Fin 334 Test 2 Ch. 11
T/F: A bond's yield to maturity is equal to the internal rate of return of its cash flows.
True
T/F: A significant portion of a coupon bond's total return is derived from the reinvestment of the interest payments.
True
T/F: A steep yield curve is generally considered a bullish sign for bonds.
True
T/F: A yield curve depicts the term structure of interest rates for similar-risk securities.
True
T/F: According to the liquidity preference theory, borrowers should pay a higher interest rate for long-term borrowing than for short-term borrowing.
True
T/F: An increase in interest rates has a negative effect on bond prices and a positive effect on the reinvestment of coupons.
True
T/F: Buying bonds in anticipation of an expected decline in interest rates is a risky strategy.
True
T/F: Changes in the inflation rate have a direct and pronounced effect on market interest rates.
True
T/F: In building a bond ladder, an investor invests an equal amount in a series of bonds with staggered maturities.
True
T/F: The actual return earned on a bond is highly dependent upon the reinvestment rate of the coupons.
True
T/F: The duration of a bond portfolio is the weighted average of the durations of the individual bonds included in the portfolio.
True
T/F: The price of a bond is equal to the present value of the bond's future cash flows.
True
T/F: The real rate of interest is the risk free rate minus the inflation premium.
True
T/F: The real rate of return is the same for all maturities.
True
T/F: 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.
True
T/F: The required return defines the yield at which a bond should be trading and serves as the discount rate in the bond valuation process.
True
T/F: The risk premium component of a bond's market interest rate is related to the characteristics of the particular bond and its issuer.
True
T/F: The risk-free rate of return considers the expected rate of inflation.
True
T/F: The shorter the time to maturity, the less sensitive a bond's price will be to changes in interest rates.
True
T/F: Treasury bond yields are commonly used as the basis for yield curves because they are low risk and homogeneous in nature.
True
T/F: 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.
True
T/F: When yield swings are relatively small, a bond's duration is a viable predictor of its price volatility.
True
T/F: With exception of zero coupon bonds, a bond's duration is always shorter than its time to maturity.
True
T/F: Yield to call is a useful measure for bonds selling at a premium, but not for bonds selling at a discount .
True
T/F: Municipal bonds usually have higher yields than bonds issued by the U. S. Government.
False: ---> Lower
T/F: As the Federal Government's budget deficit rises, interest rates tend to fall.
False: ---> Rise (More Debt, More Interest)
T/F: A normal yield curve is flat or downward sloping.
False: ---> Upward
T/F: Predicting the direction of interest rate movements is relatively easy.
False: ---> Very Difficult
T/F: According to the expectations hypothesis, if investors anticipate higher rates of inflation in the future, the yield curve will be downsloping.
False: --->Upsloping
T/F: If a bond's yield to maturity is lower than its coupon rate, the bond will sell at a discount.
False: -->Premium
The yield-to-maturity (YTM) approach fails to consider which of the following risks? I. reinvestment risk II. price or market risk
I and II (Both)
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.
I and III
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
$876
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%?
$920
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%?
$947
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%?
-12.675 percent
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
18.29 years.
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?
2.81 years
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
30 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
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
6.49%
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?
7.16%
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?
7.75%
Which one of the following statements concerning interest rates is correct?
A federal budget surplus will cause interest rates to decline.
Explain how a yield curve is constructed and what its shape reveals about interest rates.
A 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.
T/F: A basis point is 1/10 of 1%
False:
Explain the concept of bond immunization and the benefits derived from using this technique.
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.
Explain the basic concept of bond duration and why this measure is meaningful to investors.
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.
Which one of the following statements is correct concerning bond investors?
Conservative investors buy bonds when interest rates are high.
T/F: 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.
False:
T/F: There is normally an indirect relationship between the coupon rate of a bond and the bond's yield.
False: ---> Direct
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.
I, II and IV only
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.
I, II, III and IV (All)
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
I, II, III and IV (All)
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.
I, II, III and IV (All)
Some common types of bond swaps are I. tax swaps. II. yield pickup swaps. III. substitution swaps. IV. credit default swaps.
I, II, and III
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.
I, II, and IV
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.
I, III and IV only
Rank the following taxable bonds from lowest yielding to highest yielding. I. U.S. Treasury bonds II. Corporate bonds III. Agency bonds
I, III, II
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
II and III only
Active bond trading strategies include I. buy and hold. II. trading on forecasted interest rate behavior. III. bond ladders. IV. bond swaps.
II and IV
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.
II, III only
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.
II, and III only
Explain the technique and the purpose of building bond ladders.
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.
Which of the following statements concerning the current yield is correct?
It is of great interest to conservative bond investors seeking current income.
Based on the concept of bond duration, which one of the following statements is correct?
Longer durations mean greater volatility.
Explain the differences between yield-to-maturity and yield-to-call.
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.
The mathematical link between a bond's price and interest rate changes is the
modified duration.
Evidence indicates that the theory of interest rates with the most predictive power is
a combination of expectations, market expectations and liquidity preference.
According to the expectations hypothesis, investors' expectations of decreasing inflation will result in
a downward-sloping yield curve.
Downward sloping or flat yield curves often indicate
a recession in the near future.
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 yield pickup swap.
The practical application of bond portfolio immunization to investors is that immunization
allows investors to derive a specified rate of return from bond investments for a given investment horizon.
Yield-to-call is
commonly used for bonds with deferred-call provisions.
If inflation is expected to increase significantly, cautious bondholders should
move to the short-end of the yield curve.
An inverted yield curve
generally results from actions by the Federal Reserve to control inflation.
The conventional way to calculate the bond-equivalent yield (BEY) for a bond is to
multiply the semi-annual yield by 2.
The duration of a bond will increase as the time to maturity ________ and/or as the YTM on the bond ________
increases; decreases.
The single most important factor that influences the behavior of market interest rates is
inflation.
The main purpose of a bond ladder is to
lessen the effects of changes in interest rates.
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
long-term, non-callable bonds.
Market segmentation theory explains the typical upward sloping shape of yield curves as a function of
normally greater demand for short term notes than for long-term bonds.
The value of a bond can be calculated several different ways, depending on the investor's objectives. Conservative, income-oriented bondholders will typically use
promised yield, whereas aggressive bond traders are likely to use expected return.
The risk-free rate of return is equal to the
real rate plus the inflation premium.
The expectations hypothesis states that investors
require higher long-term interest rates today if they expect higher inflation rates in the future.
In a tax swap, a bond investor typically
sells an issue which has a capital loss and replaces it with a comparable security.
Long-term bonds are ________ than short-term bonds.
subject to more uncertainty
The yield curve depicts the relationship between a bond's yield to maturity and its
term (time) to maturity.
The current yield on a bond is most similar to
the dividend yield on a stock.
As applied to bonds, duration refers to
the point in the life of a bond when its price exactly offsets its reinvestment risk.
The required return on a bond is equal to
the real rate of return plus a risk premium plus an expected inflation premium.
The market segmentation theory holds that
the yield curve reflects the maturity preferences of financial institutions and investors.
If the bond market undergoes a large change in yield (for example, more than 100 basis points), then a bond's duration will
understate the price appreciation when rates fall and overstate the price decline when rates increase.
The liquidity preference theory supports ________ yield curves.
upsloping
A bond is most likely to be called
when investors must reinvest at lower rates.
Which one of the following bonds would have a duration that exactly matches its time to maturity?
zero-coupon bond