Deck 3: Interest Rates and Rates of Return

Question 1

At an interest rate of 6%,how much will need to be invested today to have $10,000 in 5 years?

A) $5,000
B) $7,473
C) $10,000
D) $13,382

Answer 1

B

Question 2

What are three reasons that banks charge interest on loans?

Answer 2

Banks charge interest on loans to compensate for inflation,to compensate for default risk,and to compensate for the opportunity cost of waiting to spend your money.

Question 3

Compounding refers to

A) the calculation of interest rates after the compounding effect of taxes has been allowed for.
B) the paying back of both interest and principal during the life of a fixed payment loan.
C) the process of earning interest on both the interest and the principal of an investment.
D) the increased value of an investment that arises from the payment of periodic interest.

Answer 3

C

Question 4

The concept of present value

A) reveals that discount bonds have higher interest rates than coupon bonds.
B) reveals that fixed payment loans have higher interest rates than discount bonds.
C) is useful in comparing interest rates for different financial instruments.
D) limits the comparability of returns on different types of bonds.

Question 5

Suppose you have two clients who need your services for two years.One agreed to pay you $50,000 one year from now and another $50,000 in two years while the other paid $35,000 after one year,but $65,000 after two years.Assuming an interest rate of 10%,which one has a higher present value? Round off to the nearest dollar.

Question 6

What are the three possible actions that could be taken when a bank becomes insolvent?

Question 7

Simple loans and discount bonds differ from coupon bonds and fixed-payment loans in that

A) interest on simple loans and discount bonds is taxable, while interest on coupon bonds and fixed-payment loans is not.
B) interest on coupon bonds and fixed-payment loans is taxable, while interest on simple loans and discount bonds is not.
C) interest rates on simple loans and discount bonds are generally higher than interest rates on comparable coupon bonds and fixed-payment loans.
D) interest on simple loans and discount bonds is paid in a single payment, while issuers of coupon bonds and fixed-payment loans make multiple payments of interest and principal.

Question 8

$1 received n years from now has a value today of

A) ($1 + i)/i.
B) $1/(1 + i).
C) ($1 + i)ⁿ/i.
D) $1/(1 + i)ⁿ.

Question 9

Suppose you put $500 in your savings account and earn 4% interest per year.How much will you have in your account after two years? Be sure to round off to the nearest cent

Question 10

Suppose Matt's New Cars issues a discount bond with a face value of $10,000 payable in one year with an interest rate of 4%.How much will they receive for the bond?

A) $9,600
B) $9,615
C) $10,000
D) $10,400

Question 11

Debt instruments are also called

A) equities.
B) credit market instruments.
C) prospectuses.
D) units of account.

Question 12

If you deposit $10,000 in a savings account at an annual interest rate of 6%,how much will you have in the account at the end of three years?

A) $8,396
B) $11,800
C) $11,910
D) $10,600

Question 13

At an interest rate of 3%,what is the present value of $1000 to be received five years from now?

A) $863
B) $1,667
C) $1,159
D) $850

Question 14

If you deposit $500 in a savings account at an annual interest rate of 5%,how much will you have in the account at the end of five years?

A) $625
B) $392
C) $638
D) $550

Question 15

If the annual interest rate is 8%,what would you expect to pay for a discount bond paying $10,000 in ten years?

A) $4,632
B) $9,259
C) $10,000
D) $21,589

Question 16

The key to present value calculations is that they

A) are appropriate only for funds in the same time period.
B) provide a common unit for measuring funds at different times.
C) provide accurate answers only in a low-inflation environment.
D) provide accurate answers only in a high-inflation environment.

Question 17

Suppose you had $1000 and were deciding between two investments.One pays 5% a year for two years while the other pays 8% the first year and 2% the second year.Which investment would provide a higher return?

Question 18

The key difficulty in answering the question: "Would you be better off financing your new home with a 15-year mortgage at 5% or by borrowing for five years at 4% and refinancing thereafter?" is that

A) housing prices are very erratic.
B) the tax deductibility of mortgage interest payments has changed over time.
C) dollars paid in different periods do not have the same value.
D) 15-year mortgages are fixed-payment loans while 5-year mortgages are simple loans.

Question 19

If the annual interest rate is 9%,what would you expect to pay for a discount bond paying $10,000 in two years?

A) $8,417
B) $8,200
C) $10,000
D) $11,881

Question 20

A debt instrument represents

A) an ownership claim by the purchaser on the issuer.
B) a promise by a borrower to repay principal plus interest to a lender.
C) an attempt by a borrower in default to restore his or her credit.
D) a nontaxable asset, owned primarily by large corporations.

Question 21

The coupon rate is the

A) annual coupon payment divided by the face value of the bond.
B) annual coupon payment divided by the market value of the bond.
C) difference between the face value of the bond and its par value.
D) coupon paid every 6 months divided by par value.

Question 22

A discount bond involves

A) interest payments from the borrower to the lender periodically during the life of the loan.
B) payment by the borrower to the lender of the face value of the loan at maturity.
C) no payment of principal by the borrower to the lender.
D) payment of interest by the borrower to the lender every six months during the life of the loan.

Question 23

Which of the following is NOT a discount bond?

A) a U.S. savings bond
B) a U.S. Treasury bill
C) a U.S. Treasury note
D) a zero-coupon bond

Question 24

Treasury STRIPS are

A) tax-exempt bonds.
B) simple loans.
C) discount bonds.
D) fixed payment loans.

Question 25

The total payment to a lender for a one-period simple loan is

A) (P + i)ⁿ.
B) P + i.
C) i(1 + i).
D) P(1 + i).

Question 26

A coupon bond has an annual coupon of $75,a par value of $1000,and a market price of $900.Its current yield equals

A) 7.50%.
B) 8.33%.
C) its yield to maturity.
D) Not enough information has been provided to calculate the current yield for this bond.

Question 27

A coupon bond involves

A) interest payments from the borrower to the lender periodically during the life of the loan and payment by the borrower to the lender of the face value of the loan at maturity.
B) interest and principal payments from the borrower to the lender periodically during the life of the loan.
C) periodic payments by the borrower to the lender that include both principal and interest.
D) periodic payments by the borrower to the lender that include principal, but not interest.

Question 28

Treasury STRIPS came into existence because

A) investors demanded a tax-free long-term bond.
B) the Treasury wished to shift from long-term borrowing to short-term borrowing.
C) high inflation rates led to an increased demand for high-yield bonds.
D) investors demanded long-term discount bonds.

Question 29

The most common type of simple loan is a(an)

A) automobile loan from a bank.
B) mortgage loan from a bank.
C) commercial loan from a bank.
D) corporate bond.

Question 30

The current yield is equal to

A) the coupon divided by the market price of the bond.
B) the yield to maturity, if the bond is a coupon bond.
C) the coupon divided by the par value of the bond.
D) the market price of the bond divided by its par value.

Question 31

Suppose First National Bank makes a one-year simple loan of $1,000 at 7% interest to Harry's Restaurant.At the end of one year Harry's Restaurant will pay First National

A) $934.58.
B) $1007.
C) $1700.
D) $1070.

Question 32

A simple loan involves

A) interest payments from the borrower to the lender periodically during the life of the loan.
B) no payment of interest by the borrower to the lender.
C) payment of interest by the borrower to the lender only at the time the loan matures.
D) payment only of principal. by the borrower to the lender at maturity.

Question 33

Issuers of coupon bonds

A) make a single payment of principal when the bonds matures, but multiple payments of interest over the life of the bond.
B) make a single payment of interest and principal.
C) make multiple payments of principal, but a single payment of interest.
D) make a single payment of principal at the time the bond is issued and multiple payments of interest over the life of the bond.

Question 34

Which of the following is a coupon bond?

A) a U.S. savings bond
B) a U.S. Treasury bill
C) a U.S. Treasury note
D) a zero-coupon bond

Question 35

Which of the following is a fixed payment loan?

A) a home mortgage
B) a U.S. Treasury bill
C) a U.S. Treasury note
D) a zero-coupon bond

Question 36

Which of the following is NOT a fixed payment loan?

A) a home mortgage
B) a car loan
C) a U.S. Treasury note
D) a student loan

Question 37

Which of the following is NOT fixed on a coupon bond?

A) coupon
B) coupon rate
C) market price
D) par value

Question 38

A discount bond resembles a simple loan in that

A) the interest on neither is taxable.
B) the borrower repays in a single payment.
C) both represent assets to the borrowers who issue them.
D) both have par values greater than their face values.

Question 39

Which of the following is NOT true of a fixed payment loan?

A) The borrower is required to make regular periodic payments to the lender.
B) The payments made by the borrower include both interest and principal.
C) The borrower is left with a substantial unpaid principal at the maturity of the loan.
D) A home mortgage is an example of fixed payment loan.

Question 40

The amount of funds the borrower receives from the lender with a simple loan is called the

A) principal.
B) equity.
C) claim.
D) collateral.

Question 41

What is the yield to maturity of a consol with a coupon of $85 and a price of $944.44?

A) 5.56%
B) 8.50%
C) 9.00%
D) Not enough information has been provided to determine the answer.

Question 42

What is the yield to maturity on a simple loan that requires payment of $500 plus $30 in interest one year from now?

A) 6%
B) 6.38%
C) 5.3%
D) Not enough information has been provided to determine the answer.

Question 43

Suppose Matt's New Cars issues and sells a one-year discount bond for $9,259 and repays $10,000 at maturity.The interest rate on this bond would be

A) 2.6%.
B) 7.41%.
C) 8%.
D) 10%.

Question 44

Suppose a firm receives $975 for a discount bond with a face value of $1000 to be repaid in one year.What is the amount of interest on the bond? What is the interest rate on the bond? Report a percentage with two decimal places.

Question 45

What is the price of a coupon bond that has annual coupon payments of $75,a par value of $1000,a yield to maturity of 5%,and a maturity of two years?

A) $1043.08
B) $1046.49
C) $1000.00
D) $1150.00

Question 46

A one-year discount bond with a par value of $1000 sold today,at issuance,for $943 has a yield to maturity of

A) 4.30%.
B) 5.70%.
C) 6.04%.
D) 9.43%.

Question 47

On a coupon bond,the yield to maturity

A) always equals the coupon rate.
B) equates the present value of all the bond's payments to its price today.
C) increases when the market price of the bond increases.
D) equals the coupon payment divided by the current price of the bond.

Question 48

How do payments on a fixed-payment loan differ from a coupon bond?

Question 49

If the current price of a bond is greater than its face value

A) an investor will receive a capital gain by holding the bond until maturity.
B) the yield to maturity must be less than the coupon rate.
C) the coupon rate must be less than the current yield.
D) the coupon rate must be equal to the current yield.

Question 50

If i is the yield to maturity of a fixed-payment loan,

A) the value of the loan today equals i times the sum of the values of all the loan payments.
B) i equals the present value of the loan payments.
C) the value of the loan today equals the sum of the values of the loan payments.
D) the value of the loan today equals the present value of the loan payments discounted at rate i.

Question 51

A one-year discount bond with a par value of $5000 sold today,at issuance,for $4750 has a yield to maturity of

A) 5.00%.
B) 5.26%.
C) 2.50%.
D) 9.75%.

Question 52

Which of the following is fixed on a coupon bond?

A) coupon rate
B) current yield
C) market price
D) yield to maturity

Question 53

The yield to maturity on a new one-year discount bond equals

A) (F V- P)/P.
B) (D - FV)/P.
C) (FV - P)/FV.
D) (P - FV)/FV.

Question 54

What is the price of a coupon bond that has annual coupon payments of $85,a par value of $1000,a yield to maturity of 10%,and a maturity of three years?

A) $211.38
B) $898.84
C) $962.70
D) $1255.0

Question 55

A one-year discount bond has a face value of $1000 and price of $880.What is the yield to maturity on the bond? Report using percentages with two decimal places.

Question 56

A bond's price and its yield to maturity are inversely related because

A) discounting future payments at a higher rate reduces the present value of the payments.
B) discounting future payments at a higher rate increases the present value of the payments.
C) an increase in the yield to maturity will lower a bond's coupon rate and hence its price.
D) a fall in a bond's price will lower its par value and hence its yield to maturity.

Question 57

What is the yield to maturity of a perpetuity with a coupon of $40 and a price of $800?

Question 58

Suppose a bond has a coupon of $75,face value of $1000,and current price of $1100.What is the coupon rate? What is its current yield? Report a percentage with two decimal places.

Question 59

The yield to maturity is equal to

A) the interest rate at which the present value of an asset's returns is equal to its price today.
B) the face value or par value of a coupon bond.
C) any payments received from an asset at the date the asset matures.
D) interest rate on the asset minus any taxes owed on the interest received.

Question 60

For simple loans,the yield to maturity

A) is always less than the specified simple interest rate.
B) is always greater than the specified simple interest rate.
C) is always equal to the specified simple interest rate.
D) may be less than, greater than, or equal to the specified simple interest rate, depending on the maturity of the loan.

Question 61

U)S.Treasury bonds

A) carry no risk of default and are therefore not risky investments.
B) have constant yields to maturity and are therefore not risky investments.
C) have constant coupon rates and are therefore not risky investments.
D) are subject to fluctuations in their market prices and are therefore risky investments.

Question 62

The bid price for a bond is

A) the minimum price that you are allowed to bid for a bond that is being auctioned by the government.
B) the maximum price that you are allowed to bid for a bond that is being auctioned by the government.
C) the price that you will receive from a securities dealer if you sell the bond.
D) the price that you must pay a securities dealer to purchase a bond.

Question 63

If an investor is certain that market interest rates will decline in the future,which of the following will she be most likely to purchase?

A) a six-month government bill
B) a two-year government note
C) a ten-year government bond
D) a fifty-year government bond

Question 64

A corporation issues a three-year bond with a coupon of $50 and a face value of $1000.A year later,market interest rates have declined to 4%.What is the price of the bond a year after it was issued? Report your answer to the nearest dollar.

Question 65

If the current price of a bond is less than its face value,

A) an investor will receive a capital gain by holding the bond until maturity.
B) the yield to maturity must be less than the current yield.
C) the coupon rate must be greater than the current yield.
D) the coupon rate must be equal to the current yield.

Question 66

Which of the following statements about the total rate of return is NOT correct?

A) The total rate of return may be greater or less than the current yield.
B) The total rate of return may be greater or less than the rate of capital gain.
C) The total rate of return may never be negative.
D) The total rate of return is greater than the coupon, holding everything else constant.

Question 67

The total rate of return is equal to

A) the coupon rate plus the rate of capital gains.
B) the coupon rate plus the current yield.
C) the current yield plus the rate of capital gains.
D) the coupon rate multiplied by the rate of capital gains.

Question 68

If the current price of a bond is equal to its face value,

A) there is no capital gain or loss from holding the bond until maturity.
B) the yield to maturity must be greater than the current yield.
C) the current yield must be greater than the coupon rate.
D) the coupon rate must be greater than the yield to maturity.

Question 69

The total rate of return is equal to the

A) sum of the coupon rate and the current yield.
B) yield to maturity.
C) sum of the current yield and the actual rate of capital gain or loss.
D) sum of the current yield and the expected rate of capital gain.

Question 70

With respect to U.S.Treasury bills,

A) the bid price is always greater than the asked price.
B) the asked price is always greater than the bid price.
C) the bid price is only greater than the asked price if investors expect interest rates to decline in the future.
D) the asked price is only greater than the bid price if investors expect interest rates to decline in the future.

Question 71

An speculator who buys a fifty-year corporate bond

A) must be expecting to still be alive in fifty years.
B) is subject to substantial reinvestment risk.
C) is probably expecting market interest rates to increase in the future.
D) is probably expecting market interest rates to decrease in the future.

Question 72

A corporation issues a three year bond with a coupon of $50 and a face value of $1000.Immediately after being issued,market interest rates decline to 4%.What is the price of the bond? Report your answer to the nearest dollar.

Question 73

A capital gain occurs when the

A) coupon rate increases.
B) current yield increases.
C) price of an asset increases.
D) yield to maturity increases.

Question 74

In comparing the yield to maturity on a Treasury bill with the yield on a discount basis on the same bill,we can say that the yield to maturity

A) will always be greater than the yield on a discount basis.
B) will always be less than the yield on a discount basis.
C) will always be equal to the yield on a discount basis, provided the holding period is the same as the number of years to maturity.
D) rises whenever the yield on a discount basis falls.

Question 75

Banks who held mortgage-backed securities "took a bath" during the financial crisis of 2007-2009 due to:

A) rising yields in secondary markets which led to a decline in the price of mortgage-backed securities.
B) falling yields in secondary markets which led to a decline in the price of mortgage-backed securities.
C) their inability to issue new mortgages.
D) more rapid pre-payment of mortgages.

Question 76

What is the yield on a discount basis for a U.S.Treasury bill that has a face value of $10,000,has a price of $9500,and will mature in 180 days?

A) 5.00%
B) 5.25%
C) 10.00%
D) 10.67%

Question 77

If,while you are holding a coupon bond,the interest rates on other similar bonds fall,you can be sure that

A) the coupon payments on your bond will fall.
B) the market price of your bond will rise.
C) the market price of your bond will fall.
D) the par value of your bond will rise.

Question 78

For a specific change in the yield to maturity

A) the shorter the time until a bond matures, the greater will be the change in its price.
B) the longer the time until a bond matures, the greater will be the change in its price.
C) the longer the time until a bond matures, the greater will be the change in its par value.
D) the shorter the time until a bond matures, the greater will be the change in its coupon rate.

Question 79

What is the total rate of return on a bond with a coupon of $55 that was purchased for $900 and sold one year later for $950?

A) 5.56%
B) 6.11%
C) 11.67%
D) 12.43%

Question 80

If,while you are holding a coupon bond,its market price falls,you can be sure that

A) the coupon payment you are receiving must have been reduced.
B) the interest rate on other similar bonds must have fallen.
C) the interest rate on other similar bonds must have risen.
D) the par value of the bond must have declined.