Question 1

The inflation risk premium on a bond is 2 percent, the U.S. T-bill rate is 5 percent, the maturity risk premium on the bond is 3 percent, the default risk premium on the bond is 2 percent, and the liquidity risk premium on the bond is 1 percent. Calculate its nominal rate of return.

Accepted Answer

A)  16% 
B)  13% 
C)  11% 
D)  9%

Question 2

A bond rated Aaa according to Moody's, is considered ________.

Accepted Answer

A)  a high grade bond 
B)  a prime quality bond 
C)  an upper medium grade bond 
D)  a medium grade bond

Question 3

The market price of a callable bond will not generally exceed its call price, except in the case of a convertible bond.

Accepted Answer

A) True 
 B)False

Question 4

A Eurobond is a bond issued by an international borrower and sold to investors in countries with currencies other than the country in which the bond is denominated.

Accepted Answer

A) True 
 B)False

Question 5

Nico invested an amount a year ago and calculated his return on investment. He found that his purchasing power had increased by 15 percent as a result of his investment. If inflation during the year was 4 percent, then Nico's ________.

Accepted Answer

A)  real return on investment is more than 15 percent 
B)  nominal return on investment is more than 15 percent 
C)  nominal return on investment is less than 11 percent 
D)  real return on investment is equal to 4 percent

Question 6

Bondholders will convert their convertible bonds into shares of stock only when the conversion price is greater than the market price of the stock.

Accepted Answer

A) True 
 B)False

Question 7

The components of risk premium includes business risk, financial risk, interest rate risk, liquidity risk, and tax risk.

Accepted Answer

A) True 
 B)False

Question 8

In theory, the rate of return on U.S. Treasury bills should always exceed the rate of inflation as measured by the consumer price index.

Accepted Answer

A) True 
 B)False

Question 9

Nico Nelson, a management trainee at a large New York-based bank, is trying to estimate the real rate of return expected by investors. He notes that the 3-month T-bill currently yields 3 percent and has decided to use the consumer price index as a proxy for expected inflation. What is the estimated real rate of interest if the CPI is currently 2 percent?

Accepted Answer

A)  5% 
B)  1% 
C)  3% 
D)  2%

Question 10

Since a putable bond gives its holder the right to "put the bond" at specified times or because of specified actions by the issuing firm, the bond's yield would be lower than that of an otherwise equivalent non-putable bond.

Accepted Answer

A) True 
 B)False

Question 11

An A rated bond should provide investors with a higher yield than an otherwise identical B rated bond.

Accepted Answer

A) True 
 B)False

Question 12

In the valuation process, the higher the risk, the greater is the required return.

Accepted Answer

A) True 
 B)False

Question 13

An upward-sloping yield curve that indicates cheaper short-term borrowing costs than long-term borrowing costs is called as ________.

Accepted Answer

A)  normal yield curve 
B)  inverted yield curve 
C)  flat yield curve 
D)  lognormal yield curve

Question 14

The value of an asset depends on the historical cash flow(s) up to the present time.

Accepted Answer

A) True 
 B)False

Question 15

When the required return is constant and equal to the coupon rate, the price of a bond as it approaches its maturity date will ________.

Accepted Answer

A)  remain at par 
B)  increase 
C)  decrease 
D)  change depending on whether it is a discount or premium bond

Question 16

The purpose of the restrictive debt covenant that requires that subsequent borrowing be subordinated to the original loan is to ________.

Accepted Answer

A)  maintain a minimum level of liquidity 
B)  limit the amount of fixed-payment obligations 
C)  ensure a long-run cash shortage does not cause an inability to meet current obligations 
D)  protect the original lender in the priority of claims during liquidation

Question 17

Less certain a cash flow, the ________ the risk, and ________ the present value of the cash flow.

Accepted Answer

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

Question 18

The riskiness of publicly traded bond issues is rated by independent agencies. According to Moody's rating system, an Aaa bond and a Caa bond are ________ and ________ respectively.

Accepted Answer

A)  speculative; investment grade 
B)  prime quality; medium grade 
C)  prime quality; speculative 
D)  medium grade; lowest grade

Question 19

A call feature in a bond allows bondholders to change each bond into a stated number of shares of common stock.

Accepted Answer

A) True 
 B)False

Question 20

Assume the following returns and yields: U.S. T-bill = 8%, 5-year U.S. T-note = 7%, IBM common stock = 15%, IBM AAA Corporate Bond = 12% and 10-year U.S. T-bond = 6%. Based on this information, the shape of the yield curve is ________.

Accepted Answer

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

Exam 6: Interest Rates and Bond Valuation

The inflation risk premium on a bond is 2 percent, the U.S. T-bill rate is 5 percent, the maturity risk premium on the bond is 3 percent, the default risk premium on the bond is 2 percent, and the liquidity risk premium on the bond is 1 percent. Calculate its nominal rate of return.

A bond rated Aaa according to Moody's, is considered ________.

The market price of a callable bond will not generally exceed its call price, except in the case of a convertible bond.

A Eurobond is a bond issued by an international borrower and sold to investors in countries with currencies other than the country in which the bond is denominated.

Nico invested an amount a year ago and calculated his return on investment. He found that his purchasing power had increased by 15 percent as a result of his investment. If inflation during the year was 4 percent, then Nico's ________.

Bondholders will convert their convertible bonds into shares of stock only when the conversion price is greater than the market price of the stock.

The components of risk premium includes business risk, financial risk, interest rate risk, liquidity risk, and tax risk.

In theory, the rate of return on U.S. Treasury bills should always exceed the rate of inflation as measured by the consumer price index.

Since a putable bond gives its holder the right to "put the bond" at specified times or because of specified actions by the issuing firm, the bond's yield would be lower than that of an otherwise equivalent non-putable bond.

An A rated bond should provide investors with a higher yield than an otherwise identical B rated bond.

In the valuation process, the higher the risk, the greater is the required return.

An upward-sloping yield curve that indicates cheaper short-term borrowing costs than long-term borrowing costs is called as ________.

The value of an asset depends on the historical cash flow(s) up to the present time.

When the required return is constant and equal to the coupon rate, the price of a bond as it approaches its maturity date will ________.

The purpose of the restrictive debt covenant that requires that subsequent borrowing be subordinated to the original loan is to ________.

Less certain a cash flow, the the risk, and the present value of the cash flow.

The riskiness of publicly traded bond issues is rated by independent agencies. According to Moody's rating system, an Aaa bond and a Caa bond are and respectively.

A call feature in a bond allows bondholders to change each bond into a stated number of shares of common stock.

Assume the following returns and yields: U.S. T-bill = 8%, 5-year U.S. T-note = 7%, IBM common stock = 15%, IBM AAA Corporate Bond = 12% and 10-year U.S. T-bond = 6%. Based on this information, the shape of the yield curve is ________.