Fin 326--Module 3

30) YIELD CURVE FOR ZERO COUPON BONDS RATED AA Assume that there are no liquidity premiums. To the nearest basis point, what is the expected interest rate on a four-year maturity AA zero coupon bond purchased six years from today? A) 10.41 percent B) 10.05 percent C) 9.16 percent D) 10.56 percent E) 9.96 percent

A) 10.41 percent

You go to the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have decreased. The yield decreases may be explained by which one of the following? A) A decrease in U.S. inflationary expectations B) Newly expected decline in the value of the dollar C) An increase in current and expected future returns of real corporate investments D) Decreased Japanese purchases of U.S. Treasury bills/bonds E) Increases in the U.S. government budget deficit

A) A decrease in U.S. inflationary expectations

Which of the following would normally be expected to result in an increase in the supply of funds, all else equal? I. The perceived riskiness of all investments decreases. II. Expected inflation increases. III. Current income and wealth levels increase. IV. Near term spending needs of households increase as energy costs rise. A) I and III only B) II and III only C) II, III, and IV only D) I and IV only E) I, II, III, and IV

A) I and III only

Which of the following bond types pays interest that is exempt from federal taxation? A) Municipal bonds B) Corporate bonds C) Treasury bonds D) Convertible bonds E) Municipal bonds and Treasury bonds

A) Municipal bonds

According to the liquidity premium theory of interest rates, A) long-term spot rates are higher than the average of current and expected future short-term rates. B) investors prefer certain maturities and will not normally switch out of those maturities. C) investors are indifferent between different maturities if the long-term spot rates are equal to the average of current and expected future short-term rates. D) the term structure must always be upward sloping. E) long-term spot rates are totally unrelated to expectations of future short-term rates.

A) long-term spot rates are higher than the average of current and expected future short-term rates.

22) Duration is

A) the elasticity of a security's value to small coupon changes. B) the weighted average time to maturity of the bond's cash flows. C) the time until the investor recovers the price of the bond in today's dollars. D) greater than maturity for deep discount bonds and less than maturity for premium bonds. E) the second derivative of the bond price formula with respect to the YTM.

An individual actually earned a 4 percent nominal return last year. Prices went up by 3 percent over the year. Given that the investment income was subject to a federal tax rate of 28 percent and a state and local tax rate of 6 percent, what was the investor's actual real after-tax rate of return? A) −0.36 percent B) 0.66 percent C) 0.72 percent D) 1.45 percent E) 2.64 percent

A) −0.36 percent

Suppose you can save $2,000 per year for the next ten years in an account earning 7 percent per year. How much will you have at the end of the tenth year if you make the first deposit today? A) $34,187.75 B) $29,567.20 C) $31,217.36 D) $27,364.15 E) $18,364.25

B) $29,567.20

You buy a car for $38,000. You agree to a 60-month loan with a monthly interest rate of 0.55 percent. What is your required monthly payment? A) $634.24 B) $745.29 C) $605.54 D) $764.07 E) None of these choices are correct.

B) $745.29

Upon graduating from college this year, you expect to earn $25,000 per year. If you get your MBA, in one year you can expect to start at $35,000 per year. Over the year, inflation is expected to be 5 percent. In today's dollars, how much additional (less) money will you make from getting your MBA (to the nearest dollar) in your first year? A) −$2,462 B) $8,333 C) $8,750 D) $9,524 E) $10,000

B) $8,333

Inflation causes the demand curve for loanable funds to shift to the ________ and causes the supply curve to shift to the ________. A) right; right B) right; left C) left; left D) left; right

B) right; left

The relationship between maturity and yield to maturity is called the ________. A) loan covenant B) term structure C) bond indenture D) Fisher effect E) DRP structure

B) term structure

You want to have $5 million when you retire in 40 years. You believe you can earn 9 percent per year on your investment. How much must you invest each year to achieve your goal when you retire? (Ignore all taxes.) A) $10,412 B) $11,619 C) $14,798 D) $15,295 E) None of these choices are correct.

C) $14,798

An investment pays $400 in one year, X amount of dollars in two years, and $500 in three years. The total present value of all the cash flows (including X) is equal to $1,500. If i is 6 percent, what is X? A) $702.83 B) $822.41 C) $789.70 D) $749.67 E) $600.00

C) $789.70

The term structure of interest rates is upward sloping for all bond types. A certain AAA-rated non-callable 10-year corporate bond has been issued at a 6.15 percent promised yield. Which one of the following bonds probably has a higher promised yield? A) A similar quality municipal bond B) A non-callable AAA-rated corporate bond with a five-year maturity C) A callable AAA-rated corporate bond with a 15-year maturity D) A non-callable AAA-rated convertible corporate bond with a 10-year maturity E) All of these choices are correct.

C) A callable AAA-rated corporate bond with a 15-year maturity

An insurance company is trying to sell you a retirement annuity. The annuity will give you 20 payments with the first payment in 12 years when you retire. The insurance firm is asking you to pay $50,000 today. If this is a fair deal, what must the payment amount be (to the dollar) if the interest rate is 8 percent? A) $5,093 B) $12,824 C) $9,472 D) $11,874 E) $10,422

D) $11,874

A 15-payment annual annuity has its first payment in nine years. If the payment amount is $1,400 and the interest rate is 7 percent, what is the most you should be willing to pay today for this investment? A) $5,825.11 B) $12,751.08 C) $6,416.67 D) $7,421.24 E) $6,935.74

D) $7,421.24

YIELD CURVE FOR ZERO COUPON BONDS RATED AA Assume that there are no liquidity premiums. You just bought a 15-year maturity Xerox corporate bond rated AA with a 0 percent coupon. You expect to sell the bond in eight years. Find the expected interest rate at the time of sale (watch out for rounding error). A) 13.92 percent B) 11.00 percent C) 8.85 percent D) 12.49 percent E) 12.80 percent

D) 12.49 percent

An investor requires a 3 percent increase in purchasing power in order to induce her to lend. She expects inflation to be 2 percent next year. The nominal rate she must charge is about A) 3 percent. B) 2 percent. C) 1 percent. D) 5 percent. E) 7 percent.

D) 5 percent.

Classify each of the following in terms of their effect on interest rates (increase or decrease): I. Covenants on borrowing become more restrictive. II. The Federal Reserve increases the money supply. III. Total household wealth increases. A) I increases; II increases; III increases B) I increases; II decreases; III decreases C) I decreases; II increases; III increases D) I decreases; II decreases; III decreases E) None of these choices are correct.

D) I decreases; II decreases; III decreases

An annuity and an annuity due with the same number of payments have the same future value if r = 10%. Which one has the higher payment? A) They both must have the same payment since the future values are the same. B) There is no way to tell which has the higher payment. C) An annuity and an annuity due cannot have the same future value. D) The annuity has the higher payment. E) The annuity due has the higher payment.

D) The annuity has the higher payment

Of the following, the most likely effect of an increase in income tax rates would be to A) decrease the savings rate. B) decrease the supply of loanable funds. C) increase interest rates. D) all of these choices are correct.

D) all of these choices are correct.

According to the unbiased expectations theory, A) markets are segmented and buyers stay in their own segment. B) liquidity premiums are negative and time varying. C) the term structure will most often be upward sloping. D) the long-term spot rate is an average of the current and expected future short-term interest rates. E) forward rates are less than the expected future spot rates.

D) the long-term spot rate is an average of the current and expected future short-term interest rates.

An investor wants to be able to buy 4 percent more goods and services in the future in order to induce her to invest today. During the investment period prices are expected to rise by 2 percent. Which statement(s) below is/are true? I. 4 percent is the desired real risk-free interest rate. II. 6 percent is the approximate nominal rate of interest required. III. 2 percent is the expected inflation rate over the period. A) I only B) II only C) III only D) I and II only E) I, II, and III are true.

E) I, II, and III are true.

Classify each of the following in terms of their effect on interest rates (increase or decrease): I. Perceived risk of financial securities increases. II. Near term spending needs decrease. III. Future profitability of real investments increases. A) I increases: II increases: III increases B) I increases: II decreases: III decreases C) I decreases: II increases: III increases D) I decreases; II decreases; III decreases E) None of these choices are correct.

E) None of these choices are correct.

The required rate of return on a bond is A) the interest rate that equates the current market price of the bond with the present value of all future cash flows received. B) equivalent to the current yield for nonpar bonds. C) less than the E(r) for discount bonds and greater than the E(r) for premium bonds. D) inversely related to a bond's risk and coupon. E) None of these choices are correct.

E) None of these choices are correct.

Investment A pays 8 percent simple interest for 10 years. Investment B pays 7.75 percent compound interest for 10 years. Both require an initial $10,000 investment. The future value of A minus the future value of B is equal to ________ (to the nearest penny). A) $2,500.00 B) −$2,500.00 C) $1,643.32 D) $3,094.67 E) −$3,094.67

E) −$3,094.67

A 10-year maturity zero coupon bond will have lower price volatility than a 10-year bond with a 10 percent coupon.

False

A higher level of wealth causes the demand for loanable funds to increase and interest rates to fall

False

According to the liquidity premium theory, investors preferring long-term bonds over short-term bonds would require lower liquidity premium

False

An increase in interest rates increases the demand loanable funds

False

An increase in the perceived riskiness of investments would cause a movement up along the supply curve

False

As the liquidity of corporate bonds decrease, the risk premium required on those bonds decrease as well

False

At equilibrium a security's required rate of return will be less than its expected rate of return.

False

Earning a 5 percent interest rate with annual compounding is better than earning a 4.95 percent interest rate with semiannual compounding

False

Everything else equal, the interest rate required on a callable bond will be less than the interest rate on a convertible bond

False

For a given interest rate change, a 20-year bond's price change will be twice that of a 10-year bond's price change

False

If a security's realized return is negative, it must have been true that the expected return was greater than the required return.

False

If you earn 0.5 percent a month in your bank account, this would be the same as earning a 6 percent annual interest rate with annual compounding

False

Ignoring default risk, if a bond's expected return is greater than its required return, then the bond's market price must be greater than the present value of the bond's cash flows.

False

Suppose two bonds of equivalent risk and maturity have different prices such that one is a premium bond and one is a discount bond. The premium bond must have a greater expected return than the discount bond.

False

The coupon rate represents the most accurate measure of the bondholder's required return.

False

The higher the interest rate is the higher the duration, all else being equal.

False

The longer the time to maturity, the lower the security's price sensitivity to an interest rate change, ceteris paribus

False

The unbiased expectations hypothesis of the term structure posits that long-term interest rates are unrelated to expected future short-term rates

False

We expect liquidity premiums to move inversely with interest rate volatility

False

A bond with an 11 percent coupon and a 9 percent required return will sell at a premium to par.

True

A fairly priced bond with a coupon less than the expected return must sell at a discount from par.

True

A zero coupon bond has a duration equal to its maturity and a convexity equal to zero.

True

According to the market segmentation theory, short-term investors will not normally switch to intermediate- or long-term investments

True

All else equal, the holder of a fairly priced premium bond must expect a capital loss over the holding period.

True

An improvement in economic conditions would likely shift the supply curve down and the the right and shift the demand curve for funds up and to the right

True

An increase in the marginal tax rates for all U.S. taxpayers would probably result in reduced supply of funds by households

True

An investor earned a 5 percent nominal risk-free rate over the year. However, over the year, prices increased by 2 percent. The investor's real risk-free rate was less than his nominal rate of return

True

Any security that returns a greater percentage of the price sooner is less price-volatile.

True

Convertible bonds will normally have lower promised yields than straight bonds of similar terms and quality

True

For any positive interest rate the present value of a given annuity will be less than the sum of the cash flows, and the future value of the same annuity will be greater than the sum of the cash flows

True

Higher interest rates lead to lower bond convexity, ceteris paribus.

True

Households generally supply more funds to the markets as their income and wealth increase, ceteris paribus

True

If interest rates increase, the value of a fixed income contract decreases and vice versa.

True

Simple interest calculations assume that interest earned is never reinvested.

True

The duration of a four-year maturity 10 percent coupon bond is less than four years.

True

The greater a security's coupon, the lower the security's price sensitivity to an interest rate change, ceteris paribus

True

The higher a bond's coupon, the lower the bond's price volatility.

True

The lower the level of interest rates, the greater a bond's price sensitivity to interest rate changes

True

The real risk-free rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption

True

The risk that a security cannot be sold at a predictable price with low transaction costs at short notice is called liquidity risk

True

The term structure of interest rates is the relationship between interest rates on bonds similar in terms except for maturity

True

The traditional liquidity premium theory states that long-term interest rates are greater than the average of current and expected future short-term interest rates

True

When the quantity of a financial security supplied or demanded changes at every given interest rate in response to a change in a factor, this causes a shift in the supply or demand curve

True

With a zero interest rate both the present value and the future value of an N payment annuity would equal N x payment

True