Deck 20: Fundamentals of Bond Valuation

Question 1

The unbiased expectations theory is alternatively known as the ____ theory.

A) pure expectations
B) interest rate risk
C) efficient expectations
D) preferred habitat

Answer 1

A

Question 2

The assumption that all bond interest income can be reinvested at the yield-to-maturity assumes the yield curve

A) has an increasingly negative slope.
B) is flat.
C) has a positive sloped, linear shape.
D) has an increasing rate of growth.

Answer 2

B

Question 3

The pattern of interest rates appropriate for discounting cash flows of various maturities is known as the

A) market's prime-rate liquidity
B) random error of interest rates
C) random walk with drift
D) term structure of interest rates

Answer 3

D

Question 4

Empirical evidence of liquidity premiums indicates

A) the longer the maturity, the larger the liquidity premium.
B) they exist for up to one-year maturity.
C) they only explain flat yield curves.
D) they don't exist.

Question 5

The current real return on an investment is 3%. If the nominal rate of return is 7.9%, what is the expected rate of inflation?

A) 10.9%
B) 7.9%
C) 4.5%
D) 4.9%

Question 6

The yield-to-maturity for corporate bonds is typically done assuming compounding that is

A) semi-annual.
B) monthly.
C) annually.
D) quarterly.

Question 7

For a particular fixed-income security, the single interest rate that, if paid by a bank on the amount invested in the security, would enable the investor to obtain all the payments made by that security is referred to as the

A) current yield
B) holding period yield
C) promised yield
D) yield-to-maturity

Question 8

Federal Truth-In-Lending requires a lender to disclose the

A) daily percentage rate.
B) quarterly percentage rate.
C) semi-annual percentage rate.
D) annual percentage rate.

Question 9

The most common measure of return on a callable bond would be its

A) current yield.
B) return on average investment.
C) yield-to-maturity.
D) yield-to-call.

Question 10

Yield curves

A) will have a downward slope if the inflation rate is expected to increase.
B) have been upward sloping during periods of high interest rates.
C) are generally upward sloping.
D) are plotted as real rather than nominal rates.

Question 11

The theory that states yield curve shape is formed by the relationship of supply and demand curves for various security maturities is

A) liquidity preference theory.
B) term structure theory.
C) market segmentation theory.
D) risk minimization theory.

Question 12

A yield curve is developed using the yield-to-maturities on

A) common stocks.
B) treasury issues.
C) corporate bonds.
D) muni bonds.

Question 13

The liquidity preference theory states that an investor

A) does not consider interest rate risk.
B) wishes to reduce price risk.
C) assumes a declining yield curve.
D) will prefer a maturity to a rollover strategy.

Question 14

The _____ factor is the present value of $1 to be received in a specified number of years.
A) discount

A) future value
B) premium
C) liquidity

Question 15

The ____ is the current interest rate appropriate for discounting a cash flow of some given maturity.

A) spot rate
B) forward rate
C) future spot rate
D) futures rate

Question 16

The yield-to-maturities on treasury issues do not give a direct reading of future spot rates as

A) not enough years of maturities are available.
B) there is no default risk measured.
C) most have coupon rates.
D) the treasury market is not large enough to draw conclusions.

Question 17

______ curves are a visual representation of the term structure of interest rates.

A) Rate of return
B) Indifference
C) Yield
D) Demand

Question 18

Finding a bond's yield-to-maturity is the same as finding its

A) NPV.
B) Return on Assets.
C) IRR.
D) Profitability Index.

Question 19

The bond matures in one year. The annual rate is 8%, the par value is $1,000, and the market price is $990. What is the yield to maturity?

A) 9.09%
B) 9.01%
C) 8.54%
D) 8.00%

Question 20

The types of securities priced in accord with the set of spot rate are

A) treasury issues.
B) municipal bonds.
C) common stocks.
D) preferred stocks.

Question 21

One of the major differences between the market segmentation and preferred habitat theories is that in the latter, investors

A) will strictly adhere to the preferred market segment.
B) will shift out of their preferred habitat based on hedging strategies.
C) will leave their desired maturity segment if there are differences in yields between segments.
D) face positive or negative risk premia in various segments.

Question 22

There is With a liquidity premium of .3%, the liquidity preference theory states that the spot rate for year two should be

A) 7.7%.
B) 2.4%.
C) 8.0%.
D) 8.3%.

Question 23

In the ___ theory, more emphasis is placed on the role of the extra return given investors which entices them to purchase the riskier security.

A) liquidity preference
B) preferred habitat
C) market segmentation
D) market anomaly

Question 24

If investors feel that half of the time future spot rates will rise and half of the time they will decline, the liquidity preference theory

A) shows the average yield curve will be flat.
B) does not explain the declining yield curve situation.
C) supports the majority of yield curves will be declining.
D) suggests there will be a majority of upward sloping yield curves.

Question 25

A pure discount, $1,000 bond will mature in 4 years. If its present market price is $735, its yield-to-maturity is

A) 7.5%.
B) 8.7%.
C) 7%.
D) 8%.

Question 26

If there is a one-year spot rate of 8% and a two-year spot rate of 7%, the forward rate from year one to two is

A) 8.12%.
B) 6.01%.
C) 5.78%.
D) 7.53%.

Question 27

Which of the following is NOT correct concerning forward rates?

A) Forward rates link the current spot rate over one holding period to the current spot rate over a longer holding period.
B) They apply to contracts made now but relating to a period forward in time.
C) The forward rate, in reality, is the interest rate specified on a one-year loan.
D) Forward rates involve contracts made now for a loan made one year from now and paid back two years from now.

Question 28

In the ____ theory, it is assumed that markets are inhabited by various investors who strictly prefer different investment horizons.

A) liquidity premium
B) market segmentation
C) preferred habitat
D) market anomaly

Question 29

On which of the following bonds will a 1% increase in yield have the greatest impact?

A) 30-year maturity, selling at $1,000
B) 30-year maturity, selling at $900
C) 20-year maturity, selling at $850
D) 20-year maturity, selling at $1,050

Question 30

If an investor were to borrow $10,000 from a bank at an 8% interest rate and the bank uses a discount method, what is the effective interest rate?

A) 8.0%
B) 8.9%
C) 8.7%
D) 8.5%

Question 31

An investor adopts the strategy of investing for one year anUnder unbiased expectations theory, he must expect that

A) the one-year forward rate for years one to two will be above 9%.
B) the two-year spot rate is too high.
C) the inflation rate will drop more than the market expects.
D) the one-year forward rate for years one to two will be at least 7%.

Question 32

If there is a one-year spot rate of 6% and two-year spot rate of 8%, the forward rate from year 1 to 2 is

A) 9.06%.
B) 9.72%.
C) 8.12%.
D) 10.04%.

Question 33

The spot rate for year 1 is 7.5% and the forward rate for year one to two is 8%. The two-year discount factor is

A) .845.
B) .861.
C) .852.
D) .888.

Question 34

Which of the following statements is false?

A) The market segmentation theory has received relatively little empirical verification.
B) Evidence suggests that the term structure provides little information about expected future spot rates.
C) The evidence tends to favor the liquidity preference theory.
D) There appears to be liquidity premiums of increasing size associated with Treasury securities.

Question 35

All of the following statements are true about holding period returns EXCEPT

A) The most appropriate holding period is often uncertain.
B) An investment manager prefers to hold an asset only as long as it outperforms available alternatives.
C) Holding period return is a useful device for simplifying the complex investment environment.
D) Although an investor's situation can be predicted with certainty, it is not the case for her preference for a holding period.

Question 36

If the number of compounding intervals are increased within a year, it will

A) increase or decrease the effective annual interest rate depending on the coupon rate.
B) not affect the calculation of the annual interest rate.
C) decrease the effective annual interest rate of a low coupon bond.
D) increase the annual effective interest rate.

Question 37

With the liquidity preference theory, a declining yield curve

A) cannot be explained.
B) follows the same forecasted spot rates as unbiased expectations.
C) assumes no change in future interest rates.
D) forecasts a steeper drop in future spot rates than the unbiased expectations.

Question 38

Under unbiased expectations theory, the expected future spot rate is

A) the mean of future spot rates.
B) equal to the forward rate.
C) equal to the level of future inflation.
D) less than the forward rate.

Question 39

The best method for an investor to guarantee higher interest rates would be to purchase a bond which has a _____ coupon and a _____ term to maturity.

A) low, short
B) low, long
C) high, short
D) zero, very long

Question 40

If an investment advisor was recommending a bond, which of the following would be the least attractive purchase?

A) a 5-year bond with a 9% coupon rate selling at $1,050
B) a 10-year bond with a 9% coupon rate selling at $1,000
C) a 10-year bond with a 9% coupon rate selling at $1,050
D) a 5-year bond with a 9.5% coupon rate selling at $1,025

Question 41

A one year Treasury bill has a yield of 5%. A bond will pay $40 at the end of year one and $1,040 at the end of year 2. If its market value is $946.50, the two-year spot rate is

A) 9%.
B) 5%.
C) 7%.
D) 6%.

Question 42

A one-year Treasury bill has a yield of 6%. A bond will pay $70 at the end of year 1 and $1,070 at the end of year 2. If its market value is $1,036.50, the two-year spot rate is

A) 6%.
B) 9%.
C) 7%.
D) 5%.