Is this a discount or premium bond?
A. discount
B. premium
50. Compute Bond Price Compute the price of a 6 percent coupon bond with 10 years left to
maturity and a market interest rate of 8.75 percent. (Assume interest payments are semi-
annual and par value is $1,000.) Is this a discount or premium bond?
A. discount
B. premium
51. Bond Prices and Interest Rate Changes A 6 percent coupon bond with 12 years left to
maturity is priced to offer a 6.5 percent yield to maturity. You believe that in one year, the
yield to maturity will be 6.25 percent. What is the change in price the bond will experience in
dollars? (Assume semi-annual interest payments and $1,000 par value.)
A. $19.67
B. $21.55
C. $25.00
D. $41.22
52. Bond Prices and Interest Rate Changes A 5.5 percent coupon bond with 18 years left to
maturity is priced to offer a 6.25 percent yield to maturity. You believe that in one year, the
yield to maturity will be 5.75 percent. What is the change in price the bond will experience in
dollars? (Assume semi-annual interest payments and $1,000 par value.)
A. $25.00
B. $26.89
C. $53.48
D. $80.37
7-12
53. Yield to Maturity A 5.75 percent coupon bond with 12 years left to maturity is offered
for sale at $978.83. What yield to maturity is the bond offering? (Assume interest payments
are paid semi-annually and par value is $1,000.)
A. 3.00%
B. 3.09%
C. 5.75%
D. 6.00%
54. Yield to Maturity A 4.25 percent coupon bond with 8 years left to maturity is offered for
sale at $983.36. What yield to maturity is the bond offering? (Assume interest payments are
paid semi-annually and par value is $1,000.)
A. 2.25%
B. 2.36%
C. 4.25%
D. 4.50%
55. Yield to Call A 7.25 percent coupon bond with 25 years left to maturity can be called in 5
years. The call premium is one year of coupon payments. It is offered for sale at $1066.24.
What is the yield to call of the bond? (Assume that interest payments are paid semi-annually
and par value is $1,000.)
A. 3.41%
B. 3.45%
C. 3.51%
D. 6.90%
56. Yield to Call A 4.75 percent coupon bond with 12 years left to maturity can be called in 2
years. The call premium is one year of coupon payments. It is offered for sale at $1037.35.
What is the yield to call of the bond? (Assume that interest payments are paid semi-annually
and par value is $1,000.)
A. 4.60%
B. 4.68%
C. 4.75%
D. 5.05%
7-13
57. Comparing Bond Yields A client in the 33 percent marginal tax bracket is comparing a
municipal bond that offers a 5 percent yield to maturity and a similar-risk corporate bond that
offers a 6.25 percent yield. Which bond will give the client more profit after taxes?
A. the municipal bond
B. the corporate bond
C. Both give the client equal profits after taxes.
D. There is not enough information given to determine.
municipal bond that offers a 3.25 percent yield to maturity and a similar-risk corporate bond
that offers a 4.10 percent yield. Which bond will give the client more profit after taxes?
D. There is not enough information given to determine answer.
municipal bond that offers a 4.25 percent yield to maturity and a similar-risk corporate bond
that offers a 5.10 percent yield. Which bond will give the client more profit after taxes?
D. There is not enough information given to determine answer.
60. TIPS Total Return Reconsider a 3.25% TIPS that was issued with CPI reference of
186.7. The bond is purchased at the beginning of the year (after the interest payment), when
the CPI was 197.5. For the interest in the middle of the year, the CPI was 201.1. Now, at the
end of the year, the CPI is 202.4 and the interest payment has been made. What is the total
return of the TIPS in percentage terms for the year? (Assume semi-annual interest payments
and $1,000 par value.)
A. 1.6%
B. 2.4%
C. 5.8%
D. 9.1%
7-14
61. Bond Prices and Interest Rate Changes A 6.75 percent coupon bond with 10 years left
to maturity is priced to offer a 6.5 percent yield to maturity. You believe that in one year, the
yield to maturity will be 6.65 percent. If this occurs, what would be the total return of the
bond in percent? (Assume semi-annual interest payments and $1,000 par value.)
A. 5.5%
B. 5.6%
C. 6.6%
D. 6.7%
62. Bond Prices and Interest Rate Changes A 7.25 percent coupon bond with 25 years left
to maturity is priced to offer a 7 percent yield to maturity. You believe that in one year, the
yield to maturity will be 7.15 percent. If this occurs, what would be the total return of the
bond in percent? (Assume semi-annual interest payments and $1,000 par value.)
A. 3.5%
B. 5.3%
C. 7.0%
D. 7.15%
63. Yields of a Bond A 3.25 percent coupon municipal bond has 12 years left to maturity and
has a price quote of 98.75. The bond can be called in 5 years. The call premium is one year of
coupon payments. What is the bond's taxable equivalent yield for an investor in the 35 percent
marginal tax bracket? (Assume interest payments are paid semi-annually and a par value of
$5,000.)
A. 3.38%
B. 5.00%
C. 5.20%
D. 10.12%
7-15
64. Yields of a Bond A 4.5 percent coupon municipal bond has 10 years left to maturity and
has a price quote of 97.75. The bond can be called in 4 years. The call premium is one year of
coupon payments. What is the bond's taxable equivalent yield for an investor in the 33 percent
marginal tax bracket? (Assume interest payments are paid semi-annually and a par value of
$5,000.)
A. 4.5%
B. 4.78%
C. 7.13%
D. 14.48%
65. Bond Ratings and Prices A corporate bond with a 5.75 percent coupon has 15 years left
to maturity. It has had a credit rating of BB and a yield to maturity of 6.25 percent. The firm
has recently gotten more financially stable and the rating agency is upgrading the bonds to
BBB. The new appropriate discount rate will be 6.00 percent. What will be the change in the
bond's price in dollars? (Assume interest payments are paid semi-annually and a par value of
$1,000.)
A. decrease $22.25
B. increase $22.25
C. decrease $23.72
D. increase $23.72
66. Which of the following was the catalyst for the recent financial crisis?
A. Corruption in the investment banking industry.
B. Widespread layoffs due to illegal alien hiring.
C. Defaults on subprime mortgages.
D. All of these.
67. Which of the following is not true about EE savings bonds?

A. Interest payments are received annually but are tax deductible.
B. About 1 in 6 Americans own a savings bond
C. These are tax deferred investments
D. Patriot bonds sell for one-half of their face value.
7-16
68. If Zeus Energy bonds are upgraded from BBB- to BBB+, which of the following
statements is true?
A. The current bond price will increase.
B. Interest rates required on new bond issues will increase.
C. The current bond price will decrease.
D. The current bond price will increase and interest rates on new bonds issues will decrease.
69. A 6.5% coupon bond with 12 years left to maturity can be called in 4 years. The call
premium is one year of coupon payments. It is offered for sale at $1,190.25. What is the yield
to call of the bond? (Assume interest payments are paid semi-annually and par value is
$1,000.)
A. 1.48%
B. 2.96%
C. 6.5%
D. 7.23%
70. A 7.5% coupon bond with 16 years left to maturity is offered for sale at $834.92. What
yield to maturity is the bond offering? (Assume interest payments are paid semi-annually and
par value is $1,000.)
A. 4.77%
B. 7.5%
C. 9.54%
D. 10.34%
71. An 8% coupon bond with 15 years to maturity is priced to offer a 9% yield to maturity.
You believe that in one year, the yield to maturity will be 6.5%. What is the change in price
the bond will experience in dollars? (Assume annual interest payments and par value is
$1,000.)
A. $163.92
B. $176.15
C. $198.45
D. $215.82
7-17
72. Calculate the price of a 6.5% coupon bond with 27 years left to maturity and a market
interest rate of 5%. (Assume interest payments are semiannual and par value is $1,000.) Is this
a discount or premium bond?
A. $982.03; discount
B. $1,010.59; discount
C. $1,220.93; premium
D. $1,315.62; premium
73. Calculate the price of a 6.5% coupon bond with 17 years left to maturity and a market
interest rate of 10.5%. (Assume interest rates are semiannual and par value is $1,000.) Is this a
discount or premium bond?
A. $685.93; discount
B. $791.03; discount
C. $1,051.83; premium
D. $1,176.31; premium
74. Calculate the price of a zero coupon bond that matures in 20 years if the market interest
rate is 8.5%. (Assume annual compounding and a par value of $1,000.)
A. $90.29
B. $195.62
C. $1,195.62
D. $995.62
75. What is the taxable equivalent yield on a municipal bond with a yield to maturity of 4%
for an investor in the 28% tax bracket?
A. 2.88%
B. 3.87%
C. 4.51%
D. 5.56%
7-18
76. Rank from lowest credit risk to highest credit risk the following bonds, with the same time
to maturity, by their yield to maturity: Treasury bond with yield of 5.55%, IBM bond with
yield of 7.95%, Trump Casino bond with a yield of 9.15%, and Banc Ono bond with a yield
of 6.12%.
A. Treasury, Trump Casino, Banc Ono, IBM
B. Trump Casino, IBM, Banc Ono, Treasury
C. Treasury, Banc Ono, IBM, Trump Casino
D. Trump Casino, Banc Ono, IBM, Treasury
77. Consider a 4.5% TIPS with an issue CPI reference of 187.2. At the beginning of this year,
the CPI was 199.5 and was 213.7 at the end of the year. What was the capital gain of the TIPS
in dollars?
A. $32.73
B. $46.92
C. $62.49
D. $75.85
78. Rank from highest credit risk to lowest credit risk the following bonds, with the same time
to maturity, by their yield to maturity: Treasury bond with yield of 6.55%, IBM bond with
yield of 10.95%, Trump Casino bond with a yield of 9.15%, and Banc Ono bond with a yield
of 9.46%.
A. Treasury, Trump Casino, Banc Ono, IBM
B. Banc Ono, Trump Casino, IBM, Treasury
C. Trump Casino, Treasury, Banc Ono, IBM
D. IBM, Banc Ono, Trump Casino, Treasury
79. Consider the following bond quote: a municipal bond quoted at 101.25. If the municipal
bond has a par value of $5,000, what is the price of the bond in dollars?
A. $5,089.06
B. $5,050.19
C. $5,062.50
D. $5,109.75
7-19
80. A 3.75% TIPS has an original reference CPI of 183.9. If the current CPI is 214.7, what is
the current interest payment? (Assume semi-annual interest payments and a par value of
$1,000.)
A. $43.78
B. $37.50
C. $21.89
D. $18.75
81. A 5 1/8% TIPS has an original reference CPI of 191.8. If the current CPI is 188.3, what is
the par value of the TIPS?
A. $981.75
B. $1,018.60
C. $992.75
D. $1,042.95
82. A 7.5% coupon bond with 9 years left to maturity is priced to offer a 10.4% yield to
maturity. You believe that in one year, the yield to maturity will be 8%. What is the change in
price the bond will experience in dollars? (Assume interest payments are semiannual and par
value is $1,000.)
A. $97.75
B. $101.50
C. $129.25
D. $137.75
83. A 6.75% coupon bond with 13 years left to maturity can be called in 2 years. The call
premium is one year of coupon payments. It is offered for sale at $919.75. What is the yield to
call of the bond? Assume interest payments are paid semi-annually and par value is $1,000.
A. 12.14%
B. 7.27%
C. 14.54%
D. 8.29%
7-20
84. A 5.5% coupon municipal bond has 16 years left to maturity and has a price quote of
92.55. The bond can be called in 9 years. The call premium is one year of coupon payments.
Compute the bond's current yield. Assume interest payments are paid semi-annually and a par
value of $5,000.
A. 5.94%
B. 11.89%
C. 12.19%
D. 13.14%
85. A 5.5% coupon municipal bond has 16 years left to maturity and has a price quote of
Compute the bond's yield to maturity and yield to call. Assume interest payments are paid
semi-annually and a par value of $5,000.
A. YTM = 6.91%; YTC = 7.52%
B. YTM = 6.24%; YTC = 7.08%
C. YTM = 5.78%; YTC = 6.61%
D. YTM = 5.92%; YTC = 6.85%
86. An 8% coupon municipal bond has 15 years left to maturity and has a price quote of 98.5.
The bond can be called in 6 years. The call premium is one year of coupon payments.
Compute the bond's yield to call and determine if the bond will be called. Assume interest
payments are paid semi-annually and a par value of $5,000.
A. 4.68%; yes, the bond will be called
B. 9.36%; yes, the bond will be called
C. 9.36%; no, the bond will not be called
D. 10.71%; no, the bond will not be called
87. An 8% coupon municipal bond has 15 years left to maturity and has a price quote of
Compute the bond's yield to call and determine if the bond will be called. Assume interest
payments are paid semi-annually and a par value of $5,000.
A. 4.31%; yes, the bond will be called
B. 8.62%; yes, the bond will be called
C. 8.62%; no, the bond will not be called
D. 11.21%; no the bond will not be called
7-21
88. A corporate bond with a 5% coupon has 10 years left to maturity. It has had a credit rating
of BBB and a yield to maturity of 8.0%. The firm has recently gotten into some trouble and
the rating agency is downgrading the bonds to BB. The new appropriate discount rate will be
9%. What will be the change in the bond's price in dollars? Assume interest payments are paid
semi-annually and par value is $1,000.
A. -$43.61
B. -$51.07
C. -$62.43
D. -$56.31
89. A corporate bond with an 8.5% coupon has 10 years left to maturity. It has had a credit
rating of A and a yield to maturity of 10%. The firm has recently gotten into some trouble and
the rating agency is downgrading the bonds to BBB. The new appropriate discount rate will
be 11.5%. What will be the change in the bond's price in dollars? Assume interest payments
are paid semi-annually and par value is $1,000.
A. -$82.13
B. -$95.19
C. -$101.37
D. -$69.85
90. Junk bonds are those bonds with a credit rating of _____________.
A. BB and lower
B. B and lower
C. BBB and lower
D. None of these.
91. Which of following are backed only by the reputation and financial stability of the
corporation?
A. Debentures
B. Unsecured bonds
C. Both a and b
D. None of these.
7-22
92. Investment grade bonds include those bonds with ratings _____________.
A. From AAA to BB
B. From AAA to BBB
C. From AAA to B
D. From AAA to A
93. Which of the following statements is correct?

A. Michael Milken pioneered an active high-yield bond market in the late 1970s that provided
much needed capital to entrepreneurs and financial innovators.
B. Prior to Milken, the only junk bonds were those issued by once financially stable firms that
had fallen on hard times.
C. Milken showed investors that, historically, junk bonds rarely defaulted and offered a very
high return to those willing to assume the risk of owning them.
D. All of these statements are correct.

A. Yield spreads between bonds of different quality remain static over time.
B. Yield spreads are set by the Securities Exchange Commission.
C. Yield spreads between bonds of different quality change over time.
D. None of these statements is correct.
95. Sally is choosing between two bonds both of which mature in 15 years and have the same
level of risk. Bond A is a municipal bond that yields 5.25%. Bond B is a corporate bond that
yields 7.75%. If Sally is in the 30% tax bracket, which bond should she select and why?
A. Sally should select Bond A because its interest income is not taxable.
B. Sally should select Bond B is better because it has lower risk.
C. Sally should select Bond A because its taxable equivalent yield is greater than the yield of
Bond B.
D. Sally should select Bond B because the taxable equivalent yield of Bond A is less than the
yield of Bond B.
7-23
B. Sally will be indifferent between Bond A and B since the taxable equivalent yield of Bond
A equals the yield of Bond B.
C. Sally should select Bond A because its TEY is greater than the yield of Bond B.
D. Sally should select Bond B because the TEY of Bond A is less than the yield of Bond B.
B. Sally will be indifferent between Bond A and B since the taxable equivalent yield of Bond
A equals the yield of Bond B.
C. Sally should select Bond A because its taxable equivalent yield is greater than the yield of
Bond B.
D. Sally should select Bond B because the taxable equivalent yield of Bond A is less than the
yield of Bond B.
98. A bond with 14 years to maturity is selling for $1070 and has a yield to maturity of
10.06%. If this bond pays its coupon payments semi-annually and par value is $1,000, what is
the bond's annual coupon rate?
A. 5.50%
B. 8.19%
C. 9.57%
D. 11.00%
99. A bond with 23 years to maturity is selling for $991 and has a yield to maturity of 8.12%.
If this bond pays its coupon payments semi-annually and par value is $1,000, what is the
bond's annual coupon rate?
A. 7.45%
B. 8.03%
C. 9.39%
D. 10.82%
7-24
100. All of the following items would need to be included in the bond's indenture agreement
except _____.
A. The coupon rate
B. The call feature
C. The credit rating
D. Steps that the bondholder can take in the event that the issuer fails to pay the interest or
principal
101. Which of the following is not a correct statement?

A. Treasury inflation-protected securities have fixed coupon rates.
B. The federal government adjusts the par value of Treasury inflation-protected securities at
the rate of inflation.
C. At maturity, investor in Treasury inflation-protected securities receives an inflation-
adjusted principal amount.
102. Which of the following would NOT be an example of an agency bond?

A. Federal Home Loan Bank bond
B. Student Loan Marketing Association bond
C. Fannie Mae bond
D. Treasury bills

A. Bonds with short-term maturities will have very little interest rate risk.
B. Bonds with large coupon payments will have very little interest rate risk.
C. Bonds with higher credit ratings will have very little interest rate risk.

A. Long-term bonds have more reinvestment rate risk than short-term bonds.
B. Long-term bonds have more interest rate risk than short-term bonds.
C. Short-term bonds with high coupons have high interest rate risk.
D. Zero coupon bonds do not have interest rate risk.
7-25
105. Which of the following bonds will have the largest percentage increase in value if
interest rates decrease by 1%?
A. 2-year, 5% coupon bond
B. 30-year, 10% coupon bond
C. 10-year, zero coupon
D. 30-year, zero coupon
106. Rank the following bonds, from highest to lowest interest rate risk: 2-year zero coupon,
2-year 5% coupon bond, 30-year 5% coupon bond, 30-year, zero coupon bond.
A. 30-year, zero coupon bond, 30-year 5% coupon bond, 2-year 5% coupon bond, 2-year zero
coupon bond
B. 2-year 5% coupon bond, 2-year zero coupon bond, 30-year 5% coupon bond, 30-year zero
coupon bond
C. 30-year, zero coupon bond, 30-year 5% coupon bond, 2-year zero coupon bond, 2-year 5%
coupon bond
D. 30-year, 5% coupon bond, 30-year zero coupon bond, 2-year 5% coupon bond, 2-year zero
coupon bond

A. All else the same, an investor will require less return to invest in a callable bond than one
that is not callable.
B. All else the same, an investor will require more return to invest in a callable bond than one
that is not callable.
C. The call feature does not impact the return that investors demand.
D. We would need to know the current level of interest rates to answer this question.
108. Under which conditions will an investor demand a larger return (yield) on a bond?
A. The bond issue is upgraded from A to AA.
B. The bond issue is downgraded from A to BBB.
C. Interest rates decrease due to decline in inflation.
D. None of these conditions will cause an increase in the bond's yield.
7-26

A. There is an inverse relationship between bond prices and bond yields.
B. There is a positive relationship between bond prices and bond yields.
C. There is no relationship between bond prices and bond yields.
D. The relationship between bond prices and bond yields is dependent on the market interest
rate.
110. If a bond is selling at a premium, then ________________________________.

A. its coupon rate must be greater than its yield
B. its coupon rate must be less than its yield
C. its coupon rate must be equal to its yield
D. its coupon rate must be equal to one-half the yield to maturity for a 5-year bond
111. The bond's annual coupon rate divided by its market price is referred to as the
__________.
A. Yield to Call
B. Yield to Maturity
C. Current Yield
D. Term Structure of Interest Rates
112. Possible shapes for the yield include all of the following except ____________.
A. Humped
B. Downward sloping
C. Flat
D. All of these are possible shapes.
113. Possible shapes for the yield curve include all of the following except ___________.
A. Upward sloping
B. Humped
C. Horizontal line
D. Vertical line
7-27
114. If a bond is selling at a discount, which of the following statements is correct?

A. The current yield must be greater than the coupon rate.
B. The coupon rate must be greater than the yield to maturity.
C. The bond must have a low bond rating.
D. All of the statements are correct.
115. If a bond is selling at par value, which of the following statements is correct?
A. The current yield must equal the coupon rate.
B. The current yield must equal the yield to maturity.
C. Both of these statements are correct.
D. None of these statements is correct.
116. To increase the liquidity for the home mortgage market, Fannie Mae and Freddie Mac
purchased home mortgages from banks and other lenders. They combined the mortgages into
diversified portfolios of loans and issued ______________.
A. Trust securities
B. Mortgage-backed securities
C. Current yield securities
D. Treasury Inflation Protected Securities
117. Under what conditions is a bond likely to be called?

A. The firm is in financial duress.
B. The firm is planning a massive expansion and needs to raise a lot of capital.
C. Interest rates have significantly declined.
D. The firm wants to increase its debt ratio.
118. A 30-year bond with an 8% coupon has a yield to maturity of 6%. The bond could be
called in 7 years and if called would generate a yield to call of 5.75%. What is this bond's call
premium? Assume the coupon payments are made annually and par value is $1,000.
A. $219.73
B. $152.64
C. $106.29
D. $301.76
7-28
119. A 15-year bond with a 10% coupon has a yield to maturity of 8%. The bond could be
called in 4 years and if called would generate a yield to call of 6%. What is this bond's call
premium? Assume the coupon payments are made semi-annually and par value is $1,000.
A. $19.73
B. $81.87
C. $41.20
D. $66.03
120. A 5% coupon bond has 10 years to maturity and could be called in 2 years. If the bond is
called, investors will earn 6.2%. The call premium is one year of coupon payments. If coupon
payments are made semi-annually and par value is $1,000, what is the bond's yield to
maturity?
A. 2.36%
B. 4.72%
C. 5.18%
D. 6.49%
121. A 7% coupon bond has 10 years to maturity and could be called in 3 years. If the bond is
called, investors will earn 5.5%. The call premium is one year of coupon payments. If coupon
payments are made semi-annually and par value is $1,000, what is the bond's yield to
maturity?
A. 2.84%
B. 3.17%
C. 5.38%
D. 5.69%
122. A 10% coupon bond has 15 years to maturity and could be called in 2 years. If the bond
is called, investors will earn 4%. The call premium is one year of coupon payments. If coupon
payments are made annually and par value is $1,000, what is the bond's yield to maturity?
A. 6.19%
B. 6.82%
C. 7.65%
D. 7.98%
Essay Questions
7-29
123. Describe the relationship between interest rate changes and bond prices.
124. Describe reasons that the U.S. Government and corporations would issue bonds.
125. Explain why high-income and wealthy people are more likely to buy a municipal bond
than a corporate bond.
126. Yields of a Bond A 4.75 percent coupon municipal bond has 20 years left to maturity
and has a price quote of 98.9. The bond can be called in 5 years. The call premium is one year
of coupon payments. Compute and discuss the bond's current yield, yield to maturity, taxable
equivalent yield (for an investor in the 35 percent marginal tax bracket), and yield to call.
(Assume interest payments are paid semi-annually and a par value of $5,000.)
7-30
127. Bond Ratings and Prices A corporate bond with a 5.75 percent coupon has 10 years left
to maturity. It has had a credit rating of BBB and a yield to maturity of 6.25 percent. The firm
has recently gotten into some trouble and the rating agency is downgrading the bonds to BB.
The new appropriate discount rate will be 6.75 percent. What will be the change in the bond's
price in dollars and percentage terms? (Assume interest payments are paid semi-annually and
a par value of $1,000.)
128. What does a call provision allow the issuer to do, and why would they do it?
129. All else equal, which bond's price is more affected by a change in interest rates, a bond
with a large coupon or a small coupon? Why?
130. Explain how investors can assess bond market performance.
7-31
131. What actions taken by the Federal Reserve preceded and possibly helped precipitate the
recent financial crisis?
7-32
Chapter 07 Valuing Bonds Answer Key
Multiple Choice Questions
1. Which of these statements is false?

A. Bonds are more important capital sources than stocks for companies and governments.
B. Some bonds offer high potential for rewards and, consequently, higher risk.
C. The bond market is larger than the stock market.
D. Bonds are always less risky than stocks.
AACSB: Reflective Thinking

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 07-01 Describe bond characteristics.
Source: NEW
Topic: Bond characteristics
2. Bonds are issued by which of the following?

A. corporations
B. federal government or its agencies
C. state and local governments
D. all of these

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
Topic: General bond
7-33
3. Which of these statements answers why bonds are known as fixed income securities?
A. Many investors on fixed incomes buy them.
B. Investors know how much they will receive in interest payments.
C. Investors will not receive their principal when the bond's term is up.
D. All of these

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
4. Which of the following is a legal contract that outlines the precise terms between the issuer
and the bondholder?
A. debenture
B. enforcement codes
C. indenture
D. prospectus

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
5. Regarding a bond's characteristics, which of the following is the principal loan amount that
the borrower must repay?
A. call premium
B. maturity date
C. par or face value
D. time to maturity value

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
7-34
6. To compensate the bondholders for getting the bond called, the issuer pays which of the
following?
A. call feature
B. call premium
C. coupon rate
D. original issue premium

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
7. This determines the dollar amount of interest paid to bondholders.

B. call premium
C. coupon rate
D. market rate

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
8. Bond prices are quoted in terms of which of the following?

B. percent of par value
C. coupon rate in dollars
D. market rate in dollars

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
7-35
9. Which of the following are main issuers of bonds?

A. U.S. Treasury bonds
B. Corporate bonds
C. Municipal bonds
D. All of these

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 07-02 Identify various bond issuers and their motivation for issuing debt.
Source: NEW
Topic: Bonds
10. Which of the following statements is true?

A. Interest payments paid to U.S. Treasury bond holders are not taxed at the federal level.
B. Interest payments paid to corporate bond holders are not taxed at the federal level.
C. Interest payments paid to corporate bond holders are not taxed at the state level.
D. Interest payments paid to municipal bond holders are not taxed at the federal level, or by
the state for which the bond is issued.

Blooms: Remember
Difficulty: 2 Intermediate
Source: NEW
Topic: Bonds and tax exemptions
11. Which of the following issues Treasury Inflation Protected Securities (TIPS)?
A. U.S. Treasury
B. Corporations
C. Municipalities
D. Nonprofits

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
Topic: Types of government securities
7-36
12. Which of the following is true regarding U.S. Government Agency Securities?
A. They carry the federal government's full faith and credit guarantee.
B. They do not carry the federal government's full faith and credit guarantee.
C. They are insured by the FDIC.
D. They are treated the same as U.S. Treasury bonds with regard to the federal government's
full faith and credit guarantee.

Blooms: Remember
Difficulty: 2 Intermediate
Source: NEW
Topic: Types of government securities
13. Which of the following is a debt security whose payments originate from other loans, such
as credit card debt, auto loans, and home equity loans?
A. asset-backed securities
B. credit quality securities
C. debentures
D. junk bonds

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
Topic: Types of debt securities
14. Which of the following is NOT a factor that determines the coupon rate of a company's
bonds?
A. The amount of uncertainty about whether the company will be able to make all the
payments.
B. The term of the loan.
C. The level of interest rates in the overall economy at the time.
D. All of these are factors that determine the coupon rate of a company's bonds.

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 07-03 Read and interpret bond quotes.
Source: NEW
7-37
15. Which of the following bonds makes no interest payments?

A. a bond whose coupon rate is equal to the market interest rates
B. a bond whose coupon rates are greater than market interest rates
C. a bond whose coupon rates are less than the market interest rates
D. zero coupon bond

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 07-04 Compute bond prices using present value concepts.
Source: NEW
Topic: Types of bonds
16. Which of the following is a true statement?

A. If interest rates fall, U.S. Treasury bonds will have decreasing values.
B. If interest rates fall, corporate bonds will have decreasing values.
C. If interest rates fall, no bonds will enjoy rising values.
D. If interest rates fall, all bonds will enjoy rising values.

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 07-05 Explain the relationship between bond prices and interest rates.
Source: NEW
Topic: Interest rates in relation to bonds
17. Which of the following terms means that during periods when interest rates change
substantially, bondholders experience distinct gains and losses in their bond investments?

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
Topic: Risk premiums
7-38
18. Which of the following terms means the chance that future interest payments will have to
be reinvested at a lower interest rate?

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
19. Which of the following terms is a comparison of market yields on securities, assuming all
characteristics except maturity are the same?

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
20. A bond's current yield is defined as

A. the bond's annual coupon rate divided by the bond's par value.
B. the bond's annual coupon rate divided by the market interest rate.
C. the bond's annual coupon rate divided by the bond's current market price.
D. the bond's annual coupon rate divided by the bond's original issue price.

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 07-06 Compute bond yields.
Source: NEW
7-39
21. Which of the following is an important advantage to the issuer of a bond with a call
provision?
C. They are able to reduce their credit risk.
D. They allow for refinancing opportunities.

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
22. Which of the following is a reason municipal bonds offer lower rates of interest income
for their investors?
C. They are able to offer reduced credit risk as they are backed by the federal government.
D. They are tax exempt—at least at the federal level.

Blooms: Remember
Difficulty: 1 Basic
Source: NEW
Topic: Bonds and tax exemptions
23. Which of the following terms is the chance that the bond issuer will not be able to make
timely payments?

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 07-07 Find bond ratings and assess credit risk's effects on bond yields.
Source: NEW
7-40
24. Which of the following bonds carry significant risk that the issuer will not make current or
future payments?
A. credit quality risk bonds
B. interest rate risk bonds
C. liquidity rate risk bonds
D. junk bonds

Blooms: Remember
Difficulty: 1 Basic
Learning Objective: 07-07 Find bond ratings and assess credit risk's effects on bond yields.
Source: NEW
A. $5.50, $6.45, $0, respectively
B. $27.50, $32.25, $0, respectively
C. $27.50, $32.25, $100, respectively
D. $55.00, $64.50, $0, respectively
5½ percent coupon corporate bond (paid semi-annually): ½ x 5.5% x $1,000 = $27.50

6.45 percent coupon Treasury note: ½ x 6.45% x $1,000 = $32.25
corporate zero coupon bond maturing in 10 years: 0% x $1,000 = $0
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 1
Topic: Interest payments
7-41
A. $2.50, $3.15, $0, respectively
B. $12.50, $15.75, $0, respectively
C. $12.50, $15.75, $100, respectively
D. $25.00, $31.50, $0, respectively
2½ percent coupon corporate bond (paid semi-annually): ½ x 2.5% x $1,000 = $12.50

3.15 percent coupon Treasury note: ½ x 3.15% x $1,000 = $15.75 corporate zero coupon bond
maturing in 10 years: 0% x $1,000 = $0
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 1
27. Interest Payments Determine the interest payment for the following three bonds: 4
A. $4.00, $4.75, $0, respectively
B. $20.00, $23.75, $0, respectively
C. $20.00, $23.75, $150, respectively
D. $40.00, $47.50, $0, respectively
4 percent coupon corporate bond (paid semi-annually): ½ x 4% x $1,000 = $20.00

4.75 percent coupon Treasury note: ½ x 4.75% x $1,000 = $23.75 corporate zero coupon bond
maturing in 10 years: 0% x $1,000 = $0
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 1
7-42
28. Time to Maturity A bond issued by a corporation on June 15, 2007, is scheduled to
mature on June 15, 2017. If today is December 16, 2008, what is this bond's time to maturity?
A. 1 year, 6 months
B. 8 years
C. 8 years, 6 months
D. 10 years
June 15, 2017 minus December 16, 2008 = 8 years and 6 months
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 3
Topic: Time to maturity
29. Time to Maturity A bond issued by a corporation on May 1, 1999, is scheduled to mature
on May 1, 2019. If today is May 2, 2009, what is this bond's time to maturity? (Assume
annual interest payments.)
A. 9 years
B. 10 years
C. 19 years
D. 20 years
May 1, 2019 minus May 2, 2009 = 10 years and 0 months
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 3
7-43
30. Time to Maturity A bond issued by a corporation on October 1, 2007, is scheduled to

mature on October 1, 3007. If today is October 2, 2009, what is this bond's time to maturity?
A. 2 years
B. 50 years
C. 998 years
D. 100 years
October 1, 3007 - October 2, 2009 = 998 years
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 3
31. Call Premium A 5.5 percent corporate coupon bond is callable in four years for a call
paid to the bondholder if the issuer calls the bond? (Assume annual interest payments.)
A. $55
B. $220
C. $1000
D. $1055
principal + call premium = $1,000 + 5.5% x $1,000 = $1,055
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 5
Topic: Call premium
7-44
32. Call Premium A 6 percent corporate coupon bond is callable in ten years for a call
A. $60
B. $600
C. $1000
D. $1060
principal + call premium = $1,000 + 6% x $1,000 = $1,060
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 5
Topic: Call premium
33. Call Premium A 4.5 percent corporate coupon bond is callable in five years for a call
A. $45
B. $225
C. $1000
D. $1045
principal + call premium = $1,000 + 4.5% x $1,000 = $1,045
AACSB: Analytical
Blooms: Analyze
Blooms: Apply
Difficulty: 1 Basic
Source: 7 - 5
Topic: Call premium
7-45
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Multiple Choice Questions

1. Which of these statements is false?

2. Bonds are issued by which of the following?

7. This determines the dollar amount of interest paid to bondholders.

8. Bond prices are quoted in terms of which of the following?

9. Which of the following are main issuers of bonds?

10. Which of the following statements is true?

15. Which of the following bonds makes no interest payments?

16. Which of the following is a true statement?

20. A bond's current yield is defined as

30. Time to Maturity A bond issued by a corporation on October 1, 2007, is scheduled to

67. Which of the following is not true about EE savings bonds?

93. Which of the following statements is correct?

94. Which of the following statements is correct?

101. Which of the following is not a correct statement?

102. Which of the following would NOT be an example of an agency bond?

103. Which of the following statements is correct?

104. Which of the following statements is correct?

107. Which of the following statements is correct?

109. Which of the following statements is correct?

110. If a bond is selling at a premium, then ________________________________.

114. If a bond is selling at a discount, which of the following statements is correct?

117. Under what conditions is a bond likely to be called?

130. Explain how investors can assess bond market performance.

Chapter 07 Valuing Bonds Answer Key

Multiple Choice Questions

1. Which of these statements is false?

AACSB: Reflective Thinking

2. Bonds are issued by which of the following?

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

7. This determines the dollar amount of interest paid to bondholders.

AACSB: Reflective Thinking

8. Bond prices are quoted in terms of which of the following?

AACSB: Reflective Thinking

9. Which of the following are main issuers of bonds?

AACSB: Reflective Thinking

10. Which of the following statements is true?

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

15. Which of the following bonds makes no interest payments?

AACSB: Reflective Thinking

16. Which of the following is a true statement?

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

20. A bond's current yield is defined as

AACSB: Reflective Thinking