FIN 310 Test 2

Which of the following bonds would have the greatest percentage increase in value of all interest rates in the economy fall by 1%?

20-year, zero coupon bond

Which of the following statements is CORRECT?

Even if the pure expectations theory is correct, there might at times be an inverted treasury yield curve.

Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds.

False

One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant.

False

Assuming the pure expectations theory is correct, which of the following statements is CORRECT?

If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise/

Which of the following statements is CORRECT, other things held constant?

If expected inflation increases, interest rates are likely to increase

Assume that a non-callable 10-year T-bond has a 12% annual coupon, while a 15-year non-callable T-bond has an 8% annual coupon. Assume also that the yield curve is flat, and all Treasury securities have a 10% yield to maturity. If interest rates decline, which is more likely to be true: the prices of both bonds would increase, but the 15-year bond would have a larger percentage increase in price; or the prices of both bonds would increase, but the 10-year bond would have a larger percentage increase in price.

If interest rates decline the prices of both bonds would increase, but the 15 year bond would have a larger percentage increase in price

Bond X has a 8% annual coupon, bond Y has a 10% annual coupon, and Bond Z has a 12% annual coupon. Each of the bonds is non-callable, has a maturity of 10 years and has a yield to maturity of 10%. Which of the following is correct?

If the bond's market interest rate remains at 10%, Bond Z's price will be lower one-year from now than it is today.

Which of the following statements is correct?

Reinvestment risk is lower, other things held constant, on long-term than on short term bonds.

Which of the following is correct?

The price of a discount bond will increase over time, assuming that the bond's yield to maturity remains constant

If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?

The yield on a 10-year bond would be less than that one 1-year bill.

Assume the following: the real risk-free rate, r*, is supposed to remain constant at 3%. Inflation is expected to be 3% next year then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given the information, which of the following statements is CORRECT?

This problem assumed a zero maturity risk premium, but that is probably not valid in the real world

If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.

True

The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present.

True

Which of the following bonds has the greatest price risk?

a 10-year, 1000 face value, zero coupon bond

A 10-Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?

both bonds would decline in price but the 10-year bond would have the greater percentage decline in price.

Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond.

false

Assume that the current corporate bond yield curve is upward sloping or normal. Under this condition, we could be sure that

maturity risk premiums could help to explain the yield curve's upward slope

You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity and the YTM is expected to remain constant. Which of the following is correct?

the price of Bond A will decrease over time but the price of Bond B will increase over time.

Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return?

the required rate of return would increase because of the bond would then be more risky to a bondholder.

Which of the following statements is true?

the total (rate of) return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year divided by the bond's price at the beginning of the year.

Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.

true

During periods where inflation is increasing, interest rates tend to increase, while interest rates tend to fall is when inflation is declining

true

The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk."

true

as a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured

true