Question 1

If investors expect interest rates to decline, they are also expecting bond prices to rise.

Accepted Answer

When interest rates decline, existing bonds with higher interest rates become more valuable, leading to an increase in their prices. This is because new bonds will be issued at the new, lower interest rates, making the older, higher-yielding bonds more attractive to investors.

Question 2

An investor may expect a bond to be called if its current yield exceeds the yield to maturity.

Accepted Answer

When a bond's current yield exceeds its yield to maturity, it suggests that the bond is trading at a premium, often because market interest rates have fallen below the bond's coupon rate. In such scenarios, issuers may choose to call (or redeem) the bond before maturity to refinance the debt at a lower interest rate, leading investors to expect a bond to be called under these conditions.

Question 3

A call penalty is a payment made to the firm to encourage early retirement of the bond.

Accepted Answer

A call penalty is a fee paid by the issuer to bondholders when the issuer calls the bond before its maturity date, not to encourage early retirement but as compensation for the early redemption.

Question 4

A call feature will have no impact on the value of a bond if interest rates rise.

Accepted Answer

A call feature gives the issuer the option to redeem the bond before maturity. If interest rates rise, the issuer is more likely to call the bond because they can issue new bonds at a lower interest rate. This reduces the value of the bond for investors.

Question 5

If interest rates have fallen, a firm may prefer to repurchase the bonds on the market instead of calling and redeeming them.

Accepted Answer

The answer of If interest rates have fallen, a firm...

Question 6

If a bond sells for a discount, the yield to maturity exceeds the current yield.

Accepted Answer

When a bond sells for a discount, its market price is below its face value. The yield to maturity accounts for the bond's price appreciation as it approaches maturity (the price moves towards its face value) in addition to the interest payments received. Therefore, the yield to maturity includes both the current yield (interest payments relative to the bond's current price) and the capital gains yield (the appreciation of the bond's price over time), making it higher than the current yield alone.

Question 7

The prices of low coupon bonds tend to fluctuate more than the prices of high coupon bonds.

Accepted Answer

Low coupon bonds are more sensitive to interest rate changes than high coupon bonds, causing their prices to fluctuate more. This is because the present value of the bond's future cash flows (which are lower for low coupon bonds) is more affected by changes in the discount rate (interest rates).

Question 8

If a $1,000 bond with a 7 percent coupon were to sell for $978, the current interest rate exceeds 7 percent.

Accepted Answer

When a bond sells for less than its face value, it indicates that the current market interest rate is higher than the bond's coupon rate.

Question 9

A few bonds called "perpetuals" never mature.

Accepted Answer

Perpetual bonds, also known as "perps," are bonds with no maturity date, meaning they pay interest indefinitely.

Question 10

If a bond sells for a premium, the current yield exceeds the yield to maturity.

Accepted Answer

When a bond sells for a premium, its market price is higher than its face value. This means that the current yield, which is calculated by dividing the annual coupon payment by the market price, will be lower than the yield to maturity, which is calculated by taking into account the time value of money and the bond's face value.

Question 11

Most bonds pay interest semi-annually.

Accepted Answer

Most bonds are structured to pay interest twice a year, known as semi-annual interest payments, to bondholders.

Question 12

The value of a bond depends on the amount of principal, when it matures, and the interest it pays.

Accepted Answer

The value of a bond is influenced by its principal amount (face value), maturity date (when the principal is due to be paid back), and the interest rate (coupon rate) it pays, as these factors determine the bond's cash flows and risk profile.

Question 13

As interest rates increase, the prices of existing bonds increase.

Accepted Answer

When interest rates increase, the prices of existing bonds typically decrease because new bonds are issued at the higher rates, making the older, lower-yielding bonds less attractive.

Question 14

A bond is more likely to be called after interest rates have fallen.

Accepted Answer

When interest rates fall, issuers are more likely to call existing bonds so they can refinance the debt at a lower interest rate, similar to how a homeowner might refinance a mortgage to take advantage of lower rates.

Question 15

Bonds that are callable often have a call penalty.

Accepted Answer

Callable bonds often include a call penalty to compensate the bondholder for the issuer's option to repay the bond before its maturity date, which can deprive the bondholder of expected interest payments.

Question 16

If interest rates increase, a bond may be called.

Accepted Answer

Callable bonds are typically called when interest rates decrease, allowing the issuer to refinance at a lower rate.

Question 17

If bond prices rise, the yield to maturity declines.

Accepted Answer

When bond prices increase, the yield to maturity (YTM) declines because the YTM is inversely related to the bond's current price. The YTM reflects the total return anticipated on a bond if the bond is held until it matures, factoring in the bond's current market price, par value, coupon interest rate, and time to maturity. As the price of the bond rises above its par value, the fixed interest payments and return of par value at maturity represent a smaller percentage return on the higher current price, thus lowering the yield to maturity.

Question 18

The current yield exceeds the yield to maturity if interest rates fall.

Accepted Answer

When interest rates fall, the present value of future cash flows increases, which leads to an increase in the current yield. However, the yield to maturity remains unchanged, as it is determined by the market price of the bond and the coupon payments. Therefore, the current yield will exceed the yield to maturity if interest rates fall.

Question 19

If a $1,000 bond has a coupon of 8 percent and matures after eight years, the price of the bond will exceed $1,000 if the current interest rate is 9 percent.

Accepted Answer

The price of a bond inversely relates to the interest rate; if the current interest rate exceeds the bond's coupon rate, the bond's price will be less than its face value ($1,000 in this case).

Question 20

If bond prices were to decline, the current yield would increase.

Accepted Answer

When bond prices decline, the fixed interest payment represents a higher percentage of the bond's price, thus increasing the current yield.

Quiz 14: The Valuation of Fixed-Income Securities