Deck 8: Bond Valuation and the Structure of Interest Rates

Question 1

Higher coupon bonds have greater interest rate risk.

Answer 1

False

Question 2

Prices in the corporate bond market tend to be more volatile than securities sold in markets with greater trading volumes.

Answer 2

True

Question 3

All other things being equal, a given change in the interest rates will have a greater impact on the price of a low-coupon bond than a higher-coupon bond with the same maturity.

Answer 3

True

Question 4

Zero coupon bonds sell well above their par value because they offer no coupons.

Question 5

Semi-strong market efficiency implies that only public information that is available to all investors is reflected in a security's market price.

Question 6

The value, or price, of any asset is the present value of its future cash flows.

Question 7

Corporate bonds have a thin market relative to shares.

Question 8

If a market is strong-form market efficient, one would be able to beat the market with inside information.

Question 9

A thin market for a security implies a high frequency of trades for that type of security in the markets.

Question 10

A security's intrinsic value is the price that reflects investors' estimates of the value of the cash flows they expect to receive in the future.

Question 11

Convertible bonds can be converted into ordinary shares at some predetermined ratio at the discretion of the bondholder.

Question 12

The largest investors in corporate bonds are life insurance companies and superannuation funds.

Question 13

The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond.

Question 14

As interest rates fall, the prices of bonds decline.

Question 15

If market prices reflect all relevant information about securities at a particular point in time, it is called operational efficiency.

Question 16

Public share markets in developed countries like Australia have strong-form of market efficiency.

Question 17

Interest rate risk is the risk that bond prices will fluctuate as interest rate changes.

Question 18

In an efficient capital market, security prices fully reflect the knowledge and expectations of all investors at a particular point in time.

Question 19

Most secondary market transactions for corporate bonds take place through dealers in the over-the-counter (OTC) market.

Question 20

Vanilla bonds have coupon payments that are fixed for the life of the bond, with the principal being repaid at maturity.

Question 21

Which one of the following statements is NOT true?

A) Competition among investors is an important driver of informational efficiency.
B) If market prices reflect all relevant information about securities at a particular point in time, the market is informationally efficient.
C) In an informationally efficient market, market prices adjust quickly to new information about a security as it becomes available.
D) All of the above are true.

Question 22

Ascending or normal yield curves are upward-sloping yield curves that occur when an economy is heading into recession.

Question 23

If investors believe inflation will be increasing in the future, the prevailing yield will be downward sloping.

Question 24

Which one of the following statements is NOT true?

A) The overall efficiency of a capital market depends on its operational efficiency and its informational efficiency.
B) Operational efficiency focuses on bringing buyers and sellers together at the lowest possible cost.
C) If market prices reflect all relevant information about securities at a particular point in time, the market is operationally efficient.
D) All of the above are true.

Question 25

Which one of the following statements is NOT true?

A) Prices in the corporate bond market also tend to be more volatile than the markets for shares or money market securities.
B) Corporate bonds are more marketable than the securities that have higher daily trading volumes.
C) The market for corporate bonds is thin.
D) The largest investors in corporate bonds are life insurance companies and superannuation funds.

Question 26

The risk that the lender may not receive payments as promised is called default risk.

Question 27

Which one of the following statements about bond price is NOT true?

A) To calculate a bond's price, one needs to calculate the present value of the bond's expected cash flows.
B) The value, or price, of any asset is the future value of its cash flows.
C) The required rate of return, or discount rate, for a bond is the market interest rate called the bond's yield to maturity
D) Estimate the expected future cash flows using the coupons that the bond will pay and the maturity value to be received.

Question 28

With strong-form market efficiency:

A) the price of a security in the market reflects all public information only.
B) it would not be possible to earn abnormally high returns by trading on private information.
C) investors who have access to inside or private information will be able to earn abnormal returns.
D) None of the above.

Question 29

Bonds sell at a discount off the par value when market rates for similar bonds are

A) less than the bond's coupon rate.
B) greater than the bond's coupon rate.
C) equal to the bond's coupon rate.
D) Market rates are irrelevant in determining a bond's price.

Question 30

In an efficient capital market,

A) security prices fully reflect the knowledge and expectations of all investors at a particular point in time.
B) investors and financial managers have no reason to believe the securities are not priced at or near their true value.
C) prices of securities adjust as new information becomes available to the market.
D) All of the above are true.

Question 31

It is easy for individuals to trade in the corporate bond market because

A) the corporate bond market is considered to be very transparent.
B) prices in the corporate bond market tend to be more stable.
C) centralised reporting of deals between buyers and sellers take place.
D) None of the above statements are true.

Question 32

With semi-strong form market efficiency:

A) the price of a security in the market reflects all public information only.
B) it would be possible to earn abnormally high returns by trading on public information.
C) investors who have access to inside or private information will be unable to earn abnormal returns.
D) None of the above.

Question 33

Australian government securities do not have any default risk and are the best proxy measure for the risk-free rate.

Question 34

Which ONE of the following statements is true?

A) Zero coupon bonds have no coupon payments over its life and only offer a single payment at maturity.
B) Zero coupon bonds sell well below their face value (at a deep discount) because they offer no coupons.
C) Zero coupon bonds must sell for less than similar bonds that make coupon payments before maturity.
D) All of the above are true.

Question 35

Which ONE of the following statements is true?

A) To secure the conversion option on a bond, bondholders would be willing to pay a premium.
B) The conversion ratio is set so that the company's share price must appreciate 15 to 20 percent before it is profitable to convert bonds into equity.
C) Convertible bonds can be converted into ordinary shares at some predetermined ratio at the discretion of the bondholder.
D) All of the above are true.

Question 36

Which ONE of the following statements is true?

A) The largest investors in corporate bonds are life insurance companies and superannuation funds.
B) The market for corporate bonds is thin.
C) Prices in the corporate bond market also tend to be more volatile.
D) All of the above are true.

Question 37

Which one of the following statements is NOT true?

A) Weak-form market efficiency implies that investors who have access to inside or private information will be able to earn abnormal returns.
B) Semi-strong form market efficiency implies that investors who have access to inside or private information will be able to earn abnormal returns.
C) Strong-form market efficiency implies that investors who have access to inside or private information will be able to earn abnormal returns.
D) None of the above.

Question 38

Bonds with a call provision sell at lower market yields than comparable noncallable bonds.

Question 39

Which one of the following statements about vanilla bonds is NOT true?

A) They have no special provisions.
B) The face value, or par value, for most corporate bonds is $1,000.
C) Coupon payments are usually made quarterly.
D) The bond's coupon rate is calculated as the annual coupon payment divided by the bond's face value.

Question 40

The real rate of interest varies with the business cycle, with the highest rates seen at the end of a period of business expansion and the lowest at the bottom of a recession.

Question 41

Bond price: Jane Thorpe has been offered a seven-year bond issued by Barone Ltd at a price of 943.22. The bond has a coupon rate of 9 percent and pays the coupon semiannually. Similar bonds in the market will yield 10 percent today. Should she buy the bonds at the offered price? (Round to the nearest dollar.)

A) Yes, the bond is worth more at $1,015.
B) No, the bond is only worth $921.
C) Yes, the bond is worth more at $951.
D) No, the bond is only worth $912.

Question 42

If a bond's coupon rate is equal to the market rate, then the bond will sell

A) at a price equal to its face value.
B) at a price greater than its face value.
C) at a price less than its face value.
D) None of the above are true.

Question 43

Bond price: Your friend recommends that you invest in a three-year bond issued by Trimer Ltd that will pay annual coupons of 10 percent. Similar investments today will yield 6 percent. How much should you pay for the bond? (Round to the nearest dollar.)

A) $1,024
B) $979
C) $886
D) $1,107

Question 44

The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments

A) exceed the price of the bond.
B) equal to zero.
C) equal to the price of the bond.
D) less than the price of the bond.

Question 45

Zero coupon bonds: Shana Norris wants to buy five-year zero coupon bonds with a face value of $1,000. Her opportunity cost is 8.5 percent. Assuming annual compounding, what would be the current market price of these bonds? (Round to the nearest dollar.)

A) $1,023
B) $665
C) $890
D) $1,113

Question 46

Zero coupon bonds: Jarmine Company is planning to fund a project by issuing 10-year zero coupon bonds with a face value of $1,000. Assuming semiannual coupons to be the norm, what will be the price of these bonds if the appropriate discount rate is 14 percent? (Round to the closest answer.)

A) $852
B) $258
C) $419
D) $841

Question 47

Yield to maturity: Jenny LePlaz is looking to invest in some five-year bonds that pay annual coupons of 6.25 percent and are currently selling at $912.34. What is the current market yield on such bonds? (Round to the closest answer.)

A) 9.5%
B) 8.5%
C) 6.5%
D) 7.5%

Question 48

Which one of the following statements is NOT true?

A) The realised yield is the return earned on a bond given the cash flows actually received by the investor.
B) The realised yield is equal to the yield to maturity even if the bond is sold prior to maturity.
C) It is the interest rate at which the present value of the actual cash flows generated by the investment equals the bond's price at the time of sale of the bond.
D) All of the above are true.

Question 49

Bond price: Jeremy Kohn is planning to invest in a 10-year bond that pays a 12 percent coupon. The current market rate for similar bonds is 9 percent. Assume semiannual coupon payments. What is the maximum price that should be paid for this bond? (Round to the nearest dollar.)

A) $951
B) $882
C) $1,033
D) $1,195

Question 50

Bond price: Regatta Ltd has six-year bonds outstanding that pay an 8.25 percent coupon rate. Investors buying the bond today can expect to earn a yield to maturity of 6.875 percent. What should the company's bonds be priced at today? Assume annual coupon payments. (Round to the nearest dollar.)

A) $972
B) $1,066
C) $1,014
D) $923

Question 51

Bond price: Triumph Company issued five-year bonds that pay a coupon of 6.375 annually. The current market rate for similar bonds is 8.5 percent. How much will you be willing to pay for Triumph's bond today? Round to the nearest dollar.

A) $1,023
B) $1,137
C) $916
D) $897

Question 52

Zero coupon bonds: Robertsons Ltd is planning to expand its specialty stores into five other states and finance the expansion by issuing 15-year zero coupon bonds with a face value of $1,000. If your opportunity cost is 8 percent and similar coupon-bearing bonds will pay semiannually, what will be the price at which you will be willing to purchase these bonds? (Round to the nearest dollar.)

A) $308
B) $383
C) $803
D) $866

Question 53

Bond price: Kevin Oh is planning to sell a bond that he owns. This bond has four years to maturity and pays a coupon of 10 percent on a semiannual basis. Similar bonds in the current market will yield 12 percent. What will be the price that he will get for his bond? (Round to the nearest dollar.)

A) $1,044
B) $938
C) $970
D) $1,102

Question 54

Bond price: Briar Corp is issuing a 10-year bond with a coupon rate of 7 percent. The interest rate for similar bonds is currently 9 percent. Assuming annual payments, what is the present value of the bond? (Round to the nearest dollar.)

A) $872
B) $1,066
C) $990
D) $945

Question 55

Bond price: Giant Electronics is issuing 20-year bonds that will pay coupons semiannually. The coupon rate on this bond is 7.8 percent. If the market rate for such bonds is 7 percent, what will the bonds sell for today? (Round to the nearest dollar.)

A) $1,037
B) $1,085
C) $861
D) $923

Question 56

In calculating the current price of a bond paying semiannual coupons, one needs to

A) use double the number of payments.
B) use half the annual coupon.
C) use half the annual rate as the discount rate.
D) All of the above need to be done.

Question 57

Which one of the following statements about zero coupon bonds is NOT true?

A) Zero coupon bonds have no coupon payments but promise a single payment at maturity.
B) Zero coupon bonds must sell for less than similar bonds that make periodic coupon payments.
C) Zero coupon bonds make coupon payments but no principal payment at maturity.
D) All of the above statements are true.

Question 58

Which one of the following statements is NOT true?

A) The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond.
B) It is the yield that the investor earns if the bond is held to maturity, and all the coupon and principal payments are made as promised.
C) A bond's yield to maturity changes daily as interest rates increase or decrease.
D) All of the above are true.

Question 59

Bond price: Kevin Rogers is interested in buying a five-year bond that pays a coupon of 10 percent on a semiannual basis. The current market rate for similar bonds is 8.8 percent. What should be the current price of this bond? (Round to the nearest dollar.)

A) $1,048
B) $965
C) $1,099
D) $982

Question 60

Zero coupon bonds: The Australian Treasury has issued 10-year zero coupon bonds with a face value of $1,000. Assume that coupon payments are normally semiannual. What will be the current market price of these bonds if the opportunity cost for similar investments in the market is 6.75 percent? (Round to the nearest dollar.)

A) $684
B) $860
C) $515
D) $604

Question 61

Which ONE of the following statements is true?

A) The lower the transaction costs are, the greater a security's marketability.
B) The interest rate, or yield, on a security varies inversely with its degree of marketability.
C) U.S. Treasury bills have the largest and most active secondary market and are considered to be the most marketable of all securities.
D) All of the above are true.

Question 62

Marketability is the ability of an investor

A) to sell a security quickly, at a low transaction cost, and at a price close to its fair market value.
B) to sell at a profit under all circumstances.
C) to sell the security above its par value.
D) None of the above.

Question 63

Effective annual yield: Stanley Hart invested in a state government bond that promised an annual yield of 6.7 percent. The bond pays coupons twice a year. What is the effective annual yield (EAY) on this investment?

A) 13.4%
B) 6.81%
C) 6.70%
D) None of the above

Question 64

Which one of the following statements is NOT true?

A) The risk that the lender may not receive payments as promised is called default risk.
B) Investors must pay a premium to purchase a security that exposes them to default risk.
C) Australian government securities do not have any default risk and are the best proxy measure for the risk-free rate.
D) All of the above are true statements.

Question 65

Effective annual yield: Suppose an investor earned a semiannual yield of 6.4 percent on a bond paying coupons twice a year. What is the effective annual yield (EAY) on this investment?

A) 12.80%
B) 6.40%
C) 13.21%
D) None of the above

Question 66

Yield to maturity: Nathan Akpan is planning to invest in a seven-year bond that pays annual coupons at a rate of 7 percent. It is currently selling at $927.23. What is the current market yield on such bonds? (Round to the closest answer.)

A) 10.4%
B) 9.5%
C) 8.4%
D) 7.5%

Question 67

Yield to maturity: John Wong purchased a five-year bond today at $1,034.66. The bond pays 6.5 percent semiannually. What will be his yield to maturity?

A) 6.7%
B) 6.2%
C) 5.9%
D) 5.7%

Question 68

The three economic factors that determine the shape of the yield curve are

A) the real rate of interest, the expected rate of inflation, and marketability.
B) the real rate of interest, the expected rate of inflation, and interest rate risk.
C) the nominal rate of interest, the expected rate of inflation, and interest rate risk.
D) the real rate of interest, the nominal rate of interest, and interest rate risk.

Question 69

Yield to maturity: Shawna Carter wants to invest her recent bonus in a four-year bond that pays a coupon of 11 percent semiannually. The bonds are selling at $962.13 today. If she buys this bond and holds it to maturity, what would be her yield?

A) 11.8%
B) 12.5%
C) 12.2%

Question 70

Realised yield: Five years ago, Shirley Harper bought a 10-year bond that pays 8 percent semiannually for $981.10. Today, she sold it for $1,067.22. What is the realised yield on her investment? (Round to the nearest percent.)

A) 7%
B) 8%
C) 9%
D) 10%

Question 71

Inverted yield curves are observed when

A) the economy is growing.
B) the economy is stagnant.
C) the economy is in recession.
D) None of the above.

Question 72

Realised yield: Jorge Cabrera paid $980 for a 15-year bond 10 years ago. The bond pays a coupon of 10 percent semiannually. Today, the bond is priced at $1,054.36. If he sold the bond today, what would be his realised yield? (Round to the nearest percent.)

A) 12%
B) 10%
C) 11%
D) 9%

Question 73

Which one of the following statements is NOT true?

A) The relationship between yield and marketability is known as the term structure of interest rates.
B) The shape of the yield curve is not constant over time.
C) As the general level of interest rises and falls over time, the yield curve shifts up and down and has different slopes.
D) Yield curves show graphically how market yields vary as term to maturity changes.

Question 74

Realised yield: Rachel McGovern bought a 10-year bond for $921.77 seven years ago. The bond pays a coupon of 15 percent semiannually. Today, the bond is priced at $961.92. If she sold the bond today, what would be her realised yield? (Round to the nearest percent.)

A) 17%
B) 18%
C) 9%
D) 16%

Question 75

Which one of the following statements is NOT true?

A) Interest rate risk is the risk that bond prices will change as interest rates change.
B) Interest rate changes and bond prices are inversely related.
C) As interest rates increase, bond prices increase.
D) Long-term bonds are more price volatile than short-term bonds of similar risk.

Question 76

Which ONE of the following statements is true?

A) Long-term bonds have lower price volatility than short-term bonds.
B) As interest rates decline, the prices of bonds rise; and as interest rates rise, the prices of bonds decline.
C) All other things being equal, short-term bonds are more risky than long-term bonds.
D) Interest rate risk decreases as maturity increases.

Question 77

Yield to maturity: Huan Zhang bought a 10-year bond that pays 8.25 percent semiannually for $911.10. What is the yield to maturity on this bond?

A) 7.6%
B) 8.6%
C) 9.6%
D) 10.6%

Question 78

Yield to maturity: Alice Trang is planning to buy a six-year bond that pays a coupon of 10 percent semiannually. Given the current price of $878.21, what is the yield to maturity on these bonds?

A) 11%
B) 12%
C) 13%
D) 14%

Question 79

Which ONE of the following statements is true?

A) The longer the maturity of a security, the greater its interest rate risk.
B) If investors believe inflation will be subsiding in the future, the prevailing yield will be upward sloping.
C) The real rate of interest varies with the business cycle, with the lowest rates seen at the end of a period of business expansion and the lowest at the bottom of a recession.
D) The interest risk premium always adds a downward bias to the slope of the yield curve.

Question 80

Yield to maturity: Jane Almeda is interested in a 10-year bond issued by Roberts Company that pays a coupon of 10 percent annually. The current price of this bond is $1,174.45. What is the yield that Jane would earn by buying it at this price and holding it to maturity? (Round to the closest answer.)

A) 7%
B) 7.5%
C) 8%
D) 8.5%