Deck 3: What Do Interest Rates Mean and What Is Their Role in Valuation

Question 1

A loan that requires the borrower to make the same payment every period until the maturity date is called a

A)simple loan.
B)fixed-payment loan.
C)discount loan.
D)same-payment loan.
E)none of the above.

Answer 1

fixed-payment loan.

Question 2

Which of the following are generally true of all bonds?

A)The longer a bond's maturity, the lower is the rate of return that occurs as a result of the increase in the interest rate.
B)Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise.
C)Prices and returns for long-term bonds are more volatile than those for shorter-term bonds.
D)All of the above are true.
E)Only A and B of the above are true.

Answer 2

All of the above are true.

Question 3

A coupon bond pays the owner of the bond

A)the same amount every month until the maturity date.
B)a fixed interest payment every period, plus the face value of the bond at the maturity date.
C)the face value of the bond plus an interest payment once the maturity date has been reached.
D)the face value at the maturity date.
E)none of the above.

Answer 3

a fixed interest payment every period, plus the face value of the bond at the maturity date.

Question 4

The interest rate that equates the present value of the cash flow received from a debt instrument with its market price today is the

A)simple interest rate.
B)discount rate.
C)yield to maturity.
D)real interest rate.

Question 5

Financial economists consider the ________ to be the most accurate measure of interest rates.

A)simple interest rate
B)discount rate
C)yield to maturity
D)real interest rate

Question 6

With an interest rate of 6 percent, the present value of $100 received one year from now is approximately

A)$106.
B)$100.
C)$94.
D)$92.

Question 7

An $8,000 coupon bond with a $400 annual coupon payment has a coupon rate of

A)5 percent.
B)8 percent.
C)10 percent.
D)40 percent.

Question 8

The concept of ________ is based on the notion that a dollar paid to you in the future is less valuable to you than a dollar today.

A)present value
B)future value
C)interest
D)deflation

Question 9

(I)A discount bond requires the borrower to repay the principal at the maturity date plus an interest payment. (II)A coupon bond pays the lender a fixed interest payment every year until the maturity date, when a specified final amount (face or par value)is repaid.

A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Question 10

Which of the following are true of coupon bonds?

A)The owner of a coupon bond receives a fixed interest payment every year until the maturity date, when the face or par value is repaid.
B)U)S. Treasury bonds and notes are examples of coupon bonds.
C)Corporate bonds are examples of coupon bonds.
D)All of the above.
E)Only A and B of the above.

Question 11

If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is

A)$650.
B)$1,300.
C)$130.
D)$13.
E)None of the above.

Question 12

The process of calculating what dollars received in the future are worth today is called

A)calculating the yield to maturity.
B)discounting the future.
C)compounding the future.
D)compounding the present.

Question 13

With an interest rate of 8 percent, the present value of $100 received one year from now is approximately

A)$93.
B)$96.
C)$100.
D)$108.

Question 14

With an interest rate of 5 percent, the present value of $100 received one year from now is approximately

A)$100.
B)$105.
C)$95.
D)$90.

Question 15

A credit market instrument that pays the owner the face value of the security at the maturity date and nothing prior to then is called a

A)simple loan.
B)fixed-payment loan.
C)coupon bond.
D)discount bond.

Question 16

(I)A simple loan requires the borrower to repay the principal at the maturity date along with an interest payment. (II)A discount bond is bought at a price below its face value, and the face value is repaid at the maturity date.

A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Question 17

The interest rate that financial economists consider to be the most accurate measure is the

A)current yield.
B)yield to maturity.
C)yield on a discount basis.
D)coupon rate.

Question 18

Dollars received in the future are worth ________ than dollars received today. The process of calculating what dollars received in the future are worth today is called ________.

A)more; discounting
B)less; discounting
C)more; inflating
D)less; inflating

Question 19

With an interest rate of 10 percent, the present value of a security that pays $1,100 next year and $1,460 four years from now is approximately

A)$1,000.
B)$2,000.
C)$2,560.
D)$3,000.

Question 20

A bond's future payments are called its

A)cash flows.
B)maturity values.
C)discounted present values.
D)yields to maturity.

Question 21

If a $10,000 face value discount bond maturing in one year is selling for $8,000, then its yield to maturity is

A)10 percent.
B)20 percent.
C)25 percent.
D)40 percent.

Question 22

If a $10,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is

A)5 percent.
B)10 percent.
C)50 percent.
D)100 percent.

Question 23

A frequently used approximation for the yield to maturity on a long-term bond is the

A)coupon rate.
B)current yield.
C)cash flow interest rate.
D)real interest rate.

Question 24

The yield to maturity on a consol bond that pays $200 yearly and sells for $1000 is

A)5 percent.
B)10 percent.
C)20 percent.
D)25 percent.

Question 25

Which of the following are true for a coupon bond?

A)When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate.
B)The price of a coupon bond and the yield to maturity are negatively related.
C)The yield to maturity is greater than the coupon rate when the bond price is above the par value.
D)All of the above are true.
E)Only A and B of the above are true.

Question 26

The yield to maturity on a consol bond that pays $100 yearly and sells for $500 is

A)5 percent.
B)10 percent.
C)12.5 percent.
D)20 percent.
E)25 percent.

Question 27

If a $10,000 face value discount bond maturing in one year is selling for $9,000, then its yield to maturity is approximately

A)9 percent.
B)10 percent.
C)11 percent.
D)12 percent.

Question 28

A consol bond is a bond that

A)pays interest annually and its face value at maturity.
B)pays interest in perpetuity and never matures.
C)pays no interest but pays its face value at maturity.
D)rises in value as its yield to maturity rises.

Question 29

The current yield on a coupon bond is the bond's ________ divided by its ________.

A)annual coupon payment; price
B)annual coupon payment; face value
C)annual return; price
D)annual return; face value

Question 30

Which of the following are true for a coupon bond?

A)When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate.
B)The price of a coupon bond and the yield to maturity are negatively related.
C)The yield to maturity is greater than the coupon rate when the bond price is below the par value.
D)All of the above are true.
E)Only A and B of the above are true.

Question 31

A $10,000, 8 percent coupon bond that sells for $10,000 has a yield to maturity of

A)8 percent.
B)10 percent.
C)12 percent.
D)14 percent.

Question 32

Which of the following are true for a coupon bond?

A)When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate.
B)The price of a coupon bond and the yield to maturity are positively related.
C)The yield to maturity is greater than the coupon rate when the bond price is above the par value.
D)All of the above are true.
E)Only A and B of the above are true.

Question 33

For a simple loan, the simple interest rate equals the

A)real interest rate.
B)nominal interest rate.
C)current yield.
D)yield to maturity.

Question 34

Which of the following $1,000 face value securities has the highest yield to maturity?

A)A 5 percent coupon bond selling for $1,000
B)A 10 percent coupon bond selling for $1,000
C)A 12 percent coupon bond selling for $1,000
D)A 12 percent coupon bond selling for $1,100

Question 35

The yield to maturity of a one-year, simple loan of $500 that requires an interest payment of $40 is

A)5 percent.
B)8 percent.
C)12 percent.
D)12.5 percent.

Question 36

Which of the following $1,000 face value securities has the highest yield to maturity?

A)A 5 percent coupon bond selling for $1,000
B)A 10 percent coupon bond selling for $1,000
C)A 15 percent coupon bond selling for $1,000
D)A 15 percent coupon bond selling for $900

Question 37

The yield to maturity for a one-year discount bond equals

A)the increase in price over the year, divided by the initial price.
B)the increase in price over the year, divided by the face value.
C)the increase in price over the year, divided by the interest rate.
D)none of the above.

Question 38

When a bond's price falls, its yield to maturity ________ and its current yield ________.

A)falls; falls
B)rises; rises
C)falls; rises
D)rises; falls

Question 39

For simple loans, the simple interest rate is ________ the yield to maturity.

A)greater than
B)less than
C)equal to
D)not comparable to

Question 40

The yield to maturity of a one-year, simple loan of $400 that requires an interest payment of $50 is

A)5 percent.
B)8 percent.
C)12 percent.
D)12.5 percent.

Question 41

The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,100 one year later is

A)5 percent.
B)10 percent.
C)14 percent.
D)15 percent.

Question 42

The nominal interest rate minus the expected rate of inflation

A)defines the real interest rate.
B)is a better measure of the incentives to borrow and lend than the nominal interest rate.
C)is a more accurate indicator of the tightness of credit market conditions than the nominal interest rate.
D)all of the above.
E)only A and B of the above.

Question 43

If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding?

A)A bond with one year to maturity
B)A bond with five years to maturity
C)A bond with ten years to maturity
D)A bond with twenty years to maturity

Question 44

Which of the following are generally true of all bonds?

A)The only bond whose return equals the initial yield to maturity is one whose time to maturity is the same as the holding period.
B)A rise in interest rates is associated with a fall in bond prices, resulting in capital losses on bonds whose term to maturities are longer than the holding period.
C)The longer a bond's maturity, the greater is the price change associated with a given interest rate change.
D)All of the above are true.
E)Only A and B of the above are true.

Question 45

Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding?

A)5 percent
B)10 percent
C)15 percent
D)20 percent

Question 46

(I)Prices of longer-maturity bonds respond more dramatically to changes in interest rates. (II)Prices and returns for long-term bonds are less volatile than those for short-term bonds.

A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Question 47

In which of the following situations would you prefer to be borrowing?

A)The interest rate is 9 percent and the expected inflation rate is 7 percent.
B)The interest rate is 4 percent and the expected inflation rate is 1 percent.
C)The interest rate is 13 percent and the expected inflation rate is 15 percent.
D)The interest rate is 25 percent and the expected inflation rate is 50 percent.

Question 48

The nominal interest rate minus the expected rate of inflation

A)defines the real interest rate.
B)is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate.
C)is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate.
D)defines the discount rate.

Question 49

The Fisher equation states that

A)the nominal interest rate equals the real interest rate plus the expected rate of inflation.
B)the real interest rate equals the nominal interest rate less the expected rate of inflation.
C)the nominal interest rate equals the real interest rate less the expected rate of inflation.
D)both A and B of the above are true.
E)both A and C of the above are true.

Question 50

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 one year later?

A)5 percent
B)10 percent
C)-5 percent
D)25 percent
E)None of the above

Question 51

The return on a 10 percent coupon bond that initially sells for $1,000 and sells for $900 one year later is

A)-10 percent.
B)-5 percent.
C)0 percent.
D)5 percent.

Question 52

If a $5,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is

A)0 percent.
B)5 percent.
C)10 percent.
D)20 percent.

Question 53

If you expect the inflation rate to be 5 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

A)-12 percent.
B)-2 percent.
C)2 percent.
D)12 percent.

Question 54

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 one year later?

A)5 percent
B)10 percent
C)-5 percent
D)-10 percent
E)None of the above

Question 55

If an investor's holding period is longer than the term to maturity of a bond, he or she is exposed to

A)interest-rate risk.
B)reinvestment risk.
C)bond-market risk.
D)yield-to-maturity risk.

Question 56

Which of the following are true concerning the distinction between interest rates and return?

A)The rate of return on a bond will not necessarily equal the interest rate on that bond.
B)The return can be expressed as the sum of the current yield and the rate of capital gains.
C)The rate of return will be greater than the interest rate when the price of the bond falls between time t and time t + 1.
D)All of the above are true.
E)Only A and B of the above are true.

Question 57

(I)Prices of longer-maturity bonds respond less dramatically to changes in interest rates. (II)Prices and returns for long-term bonds are less volatile than those for shorter-term bonds.

A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Question 58

If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

A)7 percent.
B)22 percent.
C)-15 percent.
D)-8 percent.
E)none of the above.

Question 59

In which of the following situations would you prefer to be making a loan?

A)The interest rate is 9 percent and the expected inflation rate is 7 percent.
B)The interest rate is 4 percent and the expected inflation rate is 1 percent.
C)The interest rate is 13 percent and the expected inflation rate is 15 percent.
D)The interest rate is 25 percent and the expected inflation rate is 50 percent.

Question 60

The riskiness of an asset's return that results from interest rate changes is called

A)interest-rate risk.
B)coupon-rate risk.
C)reinvestment risk.
D)yield-to-maturity risk.

Question 61

Interest-rate risk is the uncertainty that an investor faces because the interest rate at which a bond's future coupon payments can be invested is unknown.

Question 62

The interest rate that is adjusted for actual changes in the price level is called the

A)ex post real interest rate.
B)expected interest rate.
C)ex ante real interest rate.
D)none of the above.

Question 63

All else being equal, the greater the interest rate the greater the duration is.

Question 64

The duration of a ten-year, 10 percent coupon bond when the interest rate is 10 percent is 6.76 years. What happens to the price of the bond if the interest rate falls to 8 percent?

A)It rises 20 percent.
B)It rises 12.3 percent.
C)It falls 20 percent.
D)It falls 12.3 percent.

Question 65

A bond's current market value is equal to the present value of the coupon payments plus the present value of the face amount.

Question 66

Discounting the future is the procedure used to find the future value of a dollar received today.

Question 67

Prices for long-term bonds are more volatile than for shorter-term bonds.

Question 68

Increasing duration implies that interest-rate risk has increased.

Question 69

Unless a bond defaults, an investor cannot lose money investing in bonds.

Question 70

A ________ is a type of loan that has the same cash flow payment every year throughout the life of the loan.

A)discount loan
B)simple loan
C)fixed-payment loan
D)interest-free loan

Question 71

The change in the bond's price relative to the initial purchase price is

A)the current yield.
B)coupon payment.
C)yield to maturity.
D)rate of capital gain.

Question 72

A long-term bond's price is less affected by interest rate movements than a short-term bond's price.

Question 73

The return on a bond is equal to the yield to maturity when

A)the holding period is longer than the maturity of the bond.
B)the maturity of the bond is longer than the holding period.
C)the holding period and the maturity of the bond are identical.
D)none of the above.

Question 74

The current yield is the best measure of an investor's return from holding a bond.

Question 75

(I)The average lifetime of a debt security's stream of payments is called duration. (II)The duration of a portfolio is the weighted average of the durations of the individual securities, with the weights reflecting the proportion of the portfolio invested in each.

A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Question 76

Reinvestment risk is the risk that

A)a bond's value may fall in the future.
B)a bond's future coupon payments may have to be invested at a rate lower than the bond's yield to maturity.
C)an investor's holding period will be short and equal in length to the maturity of the bonds he or she holds.
D)a bond's issuer may fail to make the future coupon payments and the investor will have no cash to reinvest.

Question 77

Bonds whose term to maturity is shorter than the holding period are also subject to

A)default.
B)reinvestment risk.
C)both of the above.
D)none of the above.

Question 78

When the lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date, along with an additional payment for the interest, it is called a ________.

A)fixed-payment loan
B)discount loan
C)simple loan
D)none of the above

Question 79

The current yield is the yearly coupon payment divided by the current market price.

Question 80

A discount bond

A)is also called a coupon bond.
B)is also called a zero-coupon bond.
C)is also called a fixed-payment bond.
D)is also called a corporate bond.