Finance Quiz #2

A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, companies call bonds if interest rates rise and do not call them if interest rates decline. True/False

False

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. True/False

False

One of the four most fundamental factors that affect the cost of money as discussed in the text is the availability of production opportunities and their expected rates of return. If production opportunities are relatively good, then interest rates will tend to be relatively high, other things held constant. True/False

True

Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.90%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. a. ​8.83 b. ​7.16 c. ​7.42 d. ​8.04 e. ​6.63

a. 8.83

Adams Enterprises' noncallable bonds currently sell for $910. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity? a. 9.66% b. 9.95% c. 11.21% d. 7.34% e. 8.60%

a. 9.66%

Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 5.00%, based on semiannual compounding. What is the bond's price? a. $1,050.15 b. $1,235.47 c. $1,457.85 d. $1,359.01 e. $976.02

b. $1,235.47

Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT? a. The yield curve should be downward sloping, with the rate on a 1-year bond at 6%. b. The interest rate today on a 3-year bond should be approximately 7%. c. The interest rate today on a 2-year bond should be approximately 7%. d. The interest rate today on a 2-year bond should be approximately 6%. e. The interest rate today on a 3-year bond should be approximately 8%.

b. The interest rate today on a 3-year bond should be approximately 7%.

5-year Treasury bonds yield 4.4%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year T-bonds is 0.4%. There is no liquidity premium on these bonds. What is the real risk-free rate, r*? a. 1.91% b. 2.58% c. 2.21% d. 2.10% e. 2.39%

d. 2.10%

A 10-year 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? a. The prices of both bonds would increase by the same amount. b. The prices of both bonds will decrease by the same amount. c. One bond's price would increase, while the other bond's price would decrease. d. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. e. The prices of the two bonds would remain constant.

d. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.

Sadik Inc.'s bonds currently sell for $1,300 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)? a. 6.00% b. 4.30% c. 4.94% d. 5.10% e. 5.31%

e. 5.31%

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant. True/False

False

Because the maturity risk premium is normally positive, the yield curve is normally upward sloping. True/False

True

If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward sloping yield curve. True/False

True

Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength. True/False

True

Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. True/False

True

The "yield curve" shows the relationship between bonds' maturities and their yields. True/False

True

The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak. True/False

True

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation. True/False

True

Radoski Corporation's bonds make an annual coupon interest payment of 7.35% every year. The bonds have a par value of $1,000, a current price of $920, and mature in 12 years. What is the yield to maturity on these bonds? a. 8.44% b. 9.53% c. 7.25% d. 8.10% e. 6.83%

a. 8.44%

Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows: T-bond = 7.72% A = 9.64% AAA = 8.72% BBB = 10.18% The differences in rates among these issues were most probably caused primarily by: a. Default risk and liquidity differences. b. Real risk-free rate differences. c. Tax effects. d. Inflation differences. e. Maturity risk differences.

a. Default risk and liquidity differences.

In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t 1)%, where t is the number of years until the bond matures. Given this information, which of the following statements is CORRECT? a. The yield on 2-year Treasury securities must exceed the yield on 5-year Treasury securities. b. The yield curve must be upward sloping. c. The yield on 5-year corporate bonds must exceed the yield on 8-year Treasury bonds. d. The yield on 5-year Treasury securities must exceed the yield on 10-year corporate bonds. e. The yield curve must be "humped."

b. The yield curve must be upward sloping.

Grossnickle Corporation issued 20-year, noncallable, 7.4% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity? a. $1,196.13 b. $1,013.05 c. $1,220.55 d. $1,281.57 e. $1,000.85

c. $1,220.55

Ryngaert Inc. recently issued noncallable bonds that mature in 15 years. They have a par value of $1,000 and an annual coupon of 5.7%. If the current market interest rate is 7.0%, at what price should the bonds sell? a. $1,013.84 b. $1,040.28 c. $881.60 d. $802.25 e. $775.81

c. $881.60

Which of the following factors would be most likely to lead to an increase in nominal interest rates? a. There is a decrease in expected inflation. b. The economy falls into a recession. c. A new technology like the Internet has just been introduced, and it increases investment opportunities. d. Households reduce their consumption and increase their savings. e. The Federal Reserve decides to try to stimulate the economy.

c. A new technology like the Internet has just been introduced, and it increases investment opportunities.

Which of the following would be most likely to lead to a higher level of interest rates in the economy? a. The level of inflation begins to decline. b. The economy moves from a boom to a recession. c. Corporations step up their expansion plans and thus increase their demand for capital. d. Households start saving a larger percentage of their income. e. The Federal Reserve decides to try to stimulate the economy.

c. Corporations step up their expansion plans and thus increase their demand for capital.

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by: a. Real risk-free rate differences. b. Tax effects. c. Default and liquidity risk differences. d. Inflation differences. e. Maturity risk differences.

c. Default and liquidity risk differences.

Which of the following statements is CORRECT? a. The real risk-free rate should increase if people expect inflation to increase. b. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond. c. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond. d. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond. e. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond.

c. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 4.10%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. a. 4.49 b. 3.57 c. 3.82 d. ​4.20 e. 4.41

d. ​4.20

Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 7.00%. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a.11.59% b.7.41% c.8.46% d.9.50% e.7.70%

d.9.50%

Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 5.90%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 9.27% b. 7.29% c. 10.35% d. 8.91% e. 9.00%

e. 9.00%

Which of the following statements is CORRECT? a. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds. b. If the expectations theory holds, the Treasury bond yield curve will never be downward sloping. c. If the maturity risk premium (MRP) equals zero, the Treasury bond yield curve must be flat. d. If the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. e. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.

e. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.

A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT? a. The bond is currently selling at a price below its par value. b. If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today. c. If market interest rates decline, the price of the bond will also decline. d. The bond should currently be selling at its par value. e. If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.

e. If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.

Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT? a. In equilibrium, long-term rates must be equal to short-term rates. b. Consumer prices as measured by an index of inflation are expected to rise at a constant rate. c. An upward-sloping yield curve implies that future short-term rates are expected to decline. d. Inflation is expected to be zero. e. The maturity risk premium is assumed to be zero.

e. The maturity risk premium is assumed to be zero.