Deck 17: Bond Yields and Prices

Question 1

Relative to a decrease in interest rates, an increase in rates of the same size will produce:

A) a larger percentage change in a bond's price.
B) a smaller percentage change in a bond's price.
C) the same sized change in a bond's price.
D) no change in the bond's price since its coupon rate is fixed.

Answer 1

B

Question 2

In which case will an investor not receive the promised yield to maturity?

A) The investor holds the bond until maturity and reinvests coupon payments at the original yield to maturity.
B) Interest rates do not change during the life of the bond.
C) The issuer calls the bond prior to original maturity.
D) The realized compound yield equals the promised yield to maturity.

Answer 2

C

Question 3

What is meant by "yield to maturity"? It is measured as the:

A) coupon payment divided by the face value of the bond.
B) coupon payment divided by the current price of the bond.
C) rate that equates the bond's current price with the PV of its expected future cash flows.
D) rate that equates the bond's face value with the PV of its expected future cash flows.

Answer 3

C

Question 4

If a bond has a coupon rate that is greater than the bond's YTM, the bond:

A) will sell at a premium.
B) will sell at par.
C) will sell at a discount.
D) will not be called.

Question 5

To achieve the maximum price impact from an estimated interest rate decrease, a bond buyer should purchase bonds with relatively:

A) high coupon rates and long maturities.
B) high coupon rates and short maturities.
C) low coupon rates and long maturities.
D) low coupon rates and short maturities.

Question 6

Assume an investor is considering purchasing an 8 percent semiannual bond with 8 years remaining to maturity when market rates are 6%. The bond's value is closest to:

A) $502.
B) $798.
C) $1,000.
D) $1,126.

Question 7

Which of the following statements is most accurate? The real risk-free rate of interest is:

A) the rate quoted for the shortest-term federal government securities.
B) the rate quoted for the longest-term federal government securities.
C) the rate on federal government securities adjusted to remove the effects of inflation.
D) the rate on federal government securities adjusted to remove the effects of taxes.

Question 8

Assume an investor buys an 8 percent, semi-annual, 10-year bond at par. He sells it two years later after market interest rates have decreased to 6 percent. The investor's capital gain is closest to:

A) $41.
B) $124.
C) $126.
D) $149.

Question 9

The relation between bond prices and interest rates is:

A) inverse and linear.
B) direct and linear.
C) inverse and convex.
D) inverse and concave.

Question 10

Sam holds a $1 million bond portfolio with an average maturity of 9 years, whereas Walt holds a $1 million bond portfolio with an average maturity of 3 years. If interest rates increase substantially, Sam's portfolio will experience the:

A) larger decline in value of the two portfolios.
B) larger increase in value of the two portfolios.
C) smaller decline in value of the two portfolios.
D) smaller increase in value of the two portfolios.

Question 11

The yield-to-maturity calculation assumes that coupon payments are reinvested at the:

A) coupon rate on the bond.
B) bond's current yield.
C) bond's yield to maturity.
D) forward interest rate.

Question 12

What is the difference between yield-to-maturity (YTM) and realized compound yield (RCY)?

A) They are actually the same concept.
B) YTM is the actual return, whereas, RCY is the expected return.
C) RCY is the actual return, whereas, YTM is the expected return.
D) YTM considers only coupon payments, whereas, RCY includes all a bond's cash flows.

Question 13

What happens to the price of bonds if interest rates go up?

A) The price of bonds goes up.
B) The price of bonds stays the same.
C) The price of bonds goes down.
D) The direction of price change depends on the shape of the yield curve.

Question 14

What is meant by the real risk-free rate of interest? It is the:

A) opportunity cost of foregoing consumption.
B) rate actually used in the market, not in textbooks.
C) rate quoted on long-term Treasury bonds.
D) the nominal risk-free rate, multiplied by 1 minus the marginal tax rate.

Question 15

Six years ago, Carl purchased an 8% coupon bond that had 10 years to maturity for $1,150. Since the bond purchase, the required return on the bond has remained constant. If Carl sells the bond now, the price he receives for the bond will be:

A) $1,150.
B) between $1,000 and $1,150.
C) higher than $1,150.
D) less than $1,000.

Question 16

Which of the following is included in the "realized compound yield"?

A) The bond coupon payments, only.
B) The bond coupon and principal payments, only.
C) The bond principal payment, only.
D) The bond coupon and principal payments and the reinvestment income.

Question 17

Which of the following bonds will be most sensitive to changes in market interest rates?

A) A bond with an 8 percent semiannual coupon and 8 years to maturity
B) A bond with a 6 percent semiannual coupon and 8 years to maturity
C) A bond with an 8 percent semiannual coupon and 6 years to maturity
D) A bond with a 6 percent semiannual coupon and 6 years to maturity

Question 18

An investor has three sources of dollar returns from a bond investment. Which of the following is not included among the three sources?

A) The semi-annual coupon payments
B) The interest earned on reinvesting the coupon payments
C) The principal paid at maturity
D) The interest earned on reinvesting the last coupon and the principal

Question 19

Based on which of the following term structure theories are forward rates most useful?

A) Expectations theory
B) Liquidity preference theory
C) Preferred habitat theory
D) Market segmentation theory

Question 20

In finding a bond's value, the rate used to discount the bond's future cash flows is:

A) the bond's required return.
B) the firm's weighted average cost of capital.
C) the firm's after-tax cost of debt.
D) the bond's coupon rate

Question 21

Both stocks and bonds are valued by summing the discounted future flows of interest (or dividends) and the repayment of principal (or sale of the stock).

Question 22

A 10% Ontel bond has 5 years to maturity and is selling for $1,106. What is the bond's yield to maturity (YTM)?

Question 23

Jenna owns a 7% bond that has an 8.2% yield to maturity and 10 years to maturity. If the yield to maturity on the bond increases to 9.2%, how will the bond change in value?

Question 24

Find the price for a Bisco bond that has a coupon rate of 7%, 12 years to maturity and a required yield of 6.4%.

Question 25

If interest rates rise, then price risk and reinvestment risk decline.

Question 26

When interest rates increase, the price of an ordinary bond will always fall; however, the price of a stock may increase or decrease. Explain why.

Question 27

As interest rates increase, long bonds decrease in price more slowly than short bonds.

Question 28

Walter purchased an Intel bond with a 6% coupon rate and a 15-year maturity for $970. After holding the bond for 5 years, the bond now has a 7% YTM. What return would Walter earn if he sold the bond? Assume the coupon payments are reinvested at the calculated return.

Question 29

Bond traders use the term "basis point" to mean one percentage point in interest rate.

Question 30

Acme Inc.'s pension fund plans to purchase 10-year, zero-coupon bonds. The fund plans to purchase $50 million worth of bonds. If the required return on the bonds is 7.4%, how many bonds will the fund purchase?

Question 31

Bond calculations in the United States usually involve semiannual periods because bond interest is typically paid twice a year.
n c_t FV
P = $\Sigma$ ------------ + ------------
t=1 (1 + ytm)^t (1 + ytm)ⁿ
where
P = the current market price of the bond
n = the number of semiannual periods to maturity
ytm = the semiannual yield to maturity to be solved for
c = the semiannual coupon in dollars
FV = the face value (maturity or par value) which in this discussion is always $1,000
What does this formula imply about the term structure of interest rates? How would real-world bond investors price bonds to correct for this?

Question 32

Assume a bond has a YTM of 8% and its YTM increases by 2 basis points. What is the new YTM on the bond?

A) 8.002%
B) 8.020%
C) 8.200%
D) 10.000%

Question 33

If the yield curve has a steep upward slope, investors expect:

A) interest rates to increase and inflation rates to decrease.
B) interest rates to decrease and inflation rates to increase.
C) interest rates to increase and inflation rates to increase.
D) interest rates to decrease and inflation rates to decrease.

Question 34

The vast majority of corporate bonds pay floating rates on a quarterly basis.

Question 35

If the yield curve is downward sloping, investors expect interest rates to:

A) increase and forward rates will be higher than the observed YTM.
B) increase and forward rates will be lower than the observed YTM.
C) decrease and forward rates will be higher than the observed YTM.
D) decrease and forward rates will be lower than the observed YTM.

Question 36

Reinvestment risk represents the possibility that future payments cannot be reinvested at the assumed rate.

Question 37

The observed YTM on a 5-year, zero-coupon T-bond is 4.1%, whereas a 4-year, zero-coupon T-bond is yielding 3.8%. What is the implied one-year forward rate four years from today?

Question 38

The XYZ Corp. issued 12% bonds several years ago at $975. The bonds currently have an 8.5% yield to maturity and have eight years to maturity. What is the current price of the bonds?

Question 39

A financial crisis or an accounting scandal can just as easily cause yield spreads to widen as weak earnings at a company.