Question 1

If a security's realized return is negative,it must have been true that the expected return was greater than the required return.

Accepted Answer

A) True 
 B)False  False

Question 2

Is the realized rate of return related to the expected return? the required return? Explain.

Accepted Answer

Yes and no. The required return determines the initial size of the coupon and the offer price and,as the r changes,forces the market price to change. As the buy and sell prices and reinvestment rates on coupons change,the realized return will be affected. However,the required return is an ex-ante rate designed to compensate investors for risk. The realized return may be less than or more than the expected or the required. That is the nature of risk. If you repeated the same investment with the same terms over and over,you should,on average,earn a realized return equal to the required return.

Question 3

Convexity arises because

Accepted Answer

A) bonds pay interest semiannually. 
B) coupon changes are the opposite sign of interest rate changes. 
C) duration is an increasing function of maturity. 
D) present values are a nonlinear function of interest rates. 
E) duration increases at higher interest rates. 
A) bonds pay interest semiannually. 
B) coupon changes are the opposite sign of interest rate changes. 
C) duration is an increasing function of maturity. 
D) present values are a nonlinear function of interest rates. 
E) duration increases at higher interest rates. D

Question 4

For a given interest rate change,a 20-year bond's price change will be twice that of a 10-year bond's price change.

Accepted Answer

A) True 
 B)False

Question 5

The higher a bond's coupon,the lower the bond's price volatility.

Accepted Answer

A) True 
 B)False

Question 6

A four-year maturity 0 percent coupon corporate bond with a required rate of return of 12 percent has an annual duration of ________ years.

Accepted Answer

A) 3.05 
B) 2.97 
C) 3.22 
D) 3.71 
E) 4.00 
A) 3.05 
B) 2.97 
C) 3.22 
D) 3.71 
E) 4.00

Question 7

A nine-year maturity AAA-rated corporate bond has a 6 percent coupon rate. The bond's promised yield is currently 5.75 percent and the bond sells for its FPV. The bond pays interest semiannually and has an annual duration of 7.1023 years.
A) What is the bond's convexity?
B) If promised yields decrease to 5.45 percent,what is the bond's predicted new price,including convexity?
C) Based on your result in b,would you prefer to have a bond with more or less convexity? Explain.

Accepted Answer

a. Bond's convexity: @#IMG-DLM& b. With a new prom

Question 8

For large interest rate increases,duration ________ the fall in security prices,and for large interest rate decreases,duration ________ the rise in security prices.

Accepted Answer

A) overpredicts; overpredicts 
B) overpredicts; underpredicts 
C) underpredicts; overpredicts 
D) underpredicts; underpredicts 
E) None of these choices are correct. 
A) overpredicts; overpredicts 
B) overpredicts; underpredicts 
C) underpredicts; overpredicts 
D) underpredicts; underpredicts 
E) None of these choices are correct.

Question 9

The lower the level of interest rates,the greater a bond's price sensitivity to interest rate changes.

Accepted Answer

A) True 
 B)False

Question 10

A 10-year maturity zero coupon bond will have lower price volatility than a 10-year bond with a 10 percent coupon.

Accepted Answer

A) True 
 B)False

Question 11

What is convexity? How does convexity affect duration-based predicted price changes for interest rates changes?

Accepted Answer

Duration is the first derivative of the

Question 12

Suppose you owned stock in a company for the last three years. You originally bought the stock three years ago for $30 and just sold it for $56. The stock paid an annual dividend of $1.35 on the last day of each of the past three years. What is your realized return on this investment?

Accepted Answer

A) 15.36 percent 
B) 36.14 percent 
C) 26.85 percent 
D) 37.58 percent 
E) None of these choices are correct. 
A) 15.36 percent 
B) 36.14 percent 
C) 26.85 percent 
D) 37.58 percent 
E) None of these choices are correct.

Question 13

Explain the effects of coupon and maturity on volatility.

Accepted Answer

The longer the maturity,the greater the

Question 14

The greater a security's coupon,the lower the security's price sensitivity to an interest rate change,ceteris paribus.

Accepted Answer

A) True 
 B)False

Question 15

You are considering the purchase of a certain stock. You expect to own the stock for the next four years. The current market price of the stock is $24.50 and you expect to sell it for $55 in four years. You also expect the stock to pay an annual dividend of $1.25 at the end of year 1,$1.35 at the end of year 2,$1.45 at the end of year 3 and $1.55 at the end of year 4. What is your expected return from this investment?

Accepted Answer

A) 21.78 percent 
B) 18.36 percent 
C) 26.68 percent 
D) 32.85 percent 
E) None of these choices are correct. 
A) 21.78 percent 
B) 18.36 percent 
C) 26.68 percent 
D) 32.85 percent 
E) None of these choices are correct.

Question 16

A common stock paid a dividend at the end of last year of $3.50. Dividends have grown at a constant rate of 6 percent per year over the last 20 years,and this constant growth rate is expected to continue into the future. The stock is currently selling at a price of $35 per share. What is the expected rate of return on this stock?

Accepted Answer

A) 18.7 percent 
B) 22.5 percent 
C) 16.6 percent 
D) 8.4 percent 
E) None of these choices are correct. 
A) 18.7 percent 
B) 22.5 percent 
C) 16.6 percent 
D) 8.4 percent 
E) None of these choices are correct.

Question 17

An annual payment bond has a 9 percent required return. Interest rates are projected to fall 25 basis points. The bond's duration is 12 years. What is the predicted price change?

Accepted Answer

A) −2.75 percent 
B) 33.33 percent 
C) 1.95 percent 
D) −1.95 percent 
E) 2.75 percent 
A) −2.75 percent 
B) 33.33 percent 
C) 1.95 percent 
D) −1.95 percent 
E) 2.75 percent

Question 18

Any security that returns a greater percentage of the price sooner is less price-volatile.

Accepted Answer

A) True 
 B)False

Question 19

Which would have a longer duration: (a)a five-year fully amortized installment loan with semiannual payments or (b)a five-year semiannual payment bond,ceteris paribus. Why?

Accepted Answer

The bond will have a longer duration bec

Question 20

All else equal,the holder of a fairly priced premium bond must expect a capital loss over the holding period.

Accepted Answer

A) True 
 B)False

Exam 3: Interest Rates and Security Valuation

If a security's realized return is negative,it must have been true that the expected return was greater than the required return.

Is the realized rate of return related to the expected return? the required return? Explain.

Convexity arises because

For a given interest rate change,a 20-year bond's price change will be twice that of a 10-year bond's price change.

The higher a bond's coupon,the lower the bond's price volatility.

A four-year maturity 0 percent coupon corporate bond with a required rate of return of 12 percent has an annual duration of ________ years.

For large interest rate increases,duration ________ the fall in security prices,and for large interest rate decreases,duration ________ the rise in security prices.

The lower the level of interest rates,the greater a bond's price sensitivity to interest rate changes.

A 10-year maturity zero coupon bond will have lower price volatility than a 10-year bond with a 10 percent coupon.

What is convexity? How does convexity affect duration-based predicted price changes for interest rates changes?

Suppose you owned stock in a company for the last three years. You originally bought the stock three years ago for $30 and just sold it for $56. The stock paid an annual dividend of $1.35 on the last day of each of the past three years. What is your realized return on this investment?

Explain the effects of coupon and maturity on volatility.

The greater a security's coupon,the lower the security's price sensitivity to an interest rate change,ceteris paribus.

An annual payment bond has a 9 percent required return. Interest rates are projected to fall 25 basis points. The bond's duration is 12 years. What is the predicted price change?

Any security that returns a greater percentage of the price sooner is less price-volatile.

Which would have a longer duration: (a)a five-year fully amortized installment loan with semiannual payments or (b)a five-year semiannual payment bond,ceteris paribus. Why?

All else equal,the holder of a fairly priced premium bond must expect a capital loss over the holding period.

Introduction

Determinants of Interest Rates

The Federal Reserve System, monetary Policy, and Interest Rates

Money Markets

Bond Markets

Mortgage Markets

Stock Markets

Foreign Exchange Markets

Derivative Securities Markets

Commercial Banks: Industry Overview

Commercial Banks Financial Statements and Analysis

Regulation of Commercial Banks

Other Lending Institutions: Savings Institutions, credit Unions, and Finance Companies

Insurance Companies

Securities Firms and Investment Banks

Investment Companies

Pension Funds

Types of Risks Incurred by Financial Institutions

Managing Credit Risk on the Balance Sheet

Managing Liquidity Risk on the Balance Sheet

Managing Interest Rate Risk and Insolvency Risk on the Balance Sheet

Managing Risk Off the Balance Sheet With Derivative Securities

Managing Risk Off the Balance Sheet With Loan Sales and Securitization

Filters

For large interest rate increases,duration the fall in security prices,and for large interest rate decreases,duration the rise in security prices.