Deck 11: Bond Valuation

Question 1

Suppose you sell the 10- year, A- rated 7 percent bonds you own, which are yielding 8 percent, and replace them with an equal amount of 10- year, A- rated 8 percent bonds that are priced to yield 9 percent. In this situation, you are executing

A) an immunisation deal.
B) a yield pickup swap.
C) a spread bid.
D) a laddered bid.

Answer 1

B

Question 2

If inflation is expected to increase significantly, cautious bondholders should

A) expect a flat yield curve for the intermediate- term.
B) expect interest rates to rise.
C) buy long- term bonds today.
D) move to the short- end of the yield curve.

Answer 2

D

Question 3

If the bond market undergoes a large change in yield (for example, more than 100 basis points), then a bond's duration will

A) overstate both the price appreciation when rates fall and the price decline when rates increase.
B) overstate the price appreciation when rates fall and understate the price decline when rates increase.
C) understate the price appreciation when rates fall and overstate the price decline when rates increase.
D) understate both the price appreciation when rates fall and the price decline when rates increase.

Answer 3

C

Question 4

The main purpose of a bond ladder is to

A) maintain a highly liquid portfolio.
B) lessen the effects of changes in interest rates.
C) achieve the highest level of capital gains possible.
D) offset the effects of bond duration.

Question 5

The yield curve depicts the relationship between a bond's yield-to-maturity and its

A) term to call.
B) volatility.
C) duration.
D) term to maturity.

Question 6

The market segmentation theory holds that

A) an increase in demand for long- term borrowings leads to an inverted yield curve.
B) the yield curve reflects the maturity preferences of financial institutions and investors.
C) expectations about the future level of interest rates is the major determinant of the shape of the yield curve.
D) the shape of the yield curve is always downsloping.

Question 7

If the yield curve begins to rise sharply, it is usually an indication that

A) inflation is starting to increase, or is expected to do so in the near future.
B) inflation rates have peaked and are about to decline.
C) bond prices are expected to increase.
D) shares are offering low returns as the economy enters a recession.

Question 8

The required return on a bond is equal to

A) the real rate plus a risk premium.
B) the real rate of return plus the coupon rate plus an inflation rate.
C) the risk- free rate plus a risk premium plus an expected inflation premium.
D) the real rate of return plus a risk premium plus an expected inflation premium.

Question 9

What is the yield- to- maturity of a $1,000, 7% semi- annual coupon bond that matures in 2 years and currently sells for $997.07?

A) 6.87%.
B) 7.04%.
C) 7.31%.
D) 7.16%.

Question 10

Based on the concept of bond duration, which one of the following statements is correct?

A) Higher yields (YTMs) lead to longer durations.
B) Longer maturities mean shorter durations.
C) Lower coupons result in shorter durations.
D) Longer durations mean greater volatility.

Question 11

Yield- to- call is

A) always less than the yield- to- maturity.
B) commonly used for bonds with deferred- call provisions.
C) calculated using the time to call and the par value of the bond.
D) based solely on the call premium and ignores interest payments.

Question 12

The single most important factor that influences the behaviour of market interest rates is

A) the supply of new bonds.
B) business profits.
C) inflation.
D) the share market.

Question 13

An inverted yield curve

A) rewards long- term investors for the additional risk they are assuming.
B) generally results from actions by the Reserve Bank to control inflation.
C) means that long- term bonds are yielding more than short- term bonds.
D) exists when intermediate- term bonds have higher yields than either short- term or long- term bonds.

Question 14

The risk- free rate of return is equal to the

A) required return minus the real rate.
B) required return minus the inflation premium.
C) real rate plus a risk premium.
D) real rate plus the inflation premium.

Question 15

The conventional way to calculate the bond- equivalent yield (BEY) for a bond is to

A) calculate the effective annual yield.
B) subtract the approximate yield from the promised yield.
C) multiply the semi- annual yield by 2.
D) divide the coupon rate by 2.

Question 16

Which of the following statements concerning the current yield is correct?

A) It shows the rate of return an investor will receive by holding a bond to maturity.
B) It is of great interest to conservative bond investors seeking current income.
C) It can be determined by dividing interest income by the par value of a bond.
D) It is of great interest to aggressive bond investors seeking capital gains.

Question 17

A $1,000, 7% annual coupon bond matures in three years. The bond is currently priced at $974.23 and has a YTM of 8.0%. What is the Macaulay duration?

A) 3.00 years.
B) 1.95 years.
C) 2.81 years.
D) 2.60 years.

Question 18

The current yield on a bond is most similar to

A) the effective annual rate on a certificate of deposit.
B) the dividend yield on a share.
C) the internal rate of return if the bond is held to maturity.
D) the discount rate on a Treasury Bill.

Question 19

Long- term bonds are than short- term bonds.

A) subject to more uncertainty
B) more liquid
C) less sensitive to interest rate changes
D) less risky

Question 20

Yield-to-call on a bond with a coupon rate of 8% paid semi- annually, 10 years to maturity, a par value of $1,000 and a selling price of $1,071, callable after 5 years at $1,010 is

A) 7.0%.
B) 8.16%.
C) 3.5%.
D) 6.49%.

Question 21

Which one of the following statements concerning interest rates is correct?

A) Economic expansions will cause interest rates to decline.
B) A decrease in the money supply will cause interest rates to decline.
C) A federal budget surplus will cause interest rates to decline.
D) Rising interest rates in foreign countries will cause Australia interest rates to decline.

Question 22

The practical application of bond portfolio immunisation to investors is that immunisation

A) eliminates the possibility of losing money due to a company defaulting on its bond payments.
B) allows aggressive traders to eliminate the price effects caused by interest rate changes.
C) allows investors to derive a specified rate of return from bond investments for a given investment horizon.
D) allows investors to passively manage their bond portfolio once it is initially immunised.

Question 23

If you are an income- oriented investor and you feel that interest rates are relatively high and will decline in the future, you should purchase

A) zero- coupon, long- term bonds.
B) short- term, zero- coupon bonds.
C) long- term, freely callable bonds.
D) long- term, non- callable bonds.

Question 24

Which one of the following will tend to cause domestic interest rates to rise?

A) An increase in the money supply.
B) An increase in interest rates overseas.
C) A decrease in the federal budget deficit.
D) A decrease in the rate of inflation.

Question 25

The expectations hypothesis states that investors

A) normally expect the yield curve to be downsloping.
B) require higher long- term interest rates today if they expect higher inflation rates in the future.
C) require the real rate of return to rise in direct proportion to the length of time to maturity.
D) expect higher long- term interest rates because of the lack of liquidity for long- term bonds.

Question 26

The duration of a bond will increase as the time to maturity and/or as the YTM on the bond

A) increases; decreases.
B) decreases; increases.
C) decreases; decreases.
D) increases; increases.

Question 27

A bond matures in 30 years, has a 20 year duration and a yield-to-maturity of 9.32%. The change in the level of the market interest rate is 0.47%. The modified duration is

A) 27.44 years.
B) 18.29 years.
C) 9.4 years.
D) 14.1 years.

Question 28

The liquidity preference theory supports yield curves.

A) flat
B) upsloping
C) humped
D) downsloping

Question 29

What is the current price of a 9%, $1,000 annual coupon bond that has eighteen years to maturity and a yield-to-maturity of 9.631%?

A) $935.
B) $898.
C) $942.
D) $947.

Question 30

What is the coupon rate of an annual bond that has a yield-to-maturity of 8.5%, a current price of $942.32, a par value of $1,000 and matures in thirteen years?

A) 7.67%.
B) 7.75%.
C) 8.50%.
D) 8.33%.

Question 31

The value of a bond can be calculated several different ways, depending on the investor's objectives. Conservative, income- oriented bondholders will typically use

A) holding period return, whereas aggressive bond traders are likely to use realised yield.
B) promised yield, whereas aggressive bond traders are likely to use expected return.
C) realised yield, whereas aggressive bond traders are likely to use holding period return.
D) expected return, whereas aggressive bond traders are likely to use promised yield.

Question 32

Which one of the following bonds would have a duration that exactly matches its time to maturity?

A) Discount bond.
B) Zero- coupon bond.
C) Premium bond.
D) Treasury bond.

Question 33

Evidence indicates that the theory of interest rates with the most predictive power is

A) a combination of expectations, market expectations and liquidity preference.
B) liquidity preference theory.
C) market segmentation theory.
D) expectations theory.

Question 34

Downward sloping or flat yield curves often indicate

A) higher inflation in the near future
B) a weaker dollar in the foreign exchange markets.
C) a recession in the near future.
D) an economic expansion in the near future.

Question 35

In a tax swap, a bond investor typically

A) sells an issue which has a capital loss and replaces it with a comparable security.
B) swaps a lower- yielding security for a higher- yielding security.
C) swaps a higher- yielding security for a lower- yielding security.
D) sells an issue that has a capital gain and replaces it with a comparable security.

Question 36

As applied to bonds, duration refers to

A) the average price and annual reinvestment rate of return for a bond.
B) the average maturity of a diversified portfolio of corporate bonds.
C) the point in the life of a bond when its yield- to- maturity equals its expected yield.
D) the point in the life of a bond when its price exactly offsets its reinvestment risk.

Question 37

What is the current price of a $1,000, 6% coupon bond that pays interest semi- annually if the bond matures in ten years and has a yield- to- maturity of 7.1325%?

A) $1,030.
B) $567.
C) $920.
D) $1,080.

Question 38

A bond has a YTM of 6.5%, a modified duration of 16.9 years, a duration of 18 years and a 30 year maturity. By what percentage will the bond's price change if market interest rates increase by 0.75%?

A) +12.675 percent.
B) - 12.675 percent.
C) +0.750 percent.
D) - 0.750 percent.

Question 39

The price of a bond with an 8% coupon rate paid semi- annually and a par value of $1,000, and fifteen years to maturity is the present value of

A) 15 payments of $80 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
B) 30 payments of $80 at 1 year intervals plus $1,000 received at the end of the 30th year.
C) 30 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
D) 15 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.

Question 40

Which one of the following statements is true about a $1,000, 6% annual coupon bond that is selling for $1,012?

A) The current yield is 6%.
B) The yield- to- maturity is greater than 6%.
C) The yield- to- maturity is 6%.
D) The current yield is less than 6%.

Question 41

Predicting the direction of interest rate movements is relatively easy.

Question 42

A bond is most likely to be called

A) when investors can reinvest at higher rates.
B) when the bond sells at a large discount.
C) when market yields are close to coupon rates.
D) when investors must reinvest at lower rates.

Question 43

Changes in the inflation rate have a direct and pronounced effect on market interest rates.

Question 44

The greater of the yield- to- call or the yield- to- maturity is used as the appropriate indicator of value.

Question 45

Bond duration refers to the remaining life of a bond.

Question 46

Treasury bond yields are commonly used as the basis for yield curves because they are low risk and homogeneous in nature.

Question 47

According to the expectations hypothesis, investors' expectations of decreasing inflation will result in

A) a humped yield curve.
B) a flat yield curve.
C) an upward- sloping yield curve.
D) a downward- sloping yield curve.

Question 48

Yield-to-call is a useful measure for bonds selling at a premium, but not for bonds selling at a discount.

Question 49

A yield curve depicts the term structure of interest rates for similar- risk securities.

Question 50

The actual return earned on a bond is highly dependent upon the reinvestment rate of the coupons.

Question 51

The mathematical link between a bond's price and interest rate changes is the

A) modified duration.
B) yield to market.
C) yield- to- call.
D) Macaulay duration.

Question 52

Once a bond portfolio is initially immunised, an investor should maintain the portfolio as it is until the end of the investment horizon.

Question 53

The real rate of interest is the risk-free rate minus the inflation premium.

Question 54

The duration of a bond portfolio is the weighted average of the durations of the individual bonds included in the portfolio.

Question 55

A bond's discount or premium will tend to increase as the bond approaches its maturity date.

Question 56

When yield swings are relatively small, a bond's duration is a viable predictor of its price volatility.

Question 57

A normal yield curve is flat or downward sloping.

Question 58

According to the liquidity preference theory, borrowers should pay a higher interest rate for long- term borrowing than for short- term borrowing.

Question 59

Bond yields are set by the bond issuer.

Question 60

The required return defines the yield at which a bond should be trading and serves as the discount rate in the bond valuation process.

Question 61

The real rate of return is the same for all maturities.

Question 62

A bond's yield-to-maturity is equal to the internal rate of return of its cash flows.

Question 63

A bond portfolio manager believes that interest rates are about to increase. Given this belief, the manager should buy long duration bonds and sell short duration bonds.

Question 64

A down- sloping yield curve indicates that interest rates are about to rise.

Question 65

The shorter the time to maturity, the less sensitive a bond's price will be to changes in interest rates.

Question 66

Bonds with the same level of risk, the same maturity, and the same coupon rate will always sell for the same price whether the interest is paid annually, semi- annually or quarterly.

Question 67

With exception of zero-coupon bonds, a bond's duration is always shorter than its time to maturity.

Question 68

As the Federal Government's budget deficit rises, interest rates tend to fall.

Question 69

The higher a bond's Moody's or Standard & Poor's rating, the higher its yield.

Question 70

Generally speaking, long- term bonds have lower yields than short- term bonds.

Question 71

In building a bond ladder, an investor invests an equal amount in a series of bonds with staggered maturities.

Question 72

The risk- free rate of return considers the expected rate of inflation.

Question 73

A flat or downward sloping yield curve indicates that the economy may be heading toward a recession.

Question 74

According to the expectations hypothesis, if investors anticipate higher rates of inflation in the future, the yield curve will be downsloping.

Question 75

Yield- to- call assumes a bond is called on the last possible date.

Question 76

The price of a bond is equal to the present value of the bond's future cash flows.

Question 77

The relationship between the rate of return and the time to maturity of similar- risk securities is known as the term structure of interest rates.

Question 78

An increase in interest rates has a negative effect on bond prices and a positive effect on the reinvestment of coupons.

Question 79

When the weighted- average duration of an investor's bond portfolio is exactly equal to the investor's desired investment horizon, then the bond portfolio is said to be immunised.

Question 80

The risk premium component of a bond's market interest rate is related to the characteristics of the particular bond and its issuer.