Deck 13: Duration and Reinvestment Concepts

Question 1

High coupon bonds will usually have higher durations than low coupon bonds of the same maturity.

Answer 1

False

Question 2

Macaulay duration is a bond's weighted average life based on present value of cash flows.

Answer 2

True

Question 3

As the yield to maturity on a bond increases,the duration also increases,because of the effect of present value on duration.

Answer 3

False

Question 4

The duration of a ten year 10 percent $1,000 bond at a market rate of 6 percent is exactly equal to the duration of the same bond at a 14 percent market rate.

Question 5

The actual yield to maturity an investor receives becomes more of a function of the reinvestment rate the shorter the maturity of the bond.

Question 6

Terminal wealth analysis for a zero coupon bond is irrelevant.

Question 7

A zero-coupon bond has a duration equal to its maturity.

Question 8

Weighted average life is the most representative value for effective bond life.

Question 9

As the maturity or duration of a bond increases,the impact on price of any changes in interest rates increases at a decreasing rate.

Question 10

Duration is a useful number because it combines the effects of maturity,coupon and market rates to indicate how the price of the bond will change with a change in interest rates.

Question 11

Terminal wealth analysis is the process of measuring the effects of shifting market rates on bond prices.

Question 12

For two bonds with equal coupons,duration would be higher for the bond with the shortest maturity.

Question 13

Duration will not help international bond managers choose bonds for their portfolios because of the foreign exchange risk.

Question 14

The duration of a 20-year zero coupon bond is equal to the maturity regardless of the market rate.

Question 15

Immunization protects the portfolio value against upward movement in interest rates but not downward movement in interest rates.

Question 16

Immunization is the process of measuring bond price sensitivity to interest rate changes.

Question 17

Duration analysis is subject to the assumption that all interest income can be reinvested at the market rate of interest.

Question 18

Duration times the reinvestment rate will give the approximate change in bond price for a 1 percent change in interest rates.

Question 19

Terminal wealth analysis is one way of analyzing the effect of the reinvestment rate risk.

Question 20

There is an inverse relationship between interest rates and bond values,and between the amount of coupon payments and weighted average life.

Question 21

Duration equals maturity if

A)All cash flows are paid at the end of the year
B)The coupon rate equals the market rate
C)The bond is a zero-coupon bond
D)More than one of the above

Question 22

The highest duration and maximum price sensitivity relative to years to maturity are produced by

A)A coupon rate equal to the market rate
B)A low coupon rate
C)A zero coupon
D)None of the above

Question 23

The duration on an 8 percent,25-year bond is ______ the duration on a 9 percent,30-year bond.

A)Greater than
B)Less than
C)Equal to
D)There is not enough information to tell

Question 24

The duration of a bond is determined by a combination of the maturity date and value,and

A)The pattern of coupon payments
B)The call premium
C)Put premium
D)None of the above

Question 25

In general,duration is the number of years,on a future-value basis,that it takes to recover an initial investment in a bond.

Question 26

Immunization is the process of ________ to ensure an outcome.

A)Measuring bond price sensitivity to interest rates
B)Trying all investment decisions to a particular market interest rate
C)Tying all investment decisions to a duration period
D)None of the above

Question 27

You buy a zero-coupon bond for $250.00 and 10 years later sell it for $591.84.What annualized rate of return did you earn?

A)13.67%
B)4.24%
C)9.00%
D)2.36%
E)10.90%

Question 28

Factors which influence the relationship between duration and maturity include all of the following EXCEPT

A)The face value of the bond
B)The coupon rate of the bond
C)The number of years to maturity
D)All of the above are factors

Question 29

The value of a bond may be expressed as the sum of

A)The interest payments and the maturity value
B)The present value of the par value and the present value of the sum of the interest payments
C)The present value of the maturity value and the sum of the present values of the interest payments
D)None of the above

Question 30

The duration of a 40-year,$1,000 bond at a market rate of 4 percent is _________ the duration of an identical bond at a market rate of 6 percent.

A)Greater than
B)Less than
C)Equal to
D)There is not enough information to tell

Question 31

One of the problems with duration is that it often assumes a parallel shift in yield curves.

Question 32

Weighted average life refers to the weighted average life of the payout.

Question 33

Duration is affected primarily by

A)The maturity of the bond
B)The market rate of interest
C)The coupon rate
D)All of the above

Question 34

Duration is used primarily as a measure of

A)The relationship between coupon rate and bond rating
B)Bond price sensitivity to interest rate changes
C)The present value of investment inflows
D)None of the above

Question 35

It is possible that a bond with a shorter maturity than another bond may actually have a longer duration and be more sensitive to interest rate changes.

Question 36

Duration is:

A)Always longer than maturity
B)Always the same as maturity
C)Normally shorter than maturity
D)Always shorter than maturity

Question 37

One of the benefits of zero-coupon bonds is that they lock in a compound rate of return (or reinvestment rate)for the life of the bond if held to maturity.

Question 38

The only difference between simple weighted average life of a bond and duration of a bond is

A)The timing of interest payments
B)Duration involves the present value of individual cash flows
C)Duration involves the using of the stated value of individual cash flows
D)None of the above

Question 39

For a bond selling at par of $1000,when the coupon equals the yield to maturity in the current market,duration then is equal to the bond maturity in years.

Question 40

The duration of a 20-year,$1,000 bond at a COUPON rate of 8 percent is _________ the duration of an identical bond at a coupon rate of 6 percent.

A)Greater than
B)Less than
C)Equal to
D)There is not enough information to tell

Question 41

What type of bond investor would probably be least concerned about a drop in market interest rates?

A)Individuals who spend their interest income
B)Individuals who are building a retirement portfolio
C)Pension fund managers
D)All of the above would have cause for concern

Question 42

A terminal wealth table generates the ending value of the investment at the end of the year,assuming that the bond

A)Has a maturity date corresponding to that year
B)Has a maturity date corresponding to the next year
C)Is a zero-coupon bond
D)None of the above

Question 43

When duration of a coupon paying bond is plotted against years to maturity on the X axis,the line

A)Is linear
B)Is concave
C)Is convex
D)Is linear at a 45 degree angle

Question 44

Compute the duration for the data in this problem using a discount rate of 12%. $$\begin{array} { | c | c | } \hline & \text { Cash } \\\hline \text { Year, t } & \text { Flow } \\\hline 1 & 90 \\\hline 2 & 90 \\\hline 3 & 90 \\\hline 3 & 1000 \\\hline\end{array}$$

A)3.00 years
B)2.95 years
C)2.85 years
D)2.75 years
E)2.65 years

Question 45

You have invested $1,000 in a 12% coupon bond that matures in three years.You are investing the interest income in a fund earning 8%.At the end of three years,what was your annualized rate of return?

A)8%
B)12%
C)13.4%
D)39%
E)11.6%

Question 46

Compute the duration for a bond with a 8 percent coupon rate maturing in five years.A discount rate of 10 percent should be applied.

Question 47

Volatile high interest rates have directly caused more emphasis on duration analysis because

A)Investors have responded to the new environment by switching from short-term to longer-term securities
B)Prices of longer-term bonds are more sensitive to shifts in interest rates than shorter-term bonds
C)Duration analysis measures the degree of bond price sensitivity
D)All of the above

Question 48

You have invested $1,000 in a 12% coupon bond that matures in three years.You are investing the interest income in a fund earning 8%.At the end of three years,what will be your portfolio sum?

A)$1,120.00
B)$1,249.60
C)$1,360.00
D)$1,389.57
E)$1,540.73

Question 49

Zero-coupon bonds are said to "lock in" a particular reinvestment rate

A)Since the original price reflects the rate
B)Only if they are held to maturity
C)Although the price over the life of the bond may reflect wide swings in the market rate of return
D)More than one of the above

Question 50

Duration is

A)Positively correlated with interest rates and coupon rates but moves in the opposite direction of maturity
B)Negatively correlated with maturity but moves in the same direction as market rates of interest and coupon rates
C)Positively correlated with maturity but moves in the opposite direction of market rates of interest and coupon rates
D)None of the above

Question 51

The process of measuring the effect of a shift in market interest rates on the value of an investment is called

A)Duration analysis
B)Immunization
C)Terminal wealth analysis
D)None of the above

Question 52

Under which of the following circumstances would terminal wealth analysis NOT be relevant?

A)When the bond is sold prior to maturity
B)When market interest rates rise above the coupon rate
C)Terminal wealth analysis is ALWAYS relevant
D)None of the above

Question 53

A 10 percent coupon rate,five-year bond is currently selling to yield 12 percent and is priced at $927.50.
a)Recalculate the price of the bond based on a 7 percent yield to maturity and calculate the percentage price change. (use annual compounding)
b)If this bond has a duration of 3.40,how would you approximate the change in price of the bond for a 5 percent change in the yield to maturity?

Question 54

In order to choose the right international bonds for their portfolios,international bond managers should have

A)An interest rate forecast for each country
B)Calculated the duration of the bonds in their feasible set
C)Immunized their portfolios first
D)A and b

Question 55

For all bonds of equal risk,the bond that had the greatest duration and therefore the greatest price sensitivity is:

A)Treasury bonds
B)Zero-coupon bonds
C)Corporate bonds
D)Long-term government bonds

Question 56

One of the major criticisms of duration analysis is

A)The difficulty of measuring the market rate of interest
B)The assumption that long-term and short-term interest rates move by equal amounts
C)The assumption that long duration bonds are more price sensitive than short duration bonds
D)None of the above

Question 57

Duration is influenced by everything except:

A)Maturity
B)Market rate of interest
C)Coupon rate on the bond
D)The issuer of the bond

Question 58

Under terminal wealth analysis,the greater the period to maturity

A)The greater the shift in interest rates
B)The greater the effect of a decrease in interest rates
C)The greater the effect of any shift in interest rates
D)None of the above

Question 59

You are considering the purchase of two $1000 bonds,both issued by Tranig Corp.Your expectation is that interest rates will drop and you want to buy the bond which provides the maximum capital gains potential.The first Tranig bond has a coupon rate of 6 percent with five years to maturity,while the second has a coupon rate of 9 percent and comes due six years from now.If market rates of interest are 8 percent for both bonds,which bond has the best price potential? (Use duration to answer the question.)

Question 60

Duration represents the weighted average life of a bond where the weights are based on the:

A)Future value of the individual cash flows relative to the present value of the total cash flows
B)Present value of the individual cash flows relative to the future value of the individual cash flows
C)Present value of the individual cash flows relative to the present value of the total individual cash flows
D)Future value of the individual cash flows relative to the future value of the individual cash flows

Question 61

Assume you buy a 20 year,$1000 par value zero-coupon bond that provides a 12 percent yield to maturity.Almost immediately after you buy the bond,yields decrease to 9 percent.What will be the percentage gain on the investment?