Quiz 2 True False
A 10-year bond is currently selling at a premium. If one year passes and the yield to maturity on the bond stays the same, the new price will be lower than the price one year ago.
t
A bond with a face value of $1,000 has annual coupon payments of $100 and was issued 7 years ago. Today the bond sells for $1,000 and has 8 years left until maturity. Today, the current yield and coupon rate for this bond are equal to 10%.
t
A call provision allows a company to retire its debt early for a specified price
t
A corporate bond based on the general creditworthiness of the company is called a debenture
t
A debenture is secured only by the reputation of the issuing firm
t
A decrease in expected inflation would likely make Treasury bond prices rise
t
A sinking fund is an account into which periodic payments are made for the purpose of retiring a bond issue.
t
APR will always be less than or equal to the effective annual rate.
t
All else equal, a more liquid bond will have a lower yield.
t
All else equal, the existence of a call provision will increase the required rate of return on a bond.
t
All else equal, the riskier the bond, the lower the price.
t
An example of a bond covenant is that the firm must seek approval from bondholders before agreeing to merge with another company.
t
An example of a plausible bond covenant is that the company will limit the payout of dividends to stockholders.
t
Bonds are referred to as floating rate bonds when their coupon payments fluctuate with market rates.
t
Bonds are referred to as floating rate bonds when their coupon rates fluctuate with market interest rates.
t
Call protection refers to the period of time over which an issuer is not allowed to call an outstanding bond.
t
Callability will cause a bond to have a lower price and a higher yield (assuming other characteristics are the same).
t
Consider a zero coupon bond that initially matures in 10 years. Suppose 7 years go by (3 left to go) and now interest rates have fallen. The price today should be higher than it was 7 years ago.
t
Consider these three bonds: (X) 8% coupon, 10 years to maturity, (Y) 10% coupon, 10 years to maturity, (Z) 10% coupon, 20 years to maturity. All else equal, Bond (Y) would most likely have the least interest rate risk.
t
Consider two bonds issued by the same company with the same maturity date. Bond X has several protective covenants, but bond Y has none. If the market price of the two bonds is the same, bond Y must have a larger coupon rate than bond X.
t
Even though a bond may have a substantial coupon rate, its return can turn out to be negative if interest rates rise.
t
Firms are more likely to call their bonds when interest rates fall.
t
If a bond is sold at par value and then later interest rates fall, the bonds new "current yield" will be higher than its "yield to maturity."
t
Municipal bonds generally have lower yields to maturity than similar corporate bonds.
t
Pessimism about the economy could benefit Treasury bond prices
t
Suppose you run a bank. When marketing rates on quarterly-compounded savings accounts, you would rather advertise the effective annual rate than the nominal annual rate.
t
The "current yield" is a simple approximation for yield to maturity (this is true). It's less accurate for shorter maturity bonds and when the price is far from par.
t
The Fisher effect describes the relationship between nominal returns, real returns, and inflation. As a close approximation, the real rate of return is equal to the nominal rate minus the expected rate of inflation.
t
The future value of a perpetuity is infinite
t
The future value of an ordinary annuity is equal to the future value of an equivalent annuity due, divided by one plus the interest rate.
t
The price of one share of preferred stock in IBM is $121.52. If the required rate of return does not change, in two years the value of the preferred stock will be $121.52.
t
The relation between time to maturity and interest rates on default-free, zero coupon bonds is referred to as the term structure of interest rates.
t
The yield to maturity for a one-year zero-coupon bond equals the increase in price over the year, divided by the initial price.
t
U.S. Treasury TIPS bonds have coupon payments that vary with inflation, so their coupon rates can be thought of as real rates.
t
When you purchase US Treasury bonds, you are effectively lending money to the government.
t
You need money for tuition so you plan to sell some bonds from your portfolio. You have two types of bonds in your portfolio. The two types of bonds are identical except that X Bonds have a higher coupon rate than Y Bonds. If you think interest rates will rise soon after you sell your bonds (and stay there indefinitely), you would sell some Y bonds.
t
Your broker offers you the opportunity to purchase a bond with coupon payments of $90 and a face value of $1000. If the yield to maturity on similar bonds is 8%, this bond should sell at a premium.
t
An example of a plausible negative bond covenant is that the company must avoid dividend payments in excess of its debt expense.
T
Bond ratings by Moody's and Standard and Poor's provide information on the likelihood of default.
T
Bonds with longer maturities and/or lower coupons respond most vigorously to a change in market interest rates.
T
Consider two callable bonds. All else equal, the one with the longer call protection period will have a lower yield to maturity.
T
Consider two cash flows: $1,000 seven years from now, and $800 ten years from now. For all positive interest rates, in value today of the $1,000 (received in seven years) in will be greater than the value today of the $800 (received in ten years).
T
If a firm remains financial healthy, its bonds will typically provide higher returns than government bonds.
T
If you multiply a bond's "current yield" by its price, you get the coupon payment
T
In an amortized loan (like a car loan), the fraction of each payment that goes towards reducing the loan amount increases over time
T
Insurance companies are one type of investor who might find STRIPS more convenient than coupon bonds.
T
Prices of zero-coupon bonds generally rise as maturity nears.
T
The Fisher effect describes the relationship between nominal returns, real returns, and inflation. As a close approximation, the nominal rate of return is equal to the real rate plus the expected rate of inflation.
T
The coupon payments from Municipal bonds are exempt from Federal income taxes.
T
The market price of 20-year bond is currently equal to par value. If 5 years go by and interest rates remain the same, the bond will still sell at par value.
T
The term structure of interest rates is a plot of interest rates for different investment (or borrowing) horizons at a given point in time
T
The written, legally binding agreement between the corporate borrower and the lender detailing the terms of a bond issue is referred to as the indenture.
T
The yield to maturity for a premium bond is less than its coupon rate.
T
Treasury securities are considered riskless because there is virtually no risk of default.
T
U.S. Treasury Notes and Treasury Bonds have original maturities greater than one year.
T
You have a choice between $750,000 today or an annuity payment of $50,000 at the end of each of the next twenty years. You are indifferent between the two choices when the interest rate is 2.91% (this is true). At interest rates below this level, you would pick the annuity.
T
A bond was issued two years ago. It has a par value of $1000 and the coupon payments are $75 (paid annually). Today, the yield on the bond is 7.25%. This bond should be trading at a discount.
f
A bond was issued two years ago. It has a par value of $1000 and the coupon payments are $75 (paid annually). Today, the yield on the bond is 7.75%. This bond must be trading at a premium.
f
A bond with an annual coupon of $100 originally sold at par for $1000. The current market interest rate on this bond is now 9%. Assuming no change in risk, this bond will now sell at a discount.
f
All else equal, more liquid bonds will have higher required rates of return.
f
An annuity due receives payments at the beginning of the period. This makes the present value of an annuity due equal to the present value of an ordinary annuity, plus an extra payment.
f
An example of a protective covenant is a restriction that the company must keep the yield to maturity on the bond above a certain level.
f
An indenture is a bond secured only by the reputation of the issuing firm.
f
Callable bonds are more likely to be called in when interest rates rise.
f
Consider two bonds issued by the same company with the same maturity date. Bond X has several protective covenants, but bond Y has none. If the market price of the two bonds is the same, bond X would likely have a larger coupon rate than bond Y.
f
Consider two cash flows: $1,000 ten years from now, and $800 seven years from now. For all positive interest rates, in value today of the $800 (received in seven years) in will be greater than the value today of the $1000 (received in ten years).
f
Even though a bond has a substantial initial interest rate, its realized return can turn out to be negative if interest rates fall.
f
High yield bonds are corporate bonds with low default risk and high bond rating
f
If interest rates rise from 5 to 6 percent over the course of the year, all else equal you would prefer to have been holding a ten-year bond to a five-year bond.
f
If interest rates rise, firms are more likely to call in their callable bonds (assuming the bonds are not call protected).
f
If the rate of return on an investment is 50% per year, you will double your money in exactly 2 years.
f
If you borrow money from a bank through a compound interest loan, this means you earn interest on your interest payments, which effectively lowers the cost of the loan.
f
If you expect the inflation rate to be 3 percent next year and a one-year bond has a yield to maturity of 2 percent, then the real interest rate on this bond is approximately 5 percent.
f
If you multiply a bond's current yield by its market price you will get the coupon rate.
f
In an amortized loan (like a car loan), the dollar amount of interest you pay each period stays fixed over the life of the loan.
f
In order to compare two different investment opportunities (each with the same risk) that have interest rates reported in different manners, you should convert each interest rate to a nominal annual rate
f
Moody's and Standard & Poor's evaluate the interest rate risk of bonds.
f
Subordinated debt will tend to have a lower required rate of return than senior debt.
f
Suppose you manage a used car lot. When marketing financing rates for the cars you sell, you would rather advertise the effective annual rate than the nominal annual rate.
f
The coupon payments on municipal bonds are exempt from Federal taxes. This raises the required rate of return on the bond.
f
The coupon payments on municipal bonds are typically exempt from federal taxes. This makes their yield to maturity higher than similar taxable bonds.
f
The future value of an annuity due is equal to the present value of an equivalent ordinary annuity, multiplied by one plus the interest rate
f
The present value of an ordinary annuity is equal to the present value of an equivalent annuity due, multiplied by one plus the interest rate.
f
The term structure of interest rates describes changes in interest rates over time.
f
The written, legally binding agreement between the corporate borrower and the lender detailing the terms of a bond issue is referred to as the debenture.
f
Treasury securities are considered riskless because investors can always sell the bonds back to the government at face value.
f
Treasury securities are considered riskless because there is virtually no interest rate risk.
f
U.S. Treasury STRIPS have coupon payments that vary with the level of inflation
f
When thinking about inflation, the nominal interest rate is a better measure of the incentives to borrow and lend than the real interest rate.
f
You have a choice between $750,000 today or an annuity payment of $50,000 at the end of each of the next twenty years. You are indifferent between the two choices when the interest rate is 2.91% (this is true). At interest rates above this level, you would pick the annuity.
f
You have a choice between annuity payment of $50,000 at the end of each of the next 10 years, or a perpetuity that pays you $25,000 indefinitely. You are indifferent between the two choices when the interest rate is 7.18% (this is true). At interest rates below this level, you would pick the annuity
f
You need money for tuition so you plan to sell some bonds from your portfolio. You have two types of bonds in your portfolio. The two types of bonds are identical except that X Bonds have a longer maturity than Y Bonds. If you think interest rates will fall soon after you sell your bonds (and stay there indefinitely), you would sell some X bonds.
f
The price of a BB rated bond will always be more sensitive to changes in interest rates than a AA rated bond.
F
Treasury securities are considered riskless because investors can always sell the bonds back to the government at face value.
F
A bond with a face value of $1,000 has annual coupon payments of $100 and was issued 7 years ago. Today the yield to maturity on the bond is 10% and has 8 years left until maturity. Today, the "current yield" for this bond will be less than 10%.
F
A bond's maturity value will generally be greater than it's par value.
F
An annuity due receives payments at the beginning of the period. This makes the future value of an annuity due equal to the future value of an ordinary annuity, plus the future value of an extra payment.
F
Bonds are referred to as floating rate bonds when their par values vary with inflation.
F
For bonds selling at a premium, the "yield to maturity" is greater than the "current yield."
F