Fin 334 Ch. 11
1 3) The risk-free rate of return considers the expected rate of inflation.
Answer: TRUE
1 7) Changes in the inflation rate have a direct and pronounced effect on market interest rates.
Answer: TRUE
1) The real rate of interest is the risk free rate minus the inflation premium.
Answer: TRUE
2 7) A flat or downward sloping yield curve indicates that the economy may be heading toward a recession.
Answer: TRUE
2 11) A steep yield curve is generally considered a bullish sign for bonds.
Answer: TRUE
2 2) A yield curve depicts the term structure of interest rates for similar-risk securities.
Answer: TRUE
2 4) Treasury bond yields are commonly used as the basis for yield curves because they are low risk and homogeneous in nature.
Answer: TRUE
2 6) The real rate of return is the same for all maturities.
Answer: TRUE
2 9) According to the liquidity preference theory, borrowers should pay a higher interest rate for long-term borrowing than for short-term borrowing.
Answer: TRUE
3 5) The shorter the time to maturity, the less sensitive a bond's price will be to changes in interest rates.
Answer: TRUE
6 3) Buying bonds in anticipation of an expected decline in interest rates is a risky strategy.
Answer: TRUE
1 11) Which of the following factors will tend to cause the risk free rate to rise? I. An increase in the money supply. II. An increase in the federal budget deficit. III. An increase in the level of economic activity. IV. Falling rates in foreign markets. A) I, II, III only B) II, III only C) I and IV D) I, II, III, and IV
Answer: B
6 5) The main purpose of a bond ladder is to A) lessen the effects of changes in interest rates. B) achieve the highest level of capital gains possible. C) maintain a highly liquid portfolio. D) offset the effects of bond duration.
Answer: A
6 10) In a tax swap, a bond investor typically A) sells an issue which has a capital loss and replaces it with a comparable security. B) sells an issue that has a capital gain and replaces it with a comparable security. C) swaps a lower-yielding security for a higher-yielding security. D) swaps a higher-yielding security for a lower-yielding security.
Answer: A
5 20) The practical application of bond portfolio immunization to investors is that immunization A) allows aggressive traders to eliminate the price effects caused by interest rate changes. B) allows investors to derive a specified rate of return from bond investments for a given investment horizon. C) eliminates the possibility of losing money due to a company defaulting on its bond payments. D) allows investors to passively manage their bond portfolio once it is initially immunized.
Answer: B
6 6) Active bond trading strategies include I. buy and hold. II. trading on forecasted interest rate behavior. III. bond ladders. IV. bond swaps. A) I and III B) II and IV C) I, II, and III D) II, III, and IV
Answer: B
6 9) Suppose you sell the 10-year, A-rated 7 percent bonds you own, which are yielding 8 percent, and replace them with an equal amount of 10-year, A-rated 8 percent bonds that are priced to yield 9 percent. In this situation, you are executing A) an immunization deal. B) a yield pickup swap. C) a laddered bid. D) a spread bid.
Answer: B
6 8) Some common types of bond swaps are I. tax swaps. II. yield pickup swaps. III. substitution swaps. IV. credit default swaps. A) I and III B) II and IV C) I, II, and III D) I, II, and IV
Answer: C
5 21) Explain the basic concept of bond duration and why this measure is meaningful to investors.
Answer: Changes in interest rates affect both the price of a bond and the reinvestment rate of the interest payments. A bond's duration is the time-weighted average of its cash flows discounted at the prevailing yield to maturity on the bond. Duration addresses these opposing effects and provides investors with a means of determining how a change in interest rates will affect the price of a bond. 5 22) Explain the concept of bond immunization and the benefits derived from using this technique. -- Answer: Bond immunization is based on the offsetting reactions of bond prices and the reinvestment of interest payments. These reactions are in response to interest rate changes. Immunization is achieved when these two forces equally offset each other. The primary benefit of immunization is the ability of an investor to earn a specified rate of return on a bond portfolio regardless of what happens to market interest rates over the course of the holding period. 5 11.6 Learning Goal 6 1) In building a bond ladder, an investor invests an equal amount in a series of bonds with staggered maturities. -- Answer: TRUE
5 19) If the bond market undergoes a large change in yield (for example, more than 100 basis points), then a bond's duration will A) understate both the price appreciation when rates fall and the price decline when rates increase. B) overstate both the price appreciation when rates fall and the price decline when rates increase. C) overstate the price appreciation when rates fall and understate the price decline when rates increase. D) understate the price appreciation when rates fall and overstate the price decline when rates increase.
Answer: D
6 7) Reasons for using a bond ladder strategy include I. typically higher rates on long-term bonds. II. uncertainty concerning future interest rates. III. lower tax rates on bonds held to maturity. IV. reducing the amount of time spent managing the bond portfolio. A) I and III B) II and IV C) I, II, and III D) I, II, and IV
Answer: D
6 2) When conducting a tax swap, an investor must use identical issues in order for the swap to be allowed by the IRS.
Answer: FALSE
6 4) Once a bond portfolio is initially immunized, an investor should maintain the portfolio as it is until the end of the investment horizon.
Answer: FALSE
6 11) Explain the technique and the purpose of building bond ladders.
Answer: Investors build bond ladders by purchasing roughly equal amounts of bonds with staggered maturities ranging from short-term to some long-term investment horizon. As the short-term bonds mature, they are replaced with long term bonds. In this way, the investor is protected from changes in long-term interest rates while enjoying the typically higher yields on long-term bonds. The technique is essentially a form of dollar cost averaging.
4 2) Generally speaking, long-term bonds have lower yields than short-term bonds.
Answer: FALSE
4 16) Which one of the following statements is true about a $1,000, 6% annual coupon bond that is selling for $1,012? A) The current yield is less than 6%. B) The current yield is 6%. C) The yield-to-maturity is greater than 6%. D) The yield-to-maturity is 6%.
Answer: A
2 3) Predicting the direction of interest rate movements is relatively easy.
Answer: FALSE
2 8) According to the expectations hypothesis, if investors anticipate higher rates of inflation in the future, the yield curve will be downsloping.
Answer: FALSE
3 2) A bond's discount or premium will tend to increase as the bond approaches its maturity date.
Answer: FALSE
3 4) Bonds with the same level of risk, the same maturity, and the same coupon rate will always sell for the same price whether the interest is paid annually, semi-annually or quarterly.
Answer: FALSE
3 11.4 Learning Goal 4 1) There is normally an indirect relationship between the coupon rate of a bond and the bond's yield.
Answer: FALSE
4 9) The greater of the yield-to-call or the yield-to-maturity is used as the appropriate indicator of value.
Answer: FALSE
1 8) The required return on a bond is equal to A) the real rate of return plus a risk premium plus an expected inflation premium. B) the real rate of return plus the coupon rate plus an inflation rate. C) the risk-free rate plus a risk premium plus an expected inflation premium. D) the real rate plus a risk premium.
Answer: A
1 15) The single most important factor that influences the behavior of market interest rates is A) inflation. B) business profits. C) the supply of new bonds. D) the stock market.
Answer: A
decreases.
Answer: B
2 10) A down-sloping yield curve indicates that interest rates are about to rise.
Answer: FALSE
2 14) The expectations hypothesis states that investors A) require higher long-term interest rates today if they expect higher inflation rates in the future. B) expect higher long-term interest rates because of the lack of liquidity for long-term bonds. C) require the real rate of return to rise in direct proportion to the length of time to maturity. D) normally expect the yield curve to be downsloping.
Answer: A
2 15) According to the expectations hypothesis, investors' expectations of decreasing inflation will result in A) a downward-sloping yield curve. B) an upward-sloping yield curve. C) a flat yield curve. D) a humped yield curve.
Answer: A
2 16) Downward sloping or flat yield curves often indicate A) a recession in the near future. B) an economic expansion in the near future. C) higher inflation in the near future D) a weaker dollar in the foreign exchange markets.
Answer: A
2 18) The liquidity preference theory supports ________ yield curves. A) upsloping B) flat C) humped D) downsloping
Answer: A
2 25) Explain how a yield curve is constructed and what its shape reveals about interest rates.
Answer: A
3 13) A $1,000 par value, 12-year annual bond carries a coupon rate of 7%. If the current yield of this bond is 7.995%, its market price to the nearest dollar is A) $876. B) $925. C) $1,075. D) $1,125.
Answer: A
4 14) A bond is most likely to be called A) when investors must reinvest at lower rates. B) when the bond sells at a large discount. C) when market yields are close to coupon rates. D) when investors can reinvest at higher rates.
Answer: A
4 22) Yield-to-call is A) commonly used for bonds with deferred-call provisions. B) calculated using the time to call and the par value of the bond. C) based solely on the call premium and ignores interest payments. D) always less than the yield-to-maturity.
Answer: A
4 21) The reinvestment rate assumption is more important I. the longer the time to maturity. II. the shorter the time to maturity. III. the higher the coupon rate. IV. the lower the coupon rate. A) I and III B) I and IV C) II and III D) II and IV
Answer: A
2 5) A normal yield curve is flat or downward sloping.
Answer: FALSE
4 23) The value of a bond can be calculated several different ways, depending on the investor's objectives. Conservative, income-oriented bondholders will typically use A) promised yield, whereas aggressive bond traders are likely to use expected return. B) expected return, whereas aggressive bond traders are likely to use promised yield. C) realized yield, whereas aggressive bond traders are likely to use holding period return. D) holding period return, whereas aggressive bond traders are likely to use realized yield.
Answer: A
5 15) A portfolio consists of three bonds as follows. What is the duration of the bond portfolio? A) 7.12 years B) 8.07 years C) 8.69 years D) 11.4 years
Answer: A
1 16) Which one of the following statements concerning interest rates is correct? A) A decrease in the money supply will cause interest rates to decline. B) A federal budget surplus will cause interest rates to decline. C) Economic expansions will cause interest rates to decline. D) Rising interest rates in foreign countries will cause U.S. interest rates to decline.
Answer: B
1 13) Which of the following risks are included in the risk premium? I. interest rate risk II. liquidity risk III. financial risk IV. purchasing power risk A) I and II only B) II and III only C) III and IV only D) I and IV only
Answer: B
2 20) Market segmentation theory explains the typical upward sloping shape of yield curves as a function of A) normally greater demand for long-term bonds than for short-term notes. B) normally greater demand for short term notes than for long-term bonds. C) expectations that inflation will be higher in the future than it is now. D) the greater liquidity of short-term notes as compared to long-term bonds.
Answer: B
3 10) What is the current price of a $1,000, 6% coupon bond that pays interest semi-annually if the bond matures in ten years and has a yield-to-maturity of 7.1325%? A) $567 B) $920 C) $1,030 D) $1,080
Answer: B
3 9) What is the coupon rate of an annual bond that has a yield to maturity of 8.5%, a current price of $942.32, a par value of $1,000 and matures in thirteen years? A) 7.67% B) 7.75% C) 8.33% D) 8.50%
Answer: B
4 18) Yield to call on a bond with a coupon rate of 8% paid semi-annually, 10 years to maturity, a par value of $1,000 and a selling price of $1,071, callable after 5 years at $1,010 is A) 3.5%. B) 6.49%. C) 7.0%. D) 8.16%
Answer: B
4 12) If you are an income-oriented investor and you feel that interest rates are relatively high and will decline in the future, you should purchase A) zero-coupon, long-term bonds. B) long-term, non-callable bonds. C) short-term, zero-coupon bonds. D) long-term, freely callable bonds.
Answer: B
4 13) Which of the following statements concerning the current yield is correct? A) It is of great interest to aggressive bond investors seeking capital gains. B) It is of great interest to conservative bond investors seeking current income. C) It shows the rate of return an investor will receive by holding a bond to maturity. D) It can be determined by dividing interest income by the par value of a bond.
Answer: B
4 17) The conventional way to calculate the bond-equivalent yield (BEY) for a bond is to A) divide the coupon rate by 2. B) multiply the semi-annual yield by 2. C) subtract the approximate yield from the promised yield. D) calculate the effective annual yield.
Answer: B
4 15) Which of the following statements are correct concerning yield-to-maturity (YTM)? I. YTM considers both interest income and price appreciation. II. YTM assumes the bond is called at the earliest possible date. III. YTM is a compounded rate of return. IV. YTM assumes all interest payments are reinvested at the YTM rate. A) I and IV only B) I, III and IV only C) II, III and IV only D) I, II and III only
Answer: B
5 17) The mathematical link between a bond's price and interest rate changes is the A) Macaulay duration. B) modified duration. C) yield to market. D) yield-to-call.
Answer: B
5 8) As applied to bonds, duration refers to A) the average maturity of a diversified portfolio of corporate bonds. B) the point in the life of a bond when its price exactly offsets its reinvestment risk. C) the average price and annual reinvestment rate of return for a bond. D) the point in the life of a bond when its yield-to-maturity equals its expected yield.
Answer: B
5 12) Which of the following risks can be essentially eliminated by immunizing a bond portfolio? I. Default risk. II. Price risk. III. Reinvestment risk. IV. Liquidity risk. A) I, II and III only B) II, and III only C) II, III and IV only D) I, II, III and IV
Answer: B
1 12) Which of the following statements concerning bonds are correct? I. Municipal bond interest is federally tax-free. II. Bond yields are related to bond ratings. III. General obligation bonds yield more than revenue bonds. IV. At the time of issue, callable bonds have higher yields than noncallable bonds. A) I and III only B) II and IV only C) I, II and IV only D) I, II and III only
Answer: C
1 9) The risk-free rate of return is equal to the A) real rate plus a risk premium. B) required return minus the inflation premium. C) real rate plus the inflation premium. D) required return minus the real rate.
Answer: C
2 19) The market segmentation theory holds that A) an increase in demand for long-term borrowings leads to an inverted yield curve. B) expectations about the future level of interest rates is the major determinant of the shape of the yield curve. C) the yield curve reflects the maturity preferences of financial institutions and investors. D) the shape of the yield curve is always downsloping.
Answer: C
2 12) The yield curve depicts the relationship between a bond's yield to maturity and its A) duration. B) term to call. C) term to maturity. D) volatility.
Answer: C
2 17) Long-term bonds are ________ than short-term bonds. A) less risky B) more liquid C) subject to more uncertainty D) less sensitive to interest rate changes
Answer: C
3 11) What is the yield-to-maturity of a $1,000, 7% semi-annual coupon bond that matures in 2 years and currently sells for $997.07? A) 6.87% B) 7.04% C) 7.16% D) 7.31%
Answer: C
3 7) The price of a bond with an 8% coupon rate paid semi-annually and a par value of $1,000, and fifteen years to maturity is the present value of A) 15 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year. B) 15 payments of $80 at 6 month intervals plus $1,000 received at the end of the fifteenth year. C) 30 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year. D) 30 payments of $80 at 1 year intervals plus $1,000 received at the end of the 30th year.
Answer: C
4 19) The current yield on a bond is most similar to A) the discount rate on a Treasury Bill. B) the effective annual rate on a certificate of deposit. C) the dividend yield on a stock. D) the internal rate of return if the bond is held to maturity.
Answer: C
4 24) The yield-to-maturity (YTM) approach fails to consider which of the following risks? I. reinvestment risk II. price or market risk A) I only B) II only C) Both I and II D) Neither I nor II
Answer: C
5 10) Which one of the following bonds would have a duration that exactly matches its time to maturity? A) discount bond B) premium bond C) zero-coupon bond D) U.S. Treasury bond
Answer: C
5 14) A $1,000, 7% annual coupon bond matures in three years. The bond is currently priced at $974.23 and has a YTM of 8.0%. What is the Macaulay duration? A) 1.95 years B) 2.60 years C) 2.81 years D) 3.00 years
Answer: C
5 16) A bond matures in 30 years, has a 20 year duration and a yield to maturity of 9.32%. The change in the level of the market interest rate is 0.47%. The modified duration is A) 9.4 years. B) 14.1 years. C) 18.29 years. D) 27.44 years.
Answer: C
1 14) Which one of the following will tend to cause domestic interest rates to rise? A) an increase in the money supply B) a decrease in the rate of inflation C) a decrease in the federal budget deficit D) an increase in interest rates overseas
Answer: D
2 23) Evidence indicates that the theory of interest rates with the most predictive power is A) market segmentation theory. B) expectations theory. C) liquidity preference theory. D) a combination of expectations, market expectations and liquidity preference.
Answer: D
2 13) An inverted yield curve A) means that long-term bonds are yielding more than short-term bonds. B) exists when intermediate-term bonds have higher yields than either short-term or long-term bonds. C) rewards long-term investors for the additional risk they are assuming. D) generally results from actions by the Federal Reserve to control inflation.
Answer: D
2 21) At any given time, the yield curve is affected by I. lender preferences. II. inflationary expectations. III. liquidity preferences. IV. short- and long-term supply and demand conditions. A) I and IV only B) II, III, and IV only C) I, II and III only D) I, II, III and IV
Answer: D
2 24) If inflation is expected to increase significantly, cautious bondholders should A) expect interest rates to rise. B) expect a flat yield curve for the intermediate-term. C) buy long-term bonds today. D) move to the short-end of the yield curve.
Answer: D
2 22) If the yield curve begins to rise sharply, it is usually an indication that A) stocks are offering low returns as the economy enters a recession. B) inflation rates have peaked and are about to decline. C) bond prices are expected to increase. D) inflation is starting to increase, or is expected to do so in the near future.
Answer: D
3 12) Which of the following are needed to determine the appropriate value of a bond? I. required rate of return II. time to maturity III. frequency of interest payments IV. coupon rate A) II and III only B) III and IV only C) II, III and IV only D) I, II, III and IV
Answer: D
3 8) What is the current price of a 9%, $1,000 annual coupon bond that has eighteen years to maturity and a yield to maturity of 9.631%? A) $898 B) $935 C) $942 D) $947
Answer: D
4 11) Which one of the following statements is correct concerning bond investors? A) Aggressive investors want to lock in high interest rates. B) Aggressive investors purchase bonds when they believe interest rates will rise. C) Conservative investors seek capital gains. D) Conservative investors buy bonds when interest rates are high.
Answer: D
4 20) The actual return on a bond is dependent upon which of the following? I. the coupon rate II. the reinvested interest rate III. any changes in par value IV. any changes in market price A) I, II and III only B) II, III and IV only C) I, III and IV only D) I, II and IV only
Answer: D
5 9) Based on the concept of bond duration, which one of the following statements is correct? A) Lower coupons result in shorter durations. B) Longer maturities mean shorter durations. C) Higher yields (YTMs) lead to longer durations. D) Longer durations mean greater volatility.
Answer: D
5 11) Which of the following statements concerning duration are correct? I. Duration is a weighted-average life of a bond. II. The Macaulay duration considers the timing of a bond's cash flows. III. The Macaulay duration uses the YTM of a bond to discount the cash flows. IV. For coupon bonds, duration will be less than the actual time to maturity. A) I, II and III only B) II, III and IV only C) I, III and IV only D) I, II, III and IV
Answer: D
5 18) A bond has a YTM of 6.5%, a modified duration of 16.9 years, a duration of 18 years and a 30 year maturity. By what percentage will the bond's price change if market interest rates increase by 0.75%? A) -0.750 percent B) +0.750 percent C) +12.675 percent D) -12.675 percent
Answer: D
6 10) Rank the following taxable bonds from lowest yielding to highest yielding. I. U.S. Treasury bonds II. Corporate bonds III. Agency bonds A) I, II, III B) II, I, III C) III, II, I D) I, III, II
Answer: D
1 4) As the Federal Government's budget deficit rises, interest rates tend to fall.
Answer: FALSE
1 5) Municipal bonds usually have higher yields than bonds issued by the U. S. Government.
Answer: FALSE
1 6) The higher a bond's Moody's or Standard & Poors rating, the higher its yield.
Answer: FALSE
4 25) Explain the differences between yield-to-maturity and yield-to-call. Answer: The yield-to-maturity is based on holding a bond until it matures at which time the face value is paid. The yield-to-call is based on holding a bond until the first date at which the bond is freely callable at which time the call price will be paid. This price could be equal to the face value or it could include a call premium. 4 11.5 Learning Goal 5 1) Bond duration refers to the remaining life of a bond.
Answer: FALSE
4 3) A basis point is 1/10 of 1%.
Answer: FALSE
4 4) Bond yields are set by the bond issuer.
Answer: FALSE
4 8) Yield-to-call assumes a bond is called on the last possible date.
Answer: FALSE
5 6) A bond portfolio manager believes that interest rates are about to increase. Given this belief, the manager should buy long duration bonds and sell short duration bonds.
Answer: FALSE
yield curve plots a bond's term to maturity to its yield to maturity at any given point in time. A particular yield curve exists for only a short period of time. As the markets change, so do yield curves. Yield curves are constructed by plotting the yields for a group of bonds that are similar in all respects except maturity. The most common yield curve is upward-sloping, which means that long-term yields are higher than short-term yields. An inverted curve indicates that short-term interest rates are higher than long-term rates. A humped curve indicates that intermediate-term bonds have the highest yields. A flat curve indicates that yields are pretty much the same regardless of the bond term. 2 1) If a bond's yield to maturity is lower than its coupon rate, the bond will sell at a discount.
Answer: FALSE
1 11.2 Learning Goal 2 1) The relationship between the rate of return and the time to maturity of similar-risk securities is known as the term structure of interest rates.
Answer: TRUE
1 2) The risk premium component of a bond's market interest rate is related to the characteristics of the particular bond and its issuer.
Answer: TRUE
3 6) A significant portion of a coupon bond's total return is derived from the reinvestment of the interest payments.
Answer: TRUE
3 3) The price of a bond is equal to the present value of the bond's future cash flows.
Answer: TRUE
4 5) The required return defines the yield at which a bond should be trading and serves as the discount rate in the bond valuation process.
Answer: TRUE
4 6) A bond's yield to maturity is equal to the internal rate of return of its cash flows.
Answer: TRUE
4 7) The actual return earned on a bond is highly dependent upon the reinvestment rate of the coupons.
Answer: TRUE
4 10) Yield to call is a useful measure for bonds selling at a premium, but not for bonds selling at a discount .
Answer: TRUE
5 2) An increase in interest rates has a negative effect on bond prices and a positive effect on the reinvestment of coupons.
Answer: TRUE
5 3) The duration of a bond portfolio is the weighted average of the durations of the individual bonds included in the portfolio.
Answer: TRUE
5 4) With exception of zero coupon bonds, a bond's duration is always shorter than its time to maturity.
Answer: TRUE
5 5) When yield swings are relatively small, a bond's duration is a viable predictor of its price volatility.
Answer: TRUE
5 7) When the weighted-average duration of an investor's bond portfolio is exactly equal to the investor's desired investment horizon, then the bond portfolio is said to be immunized.
Answer: TRUE