M&B Chapter 4

) The nominal interest rate minus the expected rate of inflation ________. A) defines the real interest rate B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate C) is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate D) defines the discount rate

A

A $10000 8 percent coupon bond that sells for $10000 has a yield to maturity of ________. A) 8 percent B) 10 percent C) 12 percent D) 14 percent

A

A coupon bond that has no maturity date and no repayment of principal is called a ________. A) consol B) cabinet C) Treasury bill D) Government note

A

All else equal, when interest rates ________, the duration of a coupon bond ________. A) rise; falls B) rise; increases C) falls; falls D) falls; does not change

A

An $8000 coupon bond with a $400 coupon payment every year has a coupon rate of ________. A) 5 percent B) 8 percent C) 10 percent D) 40 percent

A

Bonds whose term-to-maturity is longer than the holding period are subject to ________. A) interest rate risk B) exchange-rate risk C) inflation D) deflation

A

By subtracting from the interest rate of a Canada coupon bond the interest rate of a similar maturity's real return bond, provides us with an insight about ________. A) the expected inflation B) the real interest rate C) the current yield D) the discounted yield

A

Examples of discount bonds include ________. A) Treasury bills B) corporate bonds C) coupon bonds D) municipal bonds

A

If $22050 is the amount payable in two years for a $20000 simple loan made today, the interest rate is ________. A) 5 percent B) 10 percent C) 22 percent D) 25 percent

A

If a $5000 face-value discount bond maturing in one year is selling for $5000, then its yield to maturity is ________. A) 0 percent B) 5 percent C) 10 percent D) 20 percent

A

If the interest rate on a Real Return Bond is 2 percent and the interest rate on a Canada bond of similar maturity is 5 percent then ________ is equal to 3 percent. A) the expected rate of inflation B) the yield to maturity C) current yield D) expected interest rate

A

If the interest rate on a Real Return Bond is 5 percent and the interest rate on a Canada bond of similar maturity is 2 percent then the expected rate of inflation is equal to ________. A) -3 percent B) 7 percent C) 3 percent D) 2 percent

A

If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding? A) A bond with one year to maturity B) A bond with five years to maturity C) A bond with ten years to maturity D) A bond with twenty years to maturity

A

If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is ________. A) -5 percent B) -2 percent C) 2 percent D) 12 percent

A

Interest-rate risk is the riskiness of an asset's returns due to ________. A) interest-rate changes B) changes in the coupon rate C) default of the borrower D) changes in the asset's maturity

A

The ________ interest rate is adjusted for expected changes in the price level. A) ex ante real B) ex post real C) ex post nominal D) ex ante nominal

A

The ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation. A) Fisher equation B) Keynesian equation C) Monetarist equation D) Marshall equation

A

The ________ states that the real interest rate equals the nominal interest rate minus the expected rate of inflation. A) Fisher equation B) Keynesian equation C) Monetarist equation D) Marshall equation

A

The duration of a coupon bond increases ________. A) the longer is the bond's term to maturity B) when interest rates increase C) the higher the coupon rate on the bond D) the higher the bond price

A

The interest rate on Real Return Bonds is a direct measure of ________. A) the real interest rate B) the nominal interest rate C) the rate of inflation D) the rate of deflation

A

The interest rate that describes how well a lender has done in real terms after the fact is called the ________. A) ex post real interest rate B) ex ante real interest rate C) ex post nominal interest rate D) ex ante nominal interest rate

A

The nominal interest rate minus the expected rate of inflation ________. A) defines the real interest rate B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate C) is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate D) defines the bank rate

A

The present value of a fixed-payment loan is calculated as the ________ of the present value of all cash flow payments. A) sum B) difference C) multiple D) log

A

The sum of the current yield and the rate of capital gain is called the ________. A) rate of return B) discount yield C) perpetuity yield D) par value

A

The yield to maturity for a discount bond is ________ related to the current bond price. A) negatively B) positively C) not D) directly

A

The yield to maturity for a one-year discount bond equals the increase in price over the year, divided by the ________. A) initial price B) face value C) interest rate D) coupon rate

A

The yield to maturity for a perpetuity is a useful approximation for the yield to maturity on long-term coupon bonds. It is called the ________ when approximating the yield for a coupon bond. A) current yield B) discount yield C) future yield D) star yield

A

There is ________ for any bond whose time to maturity matches the holding period. A) no interest-rate risk B) a large interest-rate risk C) rate-of-return risk D) yield-to-maturity risk

A

Which of the following $1000 face-value securities has the highest yield to maturity? A) A 5 percent coupon bond with a price of $600 B) A 5 percent coupon bond with a price of $800 C) A 5 percent coupon bond with a price of $1000 D) A 5 percent coupon bond with a price of $1200

A

Which of the following $1000 face-value securities has the lowest yield to maturity? A) A 5 percent coupon bond selling for $1000 B) A 10 percent coupon bond selling for $1000 C) A 15 percent coupon bond selling for $1000 D) A 15 percent coupon bond selling for $900

A

Which of the following bonds would you prefer to be buying? A) A $10000 face-value security with a 10 percent coupon selling for $9000 B) A $10000 face-value security with a 7 percent coupon selling for $10000 C) A $10000 face-value security with a 9 percent coupon selling for $10000 D) A $10000 face-value security with a 10 percent coupon selling for $10000

A

Which of the following is generally true of bonds? A) The only bond whose return equals the initial yield to maturity is one whose time to maturity is the same as the holding period. B) A rise in interest rates is associated with a fall in bond prices, resulting in capital gains on bonds whose terms to maturity are longer than the holding periods. C) The longer a bond's maturity, the smaller is the size of the price change associated with an interest rate change. D) Prices and returns for short-term bonds are more volatile than those for longer-term bonds.

A

Which of the following is true concerning the distinction between interest rates and returns? A) The rate of return on a bond will not necessarily equal the interest rate on that bond. B) The return can be expressed as the difference between the current yield and the rate of capital gains. C) The rate of return will be greater than the interest rate when the price of the bond falls between time t and time t + 1. D) The return can be expressed as the sum of the discount yield and the rate of capital gains

A

Which of the following is true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. B) The price of a coupon bond and the yield to maturity are positively related. C) The yield to maturity is greater than the coupon rate when the bond price is above the par value. D) The yield is less than the coupon rate when the bond price is below the par value

A

What is a coupon bond? Describe its basic properties.

Answer: A coupon bonds pays the owner a fixed interest payment every year until the maturity date when a specified amount called the face value is repaid. A coupon bond is identified by three pieces of information: a. the corporation or government agency that issues the bond, b. the maturity date of the bond, and c. the bond's coupon rate, the dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond.

Would it make sense to buy a house when mortgage rates are 14 percent and expected inflation is 15 percent? Explain your answer.

Answer: Even though the nominal rate for the mortgage appears high, the real cost of borrowing the funds is -1 percent. Yes, under this circumstance it would be reasonable to make this purchase.

Your favourite uncle advises you to purchase long-term bonds because their interest rate is 10 percent. Should you follow his advice?

Answer: It depends on where you think interest rates are headed in the future. If you think interest rates will be going up, you should not follow your uncle's advice because you would then have to discount your bond if you needed to sell it before the maturity date. Long-term bonds have a greater interest-rate risk.

Explain the Fisher equation. Construct a numerical example demonstrating that, depending on the expected rate of inflation, a lower nominal rate may still reflect a higher real cost of borrowing. Explain your example thoroughly.

Answer: The answer should list the equation that the nominal rate equals the real rate plus the expected rate of inflation, or an equivalent variant. The terms should be clearly defined. The example should have a higher real rate for the lower nominal rate due to relatively lower expected inflation. The example and the resultant impact on real borrowing costs should be thoroughly explained.

How is current yield defined? How can it be used to determine yield to maturity for long-term bonds?

Answer: The current yield is the is the yield to maturity of a perpetuity or consol. It is given by the formula: ic = , where C is the yearly payment and P is the price of the perpetuity. When a coupon bond has a long term to maturity, it is very much like a perpetuity. The current yield will be very close to the yield to maturity for a long term bond and is used as an approximation to describe interest rates on long term bonds.

A friend tells you that he can purchase a 10 percent coupon bond at face value. Your friend states that 10 percent is a "high" rate of interest. You know that the current rate of inflation is 8 percent, and you expect inflation to increase. What advice should you give to your friend about this bond?

Answer: The high nominal rate is reduced to a much lower real rate due to inflation. Interest-rate risk should be a concern. An increase in expected inflation will increase nominal rates due to the Fisher effect. This will result in a capital loss, and the higher nominal rate reduces the real value of the 10 percent coupon rate.

Explain why the current bond prices and interest rates are negatively related.

Answer: There are two ways to show why current bond prices and interest rates are negatively related: a. From the bond price formula: we can see that as the interest rate (yield to maturity) rises, all denominators in the bond price formula must necessarily rise. Hence, a rise in the interest rates as measured by the yield to maturity means that the price of the bond must fall. b. An increase in the interest rate means that all the future coupon payments and final payment will be worth less when discounted to the present, thus, the price of the bond must fall.

A discount bond ________. A) pays the bondholder a fixed amount every period and the face value at maturity B) pays the bondholder the face value at maturity C) pays all interest and the face value at maturity D) pays the face value at maturity plus any capital gain

B

All else equal, the ________ the coupon rate on a bond, the ________ the bond's duration. A) higher; longer B) higher; shorter C) lower; shorter D) greater; longer

B

All of the following are examples of coupon bonds except ________. A) Corporate bonds B) Treasury bills C) Zero coupon bonds D) Government bonds

B

An asset's interest rate risk ________ as the duration of the asset ________. A) increases; decreases B) decreases; decreases C) decreases; increases D) remains constant; increases

B

An equal decrease in all bond interest rates ________. A) increases the price of a five-year bond more than the price of a ten-year bond B) increases the price of a ten-year bond more than the price of a five-year bond C) decreases the price of a five-year bond more than the price of a ten-year bond D) decreases the price of a ten-year bond more than the price of a five-year bond

B

Assuming the same coupon rate and maturity length, when the interest rate on a Real Return Bond is 3 percent, and the yield on a nonindexed Canada bond is 8 percent, the expected rate of inflation is ________. A) 3 percent B) 5 percent C) 8 percent D) 11 percent

B

Comparing a discount bond and a coupon bond with the same maturity, ________. A) the coupon bond has the greater effective maturity B) the discount bond has the greater effective maturity C) the effective maturity cannot be calculated for a coupon bond D) the effective maturity cannot be calculated for a discount bond

B

If a perpetuity has a price of $500 and an annual interest payment of $25, the interest rate is ________. A) 2.5 percent B) 5 percent C) 7.5 percent D) 10 percent

B

If a security pays $110 next year and $121 the year after that, what is its yield to maturity if it sells for $200? A) 9 percent B) 10 percent C) 11 percent D) 12 percent

B

In which of the following situations would you prefer to be the lender? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 13 percent and the expected inflation rate is 15 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

B

Prices and returns for ________ bonds are more volatile than those for ________ bonds. A) long-term; long-term B) long-term; short-term C) short-term; long-term D) short-term; short-term

B

The Fisher equation states that ________. A) the real interest rate equals the nominal interest rate plus the expected rate of inflation B) the real interest rate equals the nominal interest rate less the expected rate of inflation C) the nominal interest rate equals the real interest rate less the expected rate of inflation D) the nominal interest rate equals the real interest rate plus the expected rate of inflation

B

The ________ interest rate more accurately reflects the true cost of borrowing. A) nominal B) real C) discount D) market

B

The yield to maturity is ________ than the ________ rate when the bond price is ________ its face value. A) greater; coupon; above B) greater; coupon; below C) greater; perpetuity; above D) less; perpetuity; below

B

Which of the following is generally true of all bonds? A) The longer a bond's maturity, the greater is the rate of return that occurs as a result of the increase in the interest rate. B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise. C) Prices and returns for short-term bonds are more volatile than those for longer term bonds. D) A fall in interest rates results in capital losses for bonds whose terms to maturity are longer than the holding period.

B

Which of the following is true for discount bonds? A) A discount bond is bought at par. B) The purchaser receives the face value of the bond at the maturity date. C) Canada bonds and notes are examples of discount bonds. D) The purchaser receives the par value at maturity plus any capital gains

B

A consol paying $20 annually when the interest rate is 5 percent has a price of ________. A) $100 B) $200 C) $400 D) $800

C

Duration is ________. A) an asset's term to maturity B) the time until the next interest payment for a coupon bond C) the average lifetime of a debt security's stream of payments D) the time between interest payments for a coupon bond

C

Economists consider the ________ to be the most accurate measure of interest rates. A) simple interest rate B) current yield C) yield to maturity D) real interest rate

C

For simple loans, the simple interest rate is ________ the yield to maturity. A) greater than B) less than C) equal to D) not comparable to

C

If a financial institution has 50 percent of its portfolio in a bond with a five-year duration and 50 percent of its portfolio in a bond with a seven-year duration, what is the duration of the portfolio? A) 12 years B) 7 years C) 6 years D) 5 years

C

If the amount payable in two years is $2420 for a simple loan at 10 percent interest, the loan amount is ________. A) $1000 B) $1210 C) $2000 D) $2200

C

If the interest rate on a Real Return Bond is 2 percent and the interest rate on a Canada bond of similar maturity is 5 percent then the expected rate of inflation is equal to ________. A) -3 percent B) 7 percent C) 3 percent D) 2 percent

C

If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is ________. A) -3 percent B) -2 percent C) 3 percent D) 7 percent

C

Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding? A) 5 percent B) 10 percent C) 15 percent D) 20 percent

C

The ________ is defined as the payments to the owner plus the change in a security's value expressed as a fraction of the security's purchase price. A) yield to maturity B) current yield C) rate of return D) yield rate

C

The interest rate that equates the present value of payments received from a debt instrument with its value today is the ________. A) simple interest rate B) current yield C) yield to maturity D) real interest rate

C

The nominal interest rate minus the expected rate of inflation ________. A) defines the real rate of inflation B) is a worse measure of the incentives to borrow and lend than is the nominal interest rate C) is a more accurate indicator of the tightness of credit market conditions than is the nominal interest rate D) defines the bank rate

C

The return on a 5 percent coupon bond that initially sells for $1000 and sells for $950 next year is ________. A) -10 percent B) -5 percent C) 0 percent D) 5 percent

C

What is the return on a 5 percent coupon bond that initially sells for $1000 and sells for $900 next year? A) 5 percent B) 10 percent C) -5 percent D) -10 percent

C

When the ________ interest rate is low, there are greater incentives to ________ and fewer incentives to ________. A) nominal; lend; borrow B) real; lend; borrow C) real; borrow; lend D) market; lend; borrow

C

Which of the following $1000 face-value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1000 B) A 10 percent coupon bond selling for $1000 C) A 12 percent coupon bond selling for $1000 D) A 12 percent coupon bond selling for $1100

C

) In which of the following situations would you prefer to be the borrower? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 13 percent and the expected inflation rate is 15 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

D

A ________ is bought at a price below its face value, and the ________ value is repaid at the maturity date. A) coupon bond; discount B) discount bond; discount C) coupon bond; face D) discount bond; face

D

A bond that is bought at a price below its face value and the face value is repaid at a maturity date is called a ________. A) simple loan B) fixed-payment loan C) coupon bond D) discount bond

D

A discount bond selling for $15000 with a face value of $20000 in one year has a yield to maturity of ________. A) 3 percent B) 20 percent C) 25 percent D) 33.3 percent

D

An equal increase in all bond interest rates ________. A) increases the return to all bond maturities by an equal amount B) decreases the return to all bond maturities by an equal amount C) has no effect on the returns to bonds D) decreases long-term bond returns more than short-term bond returns

D

Assuming the same coupon rate and maturity length, the difference between the yield on a Real Return Bond and the yield on a Canada bond provides insight into ________. A) the nominal interest rate B) the real interest rate C) the nominal exchange rate D) the expected inflation rate

D

For a 3-year simple loan of $10000 at 10 percent, the amount to be repaid is ________. A) $10030 B) $10300 C) $13000 D) $13310

D

If a $10000 face-value discount bond maturing in one year is selling for $5000, then its yield to maturity is ________. A) 5 percent B) 10 percent C) 50 percent D) 100 percent

D

If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the real rate of interest is ________. A) 2 percent B) 8 percent C) 10 percent D) 12 percent

D

If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is ________. A) 7 percent B) 22 percent C) -15 percent D) -8 percent

D

In Japan in 1998 and in the U.S. in 2008, interest rates were negative for a short period of time because investors found it convenient to hold six-month bills as a store of value because ________. A) of the high inflation rate B) these bills sold at a discount from face value C) the bills were denominated in small amounts and could be stored electronically D) the bills were denominated in large amounts and could be stored electronically

D

In a country where prices never change, the nominal interest rate is equal to the ________. A) real exchange rate B) inflation rate C) expected inflation rate D) real interest rate

D

The interest rate on a consol equals the ________. A) price times the coupon payment B) price divided by the coupon payment C) coupon payment plus the price D) coupon payment divided by the price

D

The price of a consol equals the coupon payment ________. A) times the interest rate B) plus the interest rate C) minus the interest rate D) divided by the interest rate

D

The price of a coupon bond and the yield to maturity are ________ related; that is, as the yield to maturity ________, the price of the bond ________. A) positively; rises; rises B) negatively; falls; falls C) positively; rises; falls D) negatively; rises; falls

D

The riskiness of an asset's returns due to changes in interest rates is ________. A) exchange-rate risk B) price risk C) asset risk D) interest-rate risk

D

What is the return on a 5 percent coupon bond that initially sells for $1000 and sells for $1200 next year? A) 5 percent B) 10 percent C) -5 percent D) 25 percent

D

Which of the following $5000 face-value securities has the highest yield-to maturity? A) A 6 percent coupon bond selling for $5000 B) A 6 percent coupon bond selling for $5500 C) A 10 percent coupon bond selling for $5000 D) A 12 percent coupon bond selling for $4500

D

Your friend tells you that she bought a 10-year to maturity discount bond that she plans to hold until maturity in order to finance her daughter's university education. She also tells you that she is worried that due to interest-rate-risk she may suffer significant capital losses if interest rates increase. Are her fears justified?

No, her fear of significant capital losses from future increases in the interest rates for bonds are not justified as she is planning to hold the 10-year bond until maturity when she is guaranteed to receive the face value of the bond back. There is no interest-rate-risk associated with this investment as the time to maturity matches the holding period and any increase in interest rates can have no effect on the price at the end of the holding period.

If the interest rate is 5 percent, what is the present value of a security that pays you $1050 next year and $1102.50 two years from now? If this security sold for $2200, is the yield to maturity greater or less than 5 percent? Why?

PV = $1050/(1 + .05) + $1102.50/ PV = $2000 If this security sold for $2200, the yield to maturity is less than 5 percent. The lower the interest rate the higher the present value.

A relative has just won a state lottery paying $20 million in installments of $1 million per year for twenty years. Your relative states that she is $20 million richer. Is she correct? Create a simple example for two years to illustrate your position.

The relative is incorrect. The discounted present value of the payments is less than $20 million. The example should demonstrate that the discounted value of the payment due in one year is less than $1 million.

A credit market instrument that provides the borrower with an amount of funds that must be repaid at the maturity date along with an interest payment is known as a ________. A) simple loan B) fixed-payment loan C) coupon bond D) discount bond

a

An increase in the time to the promised future payment ________ the present value of the payment. A) decreases B) increases C) has no effect on D) is irrelevant to

a

If a $5000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is ________. A) $650 B) $1300 C) $130 D) $13

a

The concept of ________ is based on the common-sense notion that a dollar paid to you in the future is less valuable to you than a dollar today. A) present value B) future value C) interest D) deflation

a

The dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond is called the bond's ________. A) coupon rate B) maturity rate C) face value rate D) payment rate

a

The present value of an expected future payment ________ as the interest rate increases. A) falls B) rises C) is constant D) is unaffected

a

When talking about a coupon bond, face value and ________ mean the same thing. A) par value B) coupon value C) amortized value D) discount value

a

A credit market instrument that requires the borrower to make the same payment every period until the maturity date is known as a ________. A) simple loan B) fixed-payment loan C) coupon bond D) discount bond

b

A fully amortized loan is another name for ________. A) a simple loan B) a fixed-payment loan C) a commercial loan D) an unsecured loan

b

If a security pays $55 in one year and $133 in three years, its present value is $150 if the interest rate is ________. A) 5 percent B) 10 percent C) 12.5 percent D) 15 percent

b

Which of the following is true of fixed payment loans? A) The borrower repays both the principal and interest at the maturity date. B) Installment loans and mortgages are frequently of the fixed payment type. C) The borrower pays interest periodically and the principal at the maturity date. D) Commercial loans to businesses are often of this type.

b

A ________ pays the owner a fixed coupon payment every year until the maturity date, when the ________ value is repaid. A) coupon bond; discount B) discount bond; discount C) coupon bond; face D) discount bond; face

c

A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a ________. A) simple loan B) fixed-payment loan C) coupon bond D) discount bond

c

The ________ is the final amount that will be paid to the holder of a coupon bond. A) discount value B) coupon value C) face value D) present value

c

With an interest rate of 6 percent, the present value of $100 next year is approximately ________. A) $106 B) $100 C) $94 D) $92

c

To claim that a lottery winner who is to receive $1 million per year for twenty years has won $20 million ignores the process of ________. A) face value B) par value C) deflation D) discounting the future

d