Question 1

________ bonds tend to have lower interest rates than ________ bonds.

Accepted Answer

Shorter-maturity bonds tend to have lower interest rates than longer-maturity bonds. This is because investors are willing to accept a lower interest rate in exchange for the safety and certainty of receiving their money back sooner. In contrast, longer-maturity bonds are riskier because there is a greater chance of interest rate fluctuations and inflation eroding the value of their returns over time. Therefore, investors demand higher interest rates as compensation for taking on this additional risk.

Question 2

Your loss from an increase in interest rates is ________,and your gain from a decrease in interest rates is ________,if you hold a two-year bond compared to holding a one-year bond.

Accepted Answer

A two-year bond is more sensitive to interest rate changes than a one-year bond, leading to greater potential losses when rates rise and greater potential gains when rates fall.

Question 3

Suppose an increase in real GDP is accompanied by an increase in the money supply from $600 billion to $700 billion.Draw a graph of the money market showing these changes,where the equilibrium nominal interest rate remains at 5%.

Accepted Answer

The answer of Suppose an increase in real GDP is...

Question 4

Suppose a Canada Savings Bond will mature in 4 years.If the bond pays a coupon of $200 per year and will make a final par value payment of $5000 at maturity,what is its price if the relevant market interest rate is 3%?

Accepted Answer

The correct answer is A because the price of the bond is the present value of the future cash flows, which are the annual coupon payments and the final par value payment. The present value of the annual coupon payments is $200/(1+0.03)^1 + $200/(1+0.03)^2 + $200/(1+0.03)^3 + $200/(1+0.03)^4 = $744.09. The present value of the final par value payment is $5000/(1+0.03)^4 = $4441.76. Therefore, the price of the bond is $744.09 + $4441.76 = $5185.85.

Question 5

Suppose you purchase a two-year bond that has a $450 coupon and a face value of $5000,and immediately after you purchase the bond,new bonds are issued that are otherwise identical,except they have coupons of $375.If you sell your bond,the price of your bond will be

Accepted Answer

The price of the bond will decrease because the new bonds offer a lower coupon rate, making the existing bond with a higher coupon more valuable. The price of the bond will adjust to reflect the higher coupon, resulting in a price of $5134.67.

Question 6

Luke purchases a $50 000 face value one-year Treasury bill for $46 296.30,and the next day investors decide they will only buy one-year Treasury bills if they receive an interest rate of 4%.If Luke decides to sell his Treasury bill to another investor the day after he purchased it,he will

Accepted Answer

The correct answer is A because Luke will receive a capital gain of $1780.62 if he sells his Treasury bill to another investor the day after he purchased it.

Question 7

Assume the interest rate on a current one-year bond is 3%,and the expected interest rate on the one-year bond one year from now is 6%.If the term premium on a two-year bond is 0.5%,then the interest rate on the two-year bond will be

Accepted Answer

The interest rate on the two-year bond is calculated by averaging the current one-year bond rate (3%) and the expected one-year bond rate one year from now (6%), then adding the term premium (0.5%): (3% + 6%)/2 + 0.5% = 5%.

Question 8

Bonds with ________ tend to have lower interest rates than bonds with ________.

Accepted Answer

Bonds with high liquidity are easier to sell and therefore tend to have lower interest rates compared to bonds with low liquidity, which are harder to sell and thus require higher interest rates to attract buyers.

Question 9

The relationship among interest rates on bonds that all mature at the same time is known as the

Accepted Answer

The risk structure of interest rates refers to the relationship among interest rates on bonds with the same maturity but different levels of risk.

Question 10

Suppose you purchase a one-year bond that has a $450 coupon and a face value of $5000,and immediately after you purchase the bond,new bonds are issued that are otherwise identical,except they have coupons of $375.If you sell your bond,you will

Accepted Answer

The answer of Suppose you purchase a one-year bond that...

Question 11

Assume the current interest rate on a one-year bond is 7%,and the interest rate investors expect on the one-year bond one year from now is 3%.According to the expectations hypothesis,the current interest rate (per year)on a two-year bond should be

Accepted Answer

According to the expectations hypothesis, the current interest rate on a two-year bond is the average of the expected future interest rates over the two-year period. Therefore, the current interest rate on a two-year bond should be [(7% + 3%)/2] = 5%. Therefore, the best choice is B.

Question 12

The yield curve will be downward sloping when

Accepted Answer

A downward sloping yield curve, also known as an inverted yield curve, occurs when investors expect future short-term interest rates to fall, indicating potential economic slowdown or recession.

Question 13

Suppose a Canada Savings Bond will mature in 3 years.If the bond pays a coupon of $100 per year and will make a final par value payment of $3000 at maturity,what is its price if the relevant market interest rate is 7%?

Accepted Answer

To calculate the bond's price, we need to use the present value formula:
Price = (coupon payment / (1 + interest rate)^1) + (coupon payment / (1 + interest rate)^2) + (coupon payment + par value/ (1 + interest rate)^3)

Plugging in the given values:
Price = (100 / (1 + 0.07)^1) + (100 / (1 + 0.07)^2) + (3000 / (1 + 0.07)^3)
Price = 92.52 + 86.51 + 2532.30
Price = $2711.33

Question 14

Zelda won the jackpot on a penny slot machine in Las Vegas and is given the following three options to receive her jackpot:
Option 1: $100 000 to be received right away,with four additional payments of $100 000 to be received each year for the next four years.
Option 2: $250 000 to be received right away with two additional payments of $100 000 to be received each year for the next two years.
Option 3: $400 000 to be received right away.
Which option should Zelda choose if the interest rate is 8%? Would she choose the same option if the interest rate were 10%? Why?

Accepted Answer

The answer of Zelda won the jackpot on a penny...

Question 15

Suppose you purchase a two-year bond that has a $450 coupon and a face value of $5000,and immediately after you purchase the bond,new bonds are issued that are otherwise identical,except they have coupons of $375.If you sell your bond,you will receive a gain of

Accepted Answer

First, we need to calculate the yield to maturity (YTM) of the original bond. We can do this by using the bond pricing formula:

$5000 = [$450/(1 + YTM)^1] + [$450/(1 + YTM)^2] + … + [$450/(1 + YTM)^4] + [$5000/(1 + YTM)^4]

Simplifying the equation, we get:

$5000 = $450 [(1 - 1/(1 + YTM)^4)/YTM] + $5000/(1 + YTM)^4

Solving for YTM using trial and error or a financial calculator, we get YTM = 4.5%.

Next, we need to calculate the price of the original bond after the new bonds are issued. Since the new bonds have a lower coupon rate, they will be priced lower than the original bond. We can use the same bond pricing formula, but with a coupon of $375 instead of $450:

$P = [$375/(1 + YTM)^1] + [$375/(1 + YTM)^2] + … + [$375/(1 + YTM)^4] + [$5000/(1 + YTM)^4]

Solving for P using YTM = 4.5%, we get P = $4,865.34.

Therefore, the gain from selling the original bond is:

$4,865.34 - $5,000 = -$134.66

This means that you would experience a loss of $134.66 if you sold the original bond after the new bonds were issued.

Question 16

Assume the current price investors are willing to pay on a $1000 face value one-year Canada Savings Bond is $980.39,and investors expect that they will be willing to pay $961.54 on a $1000 face value one-year Canada Savings Bond one year from now.According to the expectations hypothesis,the current interest rate (per year)on a $1000 face value two-year Canada Savings Bond should be

Accepted Answer

The expectations hypothesis states that the current interest rate on a two-year bond is equal to the average of the current one-year interest rate and the expected one-year interest rate one year from now. The current one-year interest rate is the yield to maturity on a one-year bond, which is calculated as follows:$$YTM = \frac{FV - PV}{PV * N}$$where:* YTM is the yield to maturity* FV is the face value of the bond* PV is the present value of the bond* N is the number of years to maturityIn this case, the face value of the bond is $1000, the present value is $980.39, and the number of years to maturity is 1. Therefore, the yield to maturity is:$$YTM = \frac{1000 - 980.39}{980.39 * 1} = 0.02$$or 2%.The expected one-year interest rate one year from now is the yield to maturity on a one-year bond one year from now. This is given as $961.54. Therefore, the expected one-year interest rate one year from now is:$$YTM = \frac{1000 - 961.54}{961.54 * 1} = 0.04$$or 4%.Therefore, the current interest rate on a two-year bond is:$$YTM = \frac{0.02 + 0.04}{2} = 0.03$$or 3%.

Question 17

Bonds with ________ tend to have higher interest rates than bonds with ________.

Accepted Answer

Bonds with high default risk tend to have higher interest rates than bonds with low default risk because investors demand a higher return to compensate for the higher risk of default. Bonds with high liquidity, shorter maturity, or low tax burdens on their interest may also have lower interest rates due to their lower risks or greater marketability.

Question 18

Isabel purchases a $1000 face value one-year Treasury bill for $934.58,and the next day investors decide they will only buy one-year Treasury bills if they receive an interest rate of 9%.If Isabel decides to sell her Treasury bill to another investor the day after she purchased it,she will

Accepted Answer

Isabel purchased the Treasury bill at a discount of $1000 - $934.58 = $65.42. If investors require a 9% interest rate, then the Treasury bill would be worth $1000/(1+0.09) = $917.43. Therefore, if Isabel sells the bill, she will receive $917.43, which is a capital loss of $934.58 - $917.43 = $17.15.

Question 19

Suppose you purchase a one-year bond that has a $450 coupon and a face value of $5000,and immediately after you purchase the bond,new bonds are issued that are otherwise identical,except they have coupons of $375.If you sell your bond,the price of your bond will be

Accepted Answer

To calculate the price of the bond, we have to find the present value of all the coupon payments and the face value of the bond. The interest rate used in this calculation is the yield to maturity or the required rate of return. Assuming that the required rate of return remains the same after the issuance of the new bonds, the price of the bond will decrease because the coupon payment is reduced. Using a financial calculator or Excel, we can find that the present value of the coupon payments is $4286.46 and the present value of the face value is $783.31. Therefore, the price of the bond will be $4286.46 + $783.31 = $5069.77.

Question 20

The relationship among interest rates on bonds that are otherwise similar but that have different maturities is known as the

Accepted Answer

The relationship among interest rates on bonds with different maturities is known as the term structure of interest rates. The term premium is the additional yield paid to investors for holding a longer-term bond. The risk structure of interest rates refers to the differences in interest rates due to varying levels of credit risk among issuers. Treasury bond coupon is the interest rate that the issuer of a Treasury bond pays to the bondholders.

Quiz 3: The Canadian Financial System

bonds tend to have lower interest rates than bonds.

Your loss from an increase in interest rates is ,and your gain from a decrease in interest rates is ,if you hold a two-year bond compared to holding a one-year bond.