FIN 355 Exam 2

Lee pays 1 percent per month interest on his credit card account. When his monthly rate is multiplied by 12, the resulting answer is referred to as the: A. Annual percentage rate (APR) B. Effective annual rate (EAR) C. Compounded rate D. Simple rate E. Perpetual rate

A. Annual percentage rate (APR)

A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? A. The bond's yield to maturity (YTM) is greater than its coupon rate. B. The bond's yield to maturity (YTM) is smaller than its coupon rate. C. The bond's yield to maturity (YTM) is equal to its coupon rate. D. The bond's current yield is equal to its coupon rate

A. The bond's yield to maturity (YTM) is greater than its coupon rate.

A bond has a $1,000 par value, makes annual interest payments of $100 (10% annual coupon rate), has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%. A. True B. False

A. True

All else equal, a 15-year corporate bond has greater interest rate risk than a 1-year corporate bond. A. True B. False

A. True

All else equal, the price of a 20-year, 10% annual coupon bond is more sensitive to changes in interest rates than the price of a 5-year, 10% annual coupon bond. A. True B. False

A. True

As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan). A. True B. False

A. True

Bonds A, B, and C all have a maturity of 10 years and a yield to maturity of 7%. Bond A's price exceeds its par value (premium bond), Bond B's price equals its par value (par bond), and Bond C's price is less than its par value (discount bond). None of the bonds can be called. If the yield to maturity (YTM) on each bond increases to 8%, the prices of all three bonds will decline. A. True B. False

A. True

If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. A. True B. False

A. True

One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant. A. True B. False

A. True

The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant. A. True B. False

A. True

A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has an 8% coupon. Neither is callable, and both have the same yield to maturity (YTM). If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT? A. The prices of both bonds will decrease by the same amount. B. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. C. The prices of both bonds would increase by the same amount. D. One bond's price would increase, while the other bond's price would decrease. E. The prices of the two bonds would remain constant

B. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.

Martha earned $120 in interest on her savings account last year. Martha has decided to leave the $120 in her account so that she can earn interest on the $120 this year. This process of earning interest on prior interest earnings is called: A. Discounting B. Compounding C. Duplicating D. Indexing E. Multiplying

B. Compounding

Which of the following would be most likely to lead to a higher level of interest rates in the economy? A. Households start saving a larger percentage of their income. B. Corporations step up their expansion plans and thus increase their demand for capital. C. The level of inflation begins to decline. D. The economy moves from a boom to a recession

B. Corporations step up their expansion plans and thus increase their demand for capital.

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72%The differences in these rates were probably caused primarily by: A. Tax effects. B. Default risk and liquidity risk differences. C. Maturity risk differences. D. Inflation differences. E. Real risk-free rate differences.

B. Default risk and liquidity risk differences.

If a bond's yield to maturity (YTM) exceeds its coupon rate, the bond will sell at a premium over par. A. True B. False

B. False

If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. A. True B. False

B. False

If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill. A. True B. False

B. False

Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). Investment B pays $250 at the end of every year for the next 10 years (a total of 10payments). Therefore, Investment B would have the highest future value at the end of 10 years. A. True B. False

B. False

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant. A. True B. False

B. False

The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date. A. True B. False

B. False

The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates, other things held constant. A. True B. False

B. False

A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT? A. If market interest rates decline, the price of the bond will also decline. B. If market interest rates decline, the price of the bond will increase. C. The bond is currently selling at a price below its par value. D. The bond should currently be selling at its par value

B. If market interest rates decline, the price of the bond will increase.

Travis is buying a car and will finance it with a loan that requires monthly payments of $265 for the next four years. If the payments occur at the end of each month, his car payments can be described by which one of the following terms? A. Perpetuity B. Ordinary Annuity C. Annuity due D. Lump sum

B. Ordinary Annuity

A bond trader observes the following information: The Treasury yield curve is downward sloping. Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds. Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields. On the basis of this information, which of the following statements is most CORRECT? A. A 10-year corporate bond must have a higher yield than a 5-year Treasury bond. B. A 10-year Treasury bond must have a higher yield than a 10-year corporate bond. C. A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.

C. A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.

Which of the following bonds has the greatest price risk or interest rate risk? A. A 1-year, $1,000 face value, 10% annual coupon bond B. A 5-year, $1,000 face value, 10% annual coupon bond C. A 10-year, $1,000 face value, 10% annual coupon bond D. A 15-year, $1,000 face value, 10% annual coupon bond

D. A 15-year, $1,000 face value, 10% annual coupon bond

You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest? A. Bank 1; 6.0% with monthly compounding. B. Bank 2; 6.0% with annual compounding. C. Bank 3; 6.0% with quarterly compounding. D. Bank 4; 6.0% with daily (365-day) compounding

D. Bank 4; 6.0% with daily (365-day) compounding

You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? A. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE. B. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD C. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE. D. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD

D. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD

Which of the following statements is correct? A. The yield on 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. B. The real risk-free rate is higher for corporate than for Treasury bonds. C. Liquidity premiums are higher for Treasury than for corporate bonds. D. The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.

D. The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.

In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t − 1)%, where t is the number of years until the bond matures. Given this information, which of the following statements is CORRECT? A. The yield on 2-year Treasury securities must exceed the yield on 5-year Treasury securities. B. The yield on 5-year Treasury securities must exceed the yield on 10-year corporate bonds. C. The yield on 5-year Treasury securities must exceed the yield on 8-year corporate bonds. D. The yield curve must be upward sloping

D. The yield curve must be upward sloping

If its yield to maturity (YTM) declined by 1%, which of the following bonds would have the largest percentage increase in value? A. A 1-year bond with an 8% annual coupon. B. A 5-year bond with an 8% annual coupon. C. A 10-year bond with an 8% annual coupon. D. A 15-year bond with an 8% annual coupon. E. A 30-year bond with an 8% annual coupon

E. A 30-year bond with an 8% annual coupon