Question 1

How can a bond mutual fund promise a return of over 13% when the coupon rate of the bonds they are holding are just 7% and interest rates are falling?

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Question 2

Consider two investors: one is risk-neutral and the other is risk-averse.How do they each assess a risk premium?

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Question 3

Many people are worried that, with the growing number of people that will be retiring in the U.S.over the next 40 years, the Social Security System will need to borrow large amounts of money.If we assume that Social Security taxes and the current eligibility age remain constant, explain the likely impact this will have on bond markets.

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Question 4

Explain why two countries with the same average rate of inflation may not present the same inflation risk for holders of those countries' bonds?

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Question 5

Consider the factors that affect bond demand and bond supply.Describe how the following are likely to change during a period of robust economic growth: wealth, default risk, and general business conditions.For each, state how the factor is likely to change, and discuss the implications for bond demand/supply, bond price, and yield.Bond prices tend to decrease during periods of high economic growth.What does this reveal about which of these factors is important?

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Question 6

During economic recessions, interest rates may decrease or increase.This question asks you to analyze two recent U.S.recessions:
(i) 1990-91 recession (interest rates increased)
(ii) 2001 recession (interest rates decreased)
What happened to bond prices during each of these recession? What do the interest rate data from these two recessions reveal about the shifts in bond demand and bond supply?

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Question 7

The text identified the various sources of risk for bonds.Are U.S.Treasury TIPS bonds free from risk? Explain.

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Question 8

In mid-2004 there was speculation that the Federal Reserve would be raising interest rates before the end of the year.How would this news affect the bond market and why?

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Question 9

At the time the government of Bulgrovia issued new bonds, they issued them at a price that reflected the risk-free rate because investors had no concerns regarding default risk, so did not require a risk premium.That risk-free rate was 4%.These bonds currently have one year to maturity and you notice the yield is 20%.Can you calculate the probability that the Bulgrovian government will default?

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Question 10

Which bond should sell for the higher price and why? (i) A basic U.S.Treasury bond, with a $10,000 face value and 20 years to maturity (ii) a U.S.Treasury TIPS bond with the same maturity and face value.

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Question 11

The Fisher effect refers to a situation where a change in expected inflation is offset one-for-one with a change in nominal interest rates (yield to maturity).Specifically, the real interest rate remains unchanged and the amount of borrowing remains unchanged.Assuming an increase in expected inflation, explain how this change would be reflected in the bond market.What would happen to bond prices and the quantity of bonds outstanding?

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Question 12

You win your state lottery.The lottery officials offer you the option of taking your winnings in one lump-sum payment, or fixed annual payments for the next 20 years.The sum of the 20 annual payments is larger than the lump-sum payment.Before deciding, what are the key factors you will want to consider that could influence your decision?

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Question 13

If you were going to issue bonds, would you prefer to be in a country where the average inflation rate is 3% inflation but fluctuates wildly, or in a country with a higher, 4% expected inflation rate that is stable (meaning it's always 4%).Explain.

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Question 14

Use our model of the bond market (supply and demand) to explain what happens if the U.S.economy continues to grow at robust rates.

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Question 15

In the chapter you read about David Bowie, a rock and roll artist from Great Britain, who has issued bonds.Would this be a likely avenue of financing for a new rock and roll group needing to raise funds to get their career going? Explain.

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Quiz 6: Bonds, Bond Prices, and the Determination of Interest Rates