Deck 11: Bond Valuation

Question 1

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

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

Answer 1

A

Question 2

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

Answer 2

True

Question 3

Which of the following tend to raise interest rates?
I) an increase in the money supply
II) an increase in the expected rate of inflation
III) Federal Reserve actions taken to lower expected rates of inflation
IV) an increase in investing activities by businesses

A) I, II, III only
B) II, III, IV only
C) I, II and IV only
D) I, III, and IV only

Answer 3

B

Question 4

The required rate of return on municipal bonds can be lower than on Treasury bonds because

A) they do not include an inflation premium.
B) they have less risk than Treasuries.
C) they have shorter maturities.
D) they are exempt from federal taxes.

Question 5

Actions by the Federal Reserve can not hold the risk-free rate below the rate of inflation.

Question 6

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

Question 7

A normal yield curve is flat or downward sloping.

Question 8

The real rate of return is approximately equal to

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

Question 9

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

Question 10

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

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

Question 11

Yield curves are plotted with yields on the y (vertical) axis and risk premiums on the x (horizontal) axis.

Question 12

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

Question 13

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

Question 14

The required return on a bond is equal to

A) the real rate of return plus a risk premium plus an expected inflation 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 plus a risk premium.

Question 15

Municipal bonds usually have higher yields than bonds issued by the U. S. Government.

Question 16

Which of the following factors influence short-term interest rates on government securities?
I) Federal Reserve actions
II) interest rate risk
III) expected future inflation
IV) the real rate of return

A) I and III only
B) II and IV only
C) I, II and IV only
D) I, III and IV only

Question 17

Yield curves for corporate and government securities have similar shapes, but the corporate rates track below the government rates.

Question 18

The interest rate on the 10 year Treasury Bond has rarely fallen below the rate of inflation.

Question 19

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

Question 20

Interest rates in the U.S. and in major foreign economies

A) are uncorrelated or very weakly correlated.
B) tend to move in opposite directions.
C) tend to move in the same direction.
D) are the same when adjusted for inflation.

Question 21

An inverted yield curve

A) means that long-term bonds are yielding more than short-term bonds.
B) results when investor demand for longer maturities exceeds the demand for shorter maturities.
C) rewards long-term investors for the additional risk they are assuming.
D) sometimes results from actions by the Federal Reserve to control inflation.

Question 22

Which of the following theories is consistent with yield curves sloping upward most of the time?
I) market segmentation theory
II) expectations theory
III) liquidity preference theory
IV) efficient markets hypothesis

A) III only
B) II, III and IV only
C) I, II and III only
D) I, II, III and IV

Question 23

Long term Treasury bonds are free of default risk, but not

A) call risk.
B) liquidity risk.
C) interest rate risk.
D) business risk.

Question 24

At any given time, the yield curve is affected by
I) lender preferences.
II) inflationary expectations.
III) liquidity preferences.
IV) short- and long-term supply and demand conditions.

A) I and IV only
B) II, III and IV only
C) I, II and III only
D) I, II, III and IV

Question 25

The liquidity preference theory supports yield curves.

A) upward sloping
B) flat
C) humped
D) downward sloping

Question 26

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

Question 27

Market segmentation theory explains the typical upward sloping shape of yield curves as a function of

A) normally greater demand for long-term bonds than for short-term notes.
B) normally greater demand for short term notes than for long-term bonds.
C) expectations that inflation will be higher in the future than it is now.
D) the greater liquidity of short-term notes as compared to long-term bonds.

Question 28

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

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

Question 29

According to expectations theory if the 2 year interest rate is 4% and the 1 year rate is now 3%, the 1 year rate next year is expected to be

A) 8%.
B) 5%.
C) 4%.
D) 3%.

Question 30

A primary goal of Federal Reserve actions with respect to interest rates is to

A) ensure the availability of low-interest loans.
B) reduce volatility in financial markets.
C) keep stock prices high.
D) control inflation.

Question 31

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

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

Question 32

The values of Treasury bonds can change widely with changes in interest rates.

Question 33

The expectations hypothesis states that investors

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

Question 34

Downward sloping yield curves often indicate

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

Question 35

Market segmentation theory would explain an upward sloping yield curve as a high demand for short-term securities relative to the supply.

Question 36

According to the expectations hypothesis, the relationship between today's short-term and long-term interest rates reflects investors' expectations about future interest rates.

Question 37

The market segmentation theory holds that

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

Question 38

According to expectations theory if the 1 year interest is 2.5% this year and expected to be 3.5% next year, the 2 year interest rate should be approximately

A) 8.75%.
B) 6%.
C) 3.5%.
D) 3%.

Question 39

When compared to the yield curve for Treasury securities, the yield curve for corporate securities should

A) slope in the opposite direction.
B) be similar in shape but higher.
C) be similar in shape but lower.
D) be nearly identical.

Question 40

A downward sloping yield curve (short-term rates are higher than long-term rates) often precedes a recession.

Question 41

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

Question 42

The yield to maturity on a zero coupon, $1,000 par value bond which will mature in 10 years is 5%. The price of the bond is $500.

Question 43

To the nearest dollar, what is the current price of an 8%, $1,000 annual coupon bond that has sixteen years to maturity and a yield to maturity of 7.00%?

A) $1,094
B) $1,000
C) $911
D) $701

Question 44

What is the yield-to-maturity of a $1,000, 6% semi-annual coupon bond that matures in 6 years and currently sells for $966.66?

A) 3.34%
B) 6.41%
C) 6.68%
D) 9.67%

Question 45

The price of a bond with an 6% coupon rate paid semi-annually, a par value of $1,000, and fifteen years to maturity is the present value of

A) 15 payments of $30 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
B) 15 payments of $60 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
C) 30 payments of $30 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
D) 30 payments of $60 at 1 year intervals plus $1,000 received at the end of the 30th year.

Question 46

Jordan bought a 4% semi-annual coupon bond with 25 years to maturity at par value of $1,000. If the required rate of return (yield to maturity) of this bond increases to 4.25%, by how much does the value of the bond change?

A) the price falls by $37.04
B) the price increases by $39.28
C) the price falls by $38.27
D) The value does not change if Jordan intends to hold the bond to maturity.

Question 47

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

Question 48

Bond prices change when market interest rates change.

Question 49

What is the current price of a $1,000, 5% coupon bond that pays interest semi-annually if the bond matures in ten years and has a yield-to-maturity of 7.5%?

A) $8128.40
B) $826.30
C) $897.34
D) $766.20

Question 50

A $1,000 par value, 12-year annual bond carries a coupon rate of 7%. If the current yield of this bond is 7.995%, its market price to the nearest dollar is

A) $876.
B) $925.
C) $1,075.
D) $1,125.

Question 51

If a bond's yield to maturity is lower than its coupon rate, the bond will sell at a discount.

Question 52

A bond's discount or premium will get smaller and finally disappear as the bond approaches its maturity date.

Question 53

Explain how a yield curve is constructed and what its shape reveals about interest rates.

Question 54

Liquidity preference theory suggests that when bond investors move from short-term securities to long term securities

A) they are expecting short-term rates to fall.
B) they are expecting long-term rates to rise.
C) they believe that they can earn a higher rate of return over the long term by buying bonds with longer maturities than they could by buying a series of short-term investments.
D) they want to be protected from the risk of falling bond prices in the future.

Question 55

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

Question 56

The current yield for a bond with a par value of $1,000, an annual interest payment of $57 and a market price of $950 6%.

Question 57

A bond has a coupon rate of 6%, matures in 6 years, and currently sells for $1,000 (par value). Therefore the yield to maturity is also 6%.

Question 58

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) 8.33%
D) 8.50%

Question 59

A basis point is 1/10 of 1%.

Question 60

Which of the following are needed to determine the appropriate value of a bond?
I) required rate of return
II) time to maturity
III) frequency of interest payments
IV) coupon rate

A) II and III only
B) III and IV only
C) II, III and IV only
D) I, II, III and IV

Question 61

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

Question 62

Nathan bought a zero coupon bond in 2010 for $485.19. In 2020 he redeemed it for $1,000. His internal rate of return on this investment was

A) 206.1%.
B) 20.6%.
C) 7.5%.
D) 0.00%.

Question 63

A bond's current yield is equal to the interest payment divided by par value.

Question 64

The actual return on a bond is dependent upon which of the following?
I) the coupon rate
II) whether the bond defaults or not
III) any changes in par value
IV) any changes in market price

A) I, II and III only
B) II, III and IV only
C) I, III and IV only
D) I, II and IV only

Question 65

Wayward.com $1,000 par value bonds have a 4.6% coupon paid semi-annually. They will mature in 6 years and 6 months and are currently selling at $1,015. The yield to maturity for these bonds is

A) 2.17%.
B) 4.33%.
C) 4.45%.
D) 4.00%.

Question 66

Which one of the following statements is true about a $1,000, 5% annual coupon bond that is selling for $975?

A) The current yield is more than 5%.
B) The current yield is 5%.
C) The current yield is less than 5%.
D) The yield-to-maturity is less than 5%.

Question 67

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

Question 68

Hunter bought a bond with an 8% coupon rate for $1,100 and sold it one year later for $1,150. His holding period return was

A) 11.8%.
B) 11.3%.
C) 13.0%.
D) 7.27%.

Question 69

Explain the differences between yield-to-maturity and yield-to-call.

Question 70

Yield to call on a bond with a coupon rate of 6% paid semi-annually, 5 years to maturity, a par value of $1,000 and a selling price of $1,125, callable after 5 years at $1,050 is

A) 4.12%.
B) 6.54%.
C) 3.27%.
D) 2.74%.

Question 71

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 72

Five years ago, Spencer industries issued 30 year bonds with a 7% coupon rate callable at par after five years. Inflation has subsided and the yield on bond's similar to Spencer's is now 5%.

A) Spencer is almost certain to call the bonds.
B) The yield to call on the Spencer's bonds is now 6%.
C) Spencer is not likely to call the bonds any time soon.
D) The price of the bonds will remain close to par because of their call value.

Question 73

Bond yields are set by the bond issuer.

Question 74

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

Question 75

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

Question 76

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

Question 77

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

Question 78

Which one of the following statements is correct concerning bond investors?

A) Aggressive investors want to lock in high interest rates.
B) Aggressive investors purchase bonds when they believe interest rates will rise.
C) Conservative investors seek capital gains.
D) Conservative investors buy bonds when interest rates are high.

Question 79

The current yield on a bond is most similar to

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

Question 80

Five years ago Brookfield Industries issued 30 year bonds with a 4% coupon rate callable at par after 5 years. Inflation has increased and the yield on bonds similar to Brookfield's is now 6%. Given these facts,

A) Brookfield is almost certain to call the bonds.
B) the yield to call on the Brookfield bonds is now 6%.
C) Brookfield is not likely to call the bonds any time soon.
D) the price of the bonds will remain close to par because of their call value.