Deck 11: Bond Valuation

Question 1

A yield curve depicts the term structure of interest rates for similar-risk securities.

Answer 1

True

Question 2

The risk-free rate of return considers the expected rate of inflation.

Answer 2

True

Question 3

Actions by the Federal Reserve can keep the risk-free rate below the rate of inflation, at least temporarily.

Answer 3

True

Question 4

The relationship between the rate of return and the time to maturity of similar-risk securities is known as the term structure of interest rates.

Question 5

Yield curves for corporate and government securities have similar shapes, but the corporate rates track below the government rates.

Question 6

Changes in the inflation rate have a direct and pronounced effect on market interest rates.

Question 7

Which of the following tend to raise interest rates?
I.an increase in the money supply
II.an increase in the expected rate of inflation
III.Federal Reserve actions taken to lower expected rates of inflation
IV.an increase in investing activities by businesses

A)I, II, III only
B)II, III, IV only
C)I, II and IV only
D)I, III, and IV only

Question 8

The interest rate on the 10 year Treasury Bond has rarely fallen below the rate of inflation.

Question 9

Which one of the following statements concerning interest rates is correct?

A)A decrease in the money supply will cause interest rates to decline.
B)A federal budget surplus will cause interest rates to decline.
C)Economic expansions will cause interest rates to decline.
D)Rising interest rates in foreign countries will cause U.S.interest rates to decline.

Question 10

The single most important factor that influences the behavior of market interest rates is

A)inflation.
B)business profits.
C)the supply of new bonds.
D)the stock market.

Question 11

The higher a bond's Moody's or Standard & Poor's rating, the higher its yield.

Question 12

The required return on a bond is equal to

A)the real rate of return plus a risk premium plus an expected inflation premium.
B)the real rate of return plus the coupon rate plus an inflation rate.
C)the risk-free rate plus a risk premium plus an expected inflation premium.
D)the real rate plus a risk premium.

Question 13

Treasury bond yields are commonly used as the basis for yield curves because they are low risk and homogeneous in nature.

Question 14

Interest rates in the U.S.and in major foreign economies

A)are uncorrelated or very weakly correlated.
B)tend to move in opposite directions.
C)tend to move in the same direction.
D)are the same when adjusted for inflation.

Question 15

Which one of the following will tend to cause domestic interest rates to rise?

A)an increase in the money supply
B)a decrease in the rate of inflation
C)a decrease in the federal budget deficit
D)an increase in interest rates overseas

Question 16

Municipal bonds usually have higher yields than bonds issued by the U.S.Government.

Question 17

Which of the following factors influence short-term interest rates on government securities?
I.Federal Reserve actions
II.interest rate risk
III.expected future inflation
IV.the real rate of return

A)I and III only
B)II and IV only
C)I, II and IV only
D)I, III and IV only

Question 18

Which of the following risks are included in the risk premium?
I.interest rate risk
II.liquidity risk
III.financial risk
IV.purchasing power risk

A)I and II only
B)II and III only
C)III and IV only
D)I and IV only

Question 19

The risk premium component of a bond's market interest rate is related to the characteristics of the particular bond and its issuer.

Question 20

The risk-free rate of return is equal to the

A)real rate plus a risk premium.
B)required return minus the inflation premium.
C)real rate plus the inflation premium.
D)required return minus the real rate.

Question 21

The expectations hypothesis states that investors

A)require higher long-term interest rates today if they expect higher inflation rates in the future.
B)expect higher long-term interest rates because of the lack of liquidity for long-term bonds.
C)require the real rate of return to rise in direct proportion to the length of time to maturity.
D)normally expect the yield curve to be downsloping.

Question 22

According to the expectations hypothesis, if investors anticipate higher rates of inflation in the future, the yield curve will be downsloping.

Question 23

An inverted yield curve

A)means that long-term bonds are yielding more than short-term bonds.
B)results when investor demand for longer maturities exceeds the demand for shorter maturities.
C)rewards long-term investors for the additional risk they are assuming.
D)sometimes results from actions by the Federal Reserve to control inflation.

Question 24

The yield curve depicts the relationship between a bond's yield to maturity and its

A)duration.
B)term to call.
C)term to maturity.
D)volatility.

Question 25

At any given time, the yield curve is affected by
I.lender preferences.
II.inflationary expectations.
III.liquidity preferences.
IV.short- and long-term supply and demand conditions.

A)I and IV only
B)II, III and IV only
C)I, II and III only
D)I, II, III and IV

Question 26

A downward sloping yield curve (short-term rates are higher than long-term rates)often precedes a recession.

Question 27

Market segmentation theory explains the typical upward sloping shape of yield curves as a function of

A)normally greater demand for long-term bonds than for short-term notes.
B)normally greater demand for short term notes than for long-term bonds.
C)expectations that inflation will be higher in the future than it is now.
D)the greater liquidity of short-term notes as compared to long-term bonds.

Question 28

According to expectations theory if the 1 year interest is 3% this year and expected to be 5% next year, the 2 year interest rate should be approximately

A)8%.
B)5%.
C)4%.
D)3%.

Question 29

When compared to the yield curve for Treasury securities, the yield curve for corporate securities should

A)slope in the opposite direction.
B)be similar in shape but higher.
C)be similar in shape but lower.
D)be nearly identical.

Question 30

According to expectations theory if the 2 year interest rate is 4% and the 1 year rate is now 3%, the 1 year rate next year is expected to be

A)8%.
B)5%.
C)4%.
D)3%.

Question 31

Long-term bonds are ________ than short-term bonds.

A)less risky
B)more liquid
C)subject to more uncertainty
D)less sensitive to interest rate changes

Question 32

The real rate of return is the same for all maturities.

Question 33

A normal yield curve is flat or downward sloping.

Question 34

The market segmentation theory holds that

A)an increase in demand for long-term borrowings leads to an inverted yield curve.
B)expectations about the future level of interest rates is the major determinant of the shape of the yield curve.
C)the yield curve reflects the maturity preferences of financial institutions and investors.
D)the shape of the yield curve is always downsloping.

Question 35

A steep yield curve is generally considered a bullish sign for bonds.

Question 36

The liquidity preference theory supports ________ yield curves.

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

Question 37

Which of the following theories is consistent with yield curves sloping upward most of the time?
I.market segmentation theory
II.expectations theory
III.liquidity preference theory
IV.theory of evolution

A)I and III only
B)II, III and IV only
C)I, II and III only
D)I, II, III and IV

Question 38

According to the liquidity preference theory, borrowers should pay a higher interest rate for long-term borrowing than for short-term borrowing.

Question 39

Downward sloping or flat yield curves often indicate

A)a recession in the near future.
B)an economic expansion in the near future.
C)higher inflation in the near future.
D)a weaker dollar in the foreign exchange markets.

Question 40

Market segmentation theory would explain an upward sloping yield curve as a high demand for short-term securities relative to the supply.

Question 41

If inflation is expected to increase significantly, cautious bondholders should

A)expect interest rates to rise.
B)expect a flat yield curve for the intermediate-term.
C)buy long-term bonds today.
D)move to the short-end of the yield curve.

Question 42

Evidence indicates that the theory of interest rates with the most predictive power is

A)market segmentation theory.
B)expectations theory.
C)liquidity preference theory.
D)a combination of expectations, market expectations and liquidity preference.

Question 43

To the nearest dollar, what is the current price of a 9%, $1,000 annual coupon bond that has eighteen years to maturity and a yield to maturity of 7.01%?

A)$1,200
B)$1,000
C)$826
D)$701

Question 44

Which of the following are needed to determine the appropriate value of a bond?
I.required rate of return
II.time to maturity
III.frequency of interest payments
IV.coupon rate

A)II and III only
B)III and IV only
C)II, III and IV only
D)I, II, III and IV

Question 45

A bond has a coupon rate of 6%, matures in 6 years, and currently sells for $1,000 (par value).Therefore the yield to maturity is also 6%.

Question 46

Explain how a yield curve is constructed and what its shape reveals about interest rates.

Question 47

What is the yield-to-maturity of a $1,000, 7% semi-annual coupon bond that matures in 2 years and currently sells for $997.07?

A)6.87%
B)7.04%
C)7.16%
D)7.31%

Question 48

If the yield curve begins to rise sharply, it is usually an indication that

A)stocks are offering low returns as the economy enters a recession.
B)inflation rates have peaked and are about to decline.
C)bond prices are expected to increase.
D)inflation is starting to increase, or is expected to do so in the near future.

Question 49

The yield to maturity on a zero coupon, $1,000 par value bond which will mature in 10 years is 5%.The price of the bond is $500.

Question 50

What is the current price of a $1,000, 6% coupon bond that pays interest semi-annually if the bond matures in ten years and has a yield-to-maturity of 7.1325%?

A)$567
B)$920
C)$1,030
D)$1,080

Question 51

The longer the time to maturity, the less sensitive a bond's price will be to changes in interest rates.

Question 52

What is the coupon rate of an annual bond that has a yield to maturity of 8.5%, a current price of $942.32, a par value of $1,000 and matures in thirteen years?

A)7.67%
B)7.75%
C)8.33%
D)8.50%

Question 53

If a bond's yield to maturity is lower than its coupon rate, the bond will sell at a discount.

Question 54

A $1,000 par value, 12-year annual bond carries a coupon rate of 7%.If the current yield of this bond is 7.995%, its market price to the nearest dollar is

A)$876.
B)$925.
C)$1,075.
D)$1,125.

Question 55

As a bond approaches its maturity date, its price necessarily approaches par value.

Question 56

Liquidity preference theory suggests that when bond investors move from short-term securities to long term securities

A)they are expecting short-term rates to fall.
B)they are expecting long-term rates to rise.
C)they believe that they can earn a higher rate of return over the long term by buying bonds with longer maturities than they could by buying a series of short-term investments.
D)they want to be protected from the risk of falling bond prices in the future.

Question 57

The price of a bond with an 6% coupon rate paid semi-annually, a par value of $1,000, and fifteen years to maturity is the present value of

A)15 payments of $30 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
B)15 payments of $60 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
C)30 payments of $30 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
D)30 payments of $60 at 1 year intervals plus $1,000 received at the end of the 30th year.

Question 58

A bond's discount or premium will tend to increase as the bond approaches its maturity date.

Question 59

The price of a bond is equal to the present value of the bond's future cash flows.

Question 60

A significant portion of a coupon bond's total return is derived from the reinvestment of the interest payments.

Question 61

Dylan purchased 20 GIA Inc.bonds in 2008 when the yield to maturity was 12.5%.Because of falling interest rates she had to reinvest the coupon payments at 8%, 6%, 4% and finally, 3%.The internal rate of return on her investment will be

A)greater than the coupon rate but less than the original yield to maturity.
B)less than the original yield to maturity.
C)greater than the original yield to maturity.
D)the reinvestment rate has no effect on the internal rate of return.

Question 62

Yield-to-call assumes a bond is called on the last possible date.

Question 63

Bond yields are set by the bond issuer.

Question 64

If you are an income-oriented investor and you feel that interest rates are relatively high and will decline in the future, you should purchase

A)zero-coupon, long-term bonds.
B)long-term, non-callable bonds.
C)short-term, zero-coupon bonds.
D)long-term, freely callable bonds.

Question 65

The required return defines the yield at which a bond should be trading and serves as the discount rate in the bond valuation process.

Question 66

The greater of the yield-to-call or the yield-to-maturity is used as the appropriate indicator of value.

Question 67

Which one of the following statements is true about a $1,000, 6% annual coupon bond that is selling for $1,012?

A)The current yield is less than 6%.
B)The current yield is 6%.
C)The yield-to-maturity is greater than 6%.
D)The yield-to-maturity is 6%.

Question 68

Jordan bought a 4% semi-annual coupon bond with 25 years to maturity at par value of $1,000.If the required rate of return (yield to maturity )of this bond increases to 4.25%, by how much does the value of the bond change?

A)minus $38.04
B)plus $39.28
C)minus $38.27
D)The value does not change if Jordan intends to hold the bond to maturity.

Question 69

Wayward.com $1,000 par value bonds have a 4.6% coupon paid semi-annually.They will mature in 6 years and 6 months and are currently selling at $1,015.The yield to maturity for these bonds is

A)2.17%.
B)4.33%.
C)4.45%.
D)4.00%.

Question 70

Yield to call on a bond with a coupon rate of 8% paid semi-annually, 10 years to maturity, a par value of $1,000 and a selling price of $1,071, callable after 5 years at $1,010 is

A)3.5%.
B)6.49%.
C)7.0%.
D)8.16%.

Question 71

The current yield for a bond with a par value of $1,000, an annual interest payment of $55 and a market price of $1,100 is 5%.

Question 72

The actual return earned on a bond is highly dependent upon the reinvestment rate of the coupons.

Question 73

A bond is most likely to be called

A)when investors must reinvest at lower rates.
B)when the bond sells at a large discount.
C)when market yields are close to coupon rates.
D)when investors can reinvest at higher rates.

Question 74

A basis point is 1/10 of 1%.

Question 75

Generally speaking, short-term bonds have lower yields than long-term bonds.

Question 76

A bond's current yield is equal to the interest payment divided by par value.

Question 77

Which one of the following statements is correct concerning bond investors?

A)Aggressive investors want to lock in high interest rates.
B)Aggressive investors purchase bonds when they believe interest rates will rise.
C)Conservative investors seek capital gains.
D)Conservative investors buy bonds when interest rates are high.

Question 78

Yield to call is a useful measure for bonds selling at a premium, but not for bonds selling at a discount.

Question 79

Five years ago Brookfield Industries issued 30 year bonds with a 4% coupon rate callable at par after 5 years.Inflation has increased and the yield on bonds similar to Brookfield's is now 6%.Given these facts,

A)Brookfield is almost certain to call the bonds.
B)the yield to call on the Brookfield bonds is now 6%.
C)Brookfield is not likely to call the bonds any time soon.
D)the price of the bonds will remain close to par because of their call value.

Question 80

A bond's yield to maturity is equal to the internal rate of return of its cash flows.