Deck 8: Bond Valuation and Risk

Question 1

Zero-coupon bonds with a par value of $1,000,000 have a maturity of 10 years and a required rate of return of 9 percent. What is the current price?

A)$363,212
B)$385,500
C)$422,400
D)$424,100
E)$525,400

Answer 1

C

Question 2

The prices of bonds with ____ are most sensitive to interest rate movements.

A)high coupon payments
B)zero coupon payments
C)small coupon payments
D)None of these are correct because the size of the coupon payment does not affect the sensitivity of bond prices to interest rate movements.

Answer 2

B

Question 3

A(n)____ in the expected level of inflation results in ____ pressure on bond prices.

A)increase; upward
B)increase; downward
C)decrease; downward
D)None of these are correct.

Answer 3

B

Question 4

A bond with a $1,000 par value has an 8 percent annual coupon rate. It will mature in 4 years, and annual coupon payments are made at the end of each year. Present annual yields on similar bonds are 6 percent. What should be the current price?

A)$1,069.31
B)$1,000.00
C)$971.20
D)$927.66
E)None of these are correct.

Question 5

For a bond of a given par value, the higher the investor's required rate of return is above the coupon rate, the ​

A)greater is the premium on the price.
B)greater is the discount on the price.
C)smaller is the premium on the price.
D)smaller is the discount on the price.

Question 6

Assume that the price of a $1,000 zero-coupon bond with five years to maturity is $567 when the required rate of return is 12 percent. If the required rate of return suddenly changes to 15 percent, what is the price elasticity of the bond?

A)- .980
B)+.980
C)- .494
D)+.494
E)None of these are correct.

Question 7

A bond with a 12 percent quarterly coupon rate has a yield to maturity of 16 percent. The bond has a par value of $1,000 and matures in 20 years. Based on this information, a fair price of this bond is $____.

A)1,302
B)963
C)761
D)1,299

Question 8

From the perspective of investing institutions, the most attractive foreign bonds offer a ____ and are denominated in a currency that ____ over the investment horizon.

A)high yield; appreciates
B)high yield; remains stable
C)low yield; appreciates
D)low yield; depreciates

Question 9

The appropriate discount rate for valuing any bond is the

A)bond's coupon rate.
B)bond's coupon rate adjusted for the expected inflation rate over the life of the bond.
C)Treasury bill rate with an adjustment to include a risk premium if one exists.
D)yield that could be earned on alternative investments with similar risk and maturity.

Question 10

A bank buys bonds with a par value of $25 million for $24,040,000. The coupon rate is 10 percent, and the bonds make annual payments. The bonds mature in four years. The bank wants to sell them in two years and estimates the required rate of return in two years will be 8 percent. What will the market value of the bonds be in two years? ​

A)$24,113,418
B)$24,667,230
C)$25,000,000
D)$25,891,632

Question 11

The prices of short-term bonds are commonly ____ those of long-term bonds.

A)more volatile than
B)equally as volatile as
C)less volatile than
D)More volatile and less volatile occur with about equal frequency.

Question 12

The value of ____-risk securities will be relatively ____.

A)high; high
B)high; low
C)low; low
D)None of these are correct.

Question 13

If a financial institution's bond portfolio contains a relatively large portion of ____, it will be ____.

A)high-coupon bonds; more favorably affected by declining interest rates
B)zero- or low-coupon bonds; more favorably affected by declining interest rates
C)zero- or low-coupon bonds; more favorably affected by rising interest rates
D)high-coupon bonds; completely insulated from rising interest rates

Question 14

If the coupon rate ____ the required rate of return, the price of a bond ____ par value.

A)equals; equals
B)exceeds; is less than
C)is less than; is greater than
D)exceeds; is less than AND is less than; is greater than
E)None of these are correct.

Question 15

Other things held constant, bond prices should increase when inflationary expectations rise.

Question 16

The valuation of bonds is generally perceived to be ____ the valuation of equity securities.

A)more difficult than
B)easier than
C)just as difficult as
D)None of these are correct.

Question 17

The prices of ____-coupon bonds and bonds with ____ maturities are most sensitive to changes in the required rate of return.

A)low; short
B)low; long
C)high; short
D)high; long

Question 18

If the coupon rate equals the required rate of return, the price of the bond

A)should be above its par value.
B)should be below its par value.
C)should be equal to its par value.
D)is negligible.

Question 19

A $1,000 par bond with five years to maturity is currently priced at $892. Annual interest payments are $90. What is the yield to maturity?

A)13 percent
B)12 percent
C)11 percent
D)10 percent

Question 20

When financial institutions expect interest rates to ____, they may ____.

A)increase; sell bonds and buy short-term securities
B)increase; sell short-term securities and buy bonds
C)decrease; sell bonds and buy short-term securities
D)increase; sell short-term securities and buy bonds AND decrease; sell bonds and buy short-term securities

Question 21

Consider a coupon bond that sold at par value two years ago. If interest rates are much lower now than when this bond was issued, the coupon rate of that bond will likely be ____ the prevailing interest rates, and the present value of the bond will be ____ its par value. ​

A)above; above
B)above; below
C)below; below
D)below; above

Question 22

If the level of inflation is expected to ____, there will be ____ pressure on interest rates and ____ pressure on the required rate of return on bonds.

A)increase; upward; downward
B)decrease; upward; downward
C)decrease; upward; upward
D)increase; downward; upward
E)increase; upward; upward

Question 23

If interest rates consistently decline over a specific period, the market price of a bond you own would likely ____ over this period. (Assume no major change in the bond's credit risk.)

A)consistently increase
B)consistently decrease
C)remain unchanged
D)change in a direction that cannot be determined with the above information

Question 24

Using a(n)____ strategy, investors allocate funds evenly to bonds in each of several different maturity classes.

A)matching
B)laddered
C)barbell
D)interest rate
E)None of these are correct.

Question 25

Which of the following bonds is most susceptible to interest rate risk from an investor's perspective?

A)short-term, high-coupon
B)short-term, low-coupon
C)long-term, high-coupon
D)long-term, zero-coupon

Question 26

The actual relationship reflecting the response of a bond's price to a change in bond yields is

A)concave.
B)convex.
C)linear.
D)quadratic.

Question 27

If interest rates consistently rise over a specific period, the market price of a bond you own would likely ____ over this period. (Assume no major change in the bond's credit risk.)

A)consistently increase
B)consistently decrease
C)remain unchanged
D)change in a direction that cannot be determined with the above information

Question 28

Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The modified duration of this bond is

A)1.73 years.
B)1.81 years.
C)1.90 years.
D)None of these are correct.

Question 29

When two securities have the same expected cash flows, the value of the high-risk security will be higher than the value of the low-risk security.

Question 30

If bond portfolio managers expect interest rates to increase in the future, they would likely ____ their holdings of bonds now, which could cause the prices of bonds to ____ as a result of their actions.

A)increase; increase
B)increase; decrease
C)decrease; decrease
D)decrease; increase

Question 31

Morgan would like to purchase a bond that has a par value of $1,000, pays $80 at the end of each year in coupon payments, and has 10 years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Morgan pay for the bond?

A)$1,000.00
B)$1,147.20
C)$856.80
D)None of these are correct.

Question 32

Hurricane Corp. recently purchased corporate bonds in the secondary market with a par value of $11 million, a coupon rate of 12 percent (with annual coupon payments), and four years until maturity. If Hurricane intends to sell the bonds in two years and expects investors' required rate of return on similar investments to be 14 percent at that time, what is the expected market value of the bonds in two years?

A)$9.33 million
B)$11.00 million
C)$10.64 million
D)$9.82 million
E)None of these are correct.

Question 33

Which of the following will most likely cause bond prices to increase? (Assume no possibility of higher inflation in the future.)

A)reduced Treasury borrowing along with anticipation that money supply growth will decrease
B)reduced Treasury borrowing along with anticipation that money supply growth will increase
C)an anticipated drop in money supply growth along with increasing Treasury borrowing
D)higher levels of Treasury borrowing and corporate borrowing

Question 34

With a(n)____ strategy, funds are allocated to bonds with a short term to maturity and bonds with a long term to maturity. Thus, this strategy allocates some funds to achieving a relatively high return and other funds to covering liquidity needs.

A)matching
B)laddered
C)barbell
D)interest rate
E)None of these are correct.

Question 35

If the U.S. government announces that it will borrow an additional $400 billion, this announcement will normally cause bond traders to expect ​

A)higher interest rates in the future, and they will buy bonds now.
B)higher interest rates in the future, and they will sell bonds now.
C)stable interest rates in the future, and they will buy bonds now.
D)lower interest rates in the future, and they will buy bonds now.
E)lower interest rates in the future, and they will sell bonds now.

Question 36

If analysts expect that the demand for loanable funds will increase and the supply of loanable funds will decrease, they would most likely expect interest rates to ____ and prices of existing bonds to ____.

A)increase; increase
B)increase; decrease
C)decrease; decrease
D)decrease; increase

Question 37

The bonds that are most sensitive to interest rate movements have

A)no coupon and a short-term maturity.
B)high coupons and a short-term maturity.
C)high coupons and a long-term maturity.
D)no coupon and a long-term maturity.

Question 38

Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The duration of this bond is

A)1.90 years.
B)1.50 years.
C)1.72 years.
D)None of these are correct.

Question 39

Sioux Financial Corp. has forecasted its bond portfolio value for one year ahead to be $105 million. In one year, it expects to receive $10,000,000 in coupon payments. The bond portfolio today is worth $101 million. What is the forecasted return of this bond portfolio?

A)10 percent
B)8.82 percent
C)4.32 percent
D)13.86 percent
E)None of these are correct.

Question 40

The market value of long-term bonds is ____ sensitive to interest rate movements; as interest rates fall, the market value of long-term bonds ____.

A)slightly; rises
B)very; rises
C)very; declines
D)slightly; declines

Question 41

Assume bond portfolio managers actively manage their portfolios. If they expect interest rates to ____, they would shift toward ____.

A)increase; long-maturity bonds with zero-coupon rates
B)decrease; short-maturity bonds with high-coupon rates
C)increase; high-coupon bonds with long maturities
D)decrease; long-maturity bonds with zero-coupon rates

Question 42

Any announcement that signals stronger than expected economic growth tends to increase bond prices. ​

Question 43

International diversification of bonds reduces the sensitivity of a bond portfolio to any single country's interest rate movements.

Question 44

As interest rates increase, prices of short-term bonds will decline by a greater degree than prices of long-term bonds. ​

Question 45

Foreign investors anticipating dollar depreciation are less willing to hold U.S. bonds because the coupon payments will convert to less of their home currency.

Question 46

If the Treasury issues an unusually large amount of bonds in the primary market, it places ____ pressure on bond prices and ____ pressure on yields to be earned by investors that purchase bonds and plan to hold them to maturity.

A)downward; downward
B)downward; upward
C)upward; upward
D)upward; downward

Question 47

If the level of inflation is expected to decrease, there will be upward pressure on interest rates and on the required rate of return on bonds.

Question 48

The valuation of bonds is generally perceived to be more difficult than the valuation of equity securities.

Question 49

If the coupon rate of a bond is above the investor's required rate of return, the price of the bond should be below its par value.

Question 50

The market price of a bond is partly determined by the timing of the payments made to bondholders.

Question 51

An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return and therefore causes bond prices to increase. ​

Question 52

Which of the following is most likely to cause a decrease in bond prices?

A)a decrease in money supply growth and an increase in the demand for loanable funds
B)a forecast of decreasing oil prices
C)a forecast of a stronger dollar
D)an increase in money supply growth and no change in the demand for loanable funds

Question 53

The long-term, risk-free interest rate is driven by inflationary expectations, economic growth, the money supply, and the budget deficit. ​

Question 54

A zero-coupon bond makes no coupon payments.

Question 55

A bond portfolio containing a large portion of zero-coupon bonds will be more favorably affected by declining interest rates than a bond portfolio containing no zero-coupon bonds. ​

Question 56

The appropriate price of a bond is simply the sum of the cash flows to be received.

Question 57

Duration is a measure of the life of a bond on a present value basis. ​

Question 58

Bonds that sell below their par value are called premium bonds.

Question 59

In a laddered strategy, investors create a bond portfolio that will generate periodic income that can match their expected periodic expenses.

Question 60

Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return. ​

Question 61

Julia just purchased a $1,000 par value bond with a 10 percent annual coupon rate and a life of 20 years. The bond has four years remaining until maturity, and the yield to maturity is 12 percent. How much did Julia pay for the bond?

A)$1,063.40
B)$1,000
C)$939.25
D)None of these are correct.

Question 62

Because of a change in the required rate of return from 11 percent to 13 percent, the bond price of a zero-coupon bond will fall from $1,000 to $860. Thus, the bond price elasticity for this bond is

A)0.77.
B)- 0.77.
C)- 0.90.
D)- 1.06.
E)None of these are correct.

Question 63

A $1,000 par value bond, paying $50 semiannually, with an 8 percent yield to maturity and five years remaining to maturity should sell for

A)$1,000.00.
B)$1,081.11.
C)$798.70.
D)$880.22.
E)None of these are correct.

Question 64

Which of the following are common methods of assessing the sensitivity of bonds to a change in the required rate of return on bonds?

A)duration and convexity
B)bond yield elasticity and durability
C)bond price elasticity and return sensitivity analysis
D)bond price elasticity and duration

Question 65

When holding other factors constant, increased borrowing by the Treasury can result in a _______ required return and therefore _______ prices on existing bonds.

A)higher; lower
B)higher; higher
C)lower; higher
D)lower; lower

Question 66

A bond has a $1,000 par value and an 8 percent coupon rate. The bond has four years remaining to maturity and a 10 percent yield to maturity. This bond's modified duration is ____ years.

A)1.33
B)1.27
C)3.24
D)1.31
E)None of these are correct.

Question 67

The credit risk premium tends to be larger for bonds that have longer terms to maturity.

Question 68

The ____________ was established to identify risks in the U.S. financial system and make regulatory recommendations that could reduce such risks.

A)Financial Risk Assessment Commission
B)Financial Markets Protection Agency
C)Financial Stability Oversight Council
D)Federal Bureau of Financial Markets

Question 69

If investors rely strictly on modified duration to estimate the percentage change in the price of a bond, they will tend to ____ the price decline associated with an increase in rates and ____ the price increase associated with a decrease in rates.

A)underestimate; underestimate
B)overestimate; overestimate
C)underestimate; overestimate
D)overestimate; underestimate

Question 70

Holding other factors constant, a higher budget deficit leads to ______ interest rates, and higher inflationary expectations lead to _______ interest rates.

A)higher; lower
B)higher; higher
C)lower; higher
D)lower; lower

Question 71

Stephanie would like to purchase a bond that has a par value of $1,000, pays $100 at the end of each year in coupon payments, and has three years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 12 percent, how much will Stephanie pay for the bond?

A)$1,000.00
B)$951.97
C)$856.80
D)None of these are correct.

Question 72

The process by which higher credit risk in one country is transmitted to another country is known as

A)credit epidemic.
B)credit expansion.
C)credit contagion.
D)None of these are correct.

Question 73

An economic announcement signaling ____ economic growth in the future will probably cause bond prices to ____.

A)weak; decrease
B)strong; increase
C)weak; increase
D)strong; decrease
E)weak; increase AND strong; decrease

Question 74

The required rate of return on a certain bond changes from 12 percent to 8 percent, causing the price of the bond to change from $900 to $1,100. The bond price elasticity of this bond is ​

A)- 0.36.
B)- 0.44.
C)- 0.55.
D)- 0.67.
E)0.67.

Question 75

Systemic risk could be avoided if all financial institutions would use derivative securities as a means of insuring against the default of the debt securities that they hold.

Question 76

Which of the following is NOT a factor affecting the market price of a foreign bond held by a U.S. investor?

A)foreign interest rate movements
B)credit risk
C)exchange rate fluctuations
D)All of these are factors affecting the market price of a foreign bond.

Question 77

Assume a bond with a $1,000 par value and a 7 percent coupon rate, three years remaining to maturity, and a 9 percent yield to maturity. The duration of this bond is ____ years.

A)1.92
B)2.5
C)2.8
D)None of these are correct.

Question 78

The credit crisis of 2008-2009 had substantial effects on the credit risk premiums of bonds issued by U.S. corporations, but bonds issued by corporations based in other countries were largely unaffected.

Question 79

To determine the present value of a bond that pays semiannual interest, which of the following adjustments should not be made to compute the price of the bond?

A)The annualized coupon should be split in half.
B)The annual discount rate should be divided by 2.
C)The number of annual periods should be doubled.
D)The par value should be split in half.
E)All of these adjustments have to be made.