Money & Banking Chapter 4.2

Open Question Your favorite uncle advises you to purchase long-term bonds because their interest rate is 10%. 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 uncles 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.

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

Answer: A

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

Answer: A

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

Answer: 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

Answer: A

Which of the following are 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 bonds 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.

Answer: A

Which of the following are 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.

Answer: A

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.

Answer: B

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

Answer: B

Which of the following are generally true of all bonds? A) The longer a bonds 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.

Answer: B

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

Answer: C

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

Answer: C

The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $950 next year is A) -10 percent. B) -5 percent. C) 0 percent. D) 5 percent.

Answer: C

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 next year? A) 5 percent B) 10 percent C) -5 percent D) -10 percent

Answer: C

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.

Answer: D

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

Answer: D

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 next year? A) 5 percent B) 10 percent C) -5 percent D) 25 percent

Answer: D