Money and Banking: Chapter 4

You have just won ​$20,000 in the state​ lottery, which promises to pay you ​$1,000​ (tax free) every year for the next twenty years. The interest rate is​ 5%.In​ reality, you receive the first payment of ​$1,000​ today, which is worth ______________ today.

$1000.00

The value of the second​ $1,000 payment is worth_____________ today.

$952.38

The current yield is a good approximation to the yield to maturity​ when:

1.) the maturity of the bond occurs over a​ ten-year period. 2.) the bond price is very close to par.

Suppose the interest rate​ (and therefore the yield to​ maturity) decreases by the same amount on Treasury bills and bonds. Between a​ one-year Treasury​ bill, and a​ twenty-year Treasury​ bond, an investor would prefer a

20 year Treasure Bond

To pay for​ college, you have just taken out a​ $1,000 government loan that makes you pay​ $126 per year for 25 years.​ However, you​ don't have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than​ 12% (this is the yield to maturity on a normal​ $1,000 fixed-payment loan in which you pay​ $126 per year for 25​ years)?

This is the case because the first payment due begins at a future date.

​True: A discount bond has no coupon payments so the return on the bond is equal to the rate of capital gain.

True or​ False: With a discount​ bond, the return on a bond is equal to the rate of capital gain.

The following are reasons why the yield to maturity can be less than than the return of a bond except that

the coupon payment over the purchase price remains the same.

Interest rates were lower in the​ mid-1980s than in the late​ 1970s, yet many economists have commented that real interest rates were actually much higher in the​ mid- 1980s than in the late 1970s. Consider the diagram to the right that shows the nominal interest rate and the inflation rate. The real interest rate

was higher in 1985 than​ 2005, when the real interest rate was zero.

If the nominal interest rate was originally 1313​% while the expected inflation rate was 1010​%, and then both changed to 55​% and 33​%, ​respectively, then the real interest rate____________.

Decreased

The interest rate that is adjusted for actual changes in the price level is called the ___________.

Ex-post real interest rate.

Retired persons often have much of their wealth placed in savings accounts and other​ interest-bearing investments, and complain whenever interest rates are low. Which of the​ following, if​ true, would be a valid​ complaint?

Expected inflation is falling at a slower rate than nominal interest rates.

_____________ is a coupon bond with no maturity.

Consol

Which of the following instruments pays the holder of the instrument a fixed interest payment every year until​ maturity, and then at maturity pays the holder the face value​ (principle) of the​ instrument?

Coupon Bond

When the real interest rate is ____________ there are lower incentives to borrow and more incentives to lend.

High

_______________ is a bond where the principal and interest payments are adjusted for changes in the price level over time.

Indexed Bond

Compared to bonds with longer ​maturity, bonds with shorter maturity respond___________ dramatically to changes in interest rates.

Less

Your total lottery winnings are actually worth ______________ $20,000 to you today.

Less Than

If interest rates​ decline, which would you rather be​ holding, long-term bonds or​ short-term bonds?

Long-term bonds because their price would increase more than the price of​ short-term bonds

Bonds with a maturity that is as short as the holding period have_____________ interest-rate risk.

No

A financial adviser has just given you the following​ advice: "Long-term bonds are a great investment because their interest rate is over​ 20%." Is the financial adviser necessarily​ right?

No. If interest rates rise sharply in the​ future, long-term bonds may suffer a sharp fall in​ price, causing their return to be quite low.

Which of the following statements is​ true?

Only a coupon bond can have a negative nominal interest rate.

Assuming the terms of issuance to be the same for different types of ​ loans, a government would choose to issue​ a:

Perpetuity

A rise in interest rates can mean that a bond has been​ a/an ________ investment

Poor

________________is based on the notion that a dollar paid in the future is less valuable than a dollar paid today.

Present Discounted Value

A discount bond will have a negative nominal interest rate when​ the:

current bond price is greater than its face value.

Is it better for bondholders when the yield to maturity increases or​ decreases?Bondholders are better off when the yield to​ maturity:

decreases, since this represents an increase in the price of the bond and a decrease in potential capital losses.

A U.S. Treasury bill is an example of a

discount bond.