Deck 17: Fixed Income Securities Are Available Worldwide

Question 1

For most long term bonds, when coupons are reinvested, what is the most important component of the bond's total return? a) Coupon rate.
B) Interest-on-interest.
C) Yield to Maturity
D) Interest-on-principal.

Answer 1

A

Question 2

Bond traders use the term "basis point" to mean one percentage point in interest rate.

Answer 2

False

Question 3

Which of the following bonds will be most sensitive to changes in market interest rates? a) 8 percent semiannual coupon with 8 years to maturity.
B) 6 percent semiannual coupon with 8 years to maturity.
C) 8 percent semiannual coupon with 6 years to maturity.
D) 6 percent semiannual coupon with 6 years to maturity.

Answer 3

B

Question 4

Response: We use a present value table to look up the value of the $1000 principal to be paid 8 years or 16 semi-annual periods. Looking at the 3% row (rate per semi-annual period), we find the factor of .623. Multiplying by $1000, the investor is selling the value of the principal for $623.00. Using a present value of an annuity table, we also look up R=3% and N=16 to find the factor 12.561. Multiplying 12.561 times the $40 semi-annual coupon, we find our investor is selling the remaining stream of 16 coupon payments for $502.44. Thus the price of the bond is $623.00 + $502.44 = $1,125.44. But the bond originally cost our investor $1,000, so the capital gain is 125.44 (using financial calculator, the answer is $125.61). Section: Measuring Bond Yields.

-Examine Example 17-13. The basic data is repeated here, in financial calculator format: FV = 1000, N=30, PMT=50 $\begin{array}{|l|l|l|}\hline \text { I/Y } & \text { Price=PV } & \% \text { change } \\\hline \text { At } 10 \% & \$ 1,000.00 & \\\hline \text { At } 8 \% & \$ 1,172.93 & +17.29 \% \\\hline \text { At } 12 \% & \$ 862.35 & -13.77 \% \\\hline\end{array}$
Why are the % changes different?

A) They are actually the same: the table includes an error.
B) The prices shown are rounded to the nearest penny, slightly moving the % changes.
C) The relationship between interest rates and price is not linear.
D) Other factors, including duration and coupon rate, will also affect the relationship between interest rates and prices.

Question 5

Which of the following typically contributes the greatest portion to the Total Dollar Return? a) The semi-annual coupon payments
B) The interest earned on reinvesting the coupon payments.
C) The principal paid at maturity.
D) The interest earned on reinvesting the principal.

Question 6

What is the difference between the Yield-to-Maturity and the Realized Compound Yield? a) They are actually the same concept.
B) The yield to maturity is the actual return, calculated at the end of the investment; the realized compound yield is the expected return at the beginning of the investment.
C) The realized compound yield is the actual return, calculated at the end of the investment; the yield to maturity is the expected return at the beginning of the investment.
D) The yield to maturity continues as far as the first call, the realized compound yield continues until final payment is made.

Question 7

Both stocks and bonds are valued by summing the discounted future flows of interest (or dividends), and the repayment of principal (or sale of the stock).

Question 8

What is meant by the real risk-free rate of interest? a) The opportunity cost of foregoing consumption, representing the rate that must be offered to individuals to persuade them to save rather than consume.
B) The rate actually used in the market, not in textbooks.
C) The rate quoted on short-term Treasury bills.
D) The nominal risk-free interest rate, less the expected inflation.

Question 9

Which of the following is a situation in which an investor will NOT receive the promised yield to maturity? a) The investor holds the bond until maturity, and reinvests coupon payment at the original yield to maturity.
B) Interest rates do not change during the life of the bond.
C) The issuer calls the bond prior to original maturity.
D) The realized compound yield is equal to the promised yield to maturity.

Question 10

Which of the following is NOT one of the factors used in calculating duration? a) The final maturity of the bond.
B) The coupon payment.
C) The yield to maturity.
D) The current price.

Question 11

How is the value of a bond determined? a) The present value of the bond's future cash flows is discounted by one or more appropriate rate(s).
B) The perpetuity model is used to determine the value of a bond.
C) The present value of the company's future cash flows is discounted by one or more appropriate rate(s).
D) The constant growth dividend model is often used to value bonds.

Question 12

Which of the following is the best definition of "realized compound yield"? a) The yield an investor realizes on the bond coupons.
B) The total amount of the coupon and principal payments.
C) The ending wealth divided by the starting wealth.
D) The total amount of the coupon and principal payments, and the reinvestment of these flows.

Question 13

Which of the following is NOT a true statement? a) Duration measures the time until the principal is repaid.
B) Duration is the weighted average of the timing of the bond's payments.
C) The weights in the calculation of duration are the present value of each payment, divided by the value of the bond.
D) Modified duration measures the sensitivity of the bond's price to interest rate changes.

Question 14

What is meant by "Yield to Maturity"? a) The coupon interest rate paid each year, divided by the face value of the bond.
B) The coupon interest rate paid each, divided by the current price of the bond.
C) The periodic interest rate that equates the current price with the expected future flows.
D) The periodic interest rate that equates the current price with the expected future flows, up to the time of the first call.

Question 15

Assume an investor buys a newly issued 8 percent, semi-annual 10 year bond at par. He sells it two years later, when market interest rates have decreased to 6 percent. How much is the investor's capital gain or loss? a) $1,000 gain
B) $1,125.44 gain
C) $125.44 gain
D) $377.00 loss

Question 16

Why is duration important for investing in bonds? a) Investors need to know the relationship between interest rates and prices.
B) Investors need to know the "average" maturity of the bonds they are considering.
C) Investors need to know the coupon rates of the bonds they are considering.
D) Investors need to know the yield to maturity.

Question 17

Which of the following statements is most correct? a) The real risk-free rate of interest is the rate that is shown in the Wall Street Journal for the shortest term federal securities.
B) The real risk-free rate of interest is the rate that is shown in the Wall Street Journal for the longest term federal securities.
C) The real risk-free rate of interest is a rate that has been adjusted to remove the effects of inflation for some period, while the nominal risk-free rate of interest reflects the rate of inflation for some period.
D) The real risk-free rate of interest is the rate that is shown in the Wall Street Journal for the longest term federal securities, plus a forecast of the rate of inflation for the period of the securities.

Question 18

What happens to the price of bonds, if interest rates go up? a) The price of bonds goes up.
B) The price of bonds stays the same.
C) The price of bonds goes down.
D) The relationship between interest rates and bond prices cannot be determined.

Question 19

An investor has three sources of dollar returns from a bond investment. Which of the following is NOT included among the three sources? a) The semi-annual coupon payments.
B) The interest earned on reinvesting the coupon payments.
C) The principal paid at maturity.
D) The interest earned on reinvesting the last coupon and the principal.

Question 20

Now let's look from the view of the investor who buys an 8 percent semiannual bond with 8 years remaining to maturity, when market rates are 6%. If this investor pays $1,125.44 for the bond, what is his current yield? a) 3.55 percent
B) 7.11 percent
C) 8.00 percent
D) 10.00 percent

Question 21

Reinvestment risk represents the possibility that future payments cannot be reinvested at the assumed rate.

Question 22

The term structure of interest rates denotes the relationship between _____________ and _________________ for a specific category of bonds at a particular point in time.

Question 23

Risk premiums, or yield spreads, refer to the issue characteristics of bonds. They are the result of 7 factors. Listing them, they are differences in:
1) ___________________________________________
2) ___________________________________________
3) ___________________________________________
4) ___________________________________________
5) ___________________________________________
6) ___________________________________________
7) ___________________________________________

Question 24

Yield spreads vary inversely with the: ______________________________.

Question 25

Three theories have been proposed to explain the term structure of interest rates. They are: ________________________, ______________________, and ____________________.

Question 26

If interest rates rise, then price risk and reinvestment risk decline.

Question 27

As interest rates increase, long bonds will decrease in price more slowly than shorter bonds.

Question 28

A financial crisis or an accounting scandal can just as easily cause yield spreads to widen as weak earnings at a company.

Question 29

The vast majority of corporate bonds pay floating rate interest on a quarterly basis.