Question 1

Holding all other variables constant, as market interest rates increase, bond prices decrease.

Accepted Answer

This is an inverse relationship known as the "bond-price interest-rate inverse relationship." As market interest rates increase, the present value of future cash flows for a fixed-rate bond decrease, causing the bond price to decrease.

Question 2

Investing means using a resource to benefit the future rather than for current satisfaction.

Accepted Answer

Investing is about sacrificing present consumption in order to generate benefits or returns in the future. It involves putting your money, time, or resources into investments that are expected to appreciate in value over time. The goal of investing is to achieve long-term financial growth and security.

Question 3

The longer the time to maturity, the smaller the maturity risk associated with a bond.

Accepted Answer

The longer the time to maturity, the greater the maturity risk (or interest rate risk) associated with a bond, as there is more time for interest rates to fluctuate, affecting the bond's price.

Question 4

The term coupon originated long ago when coupons were attached to bonds. When interest was due a bondholder would clip off a coupon and send it to the bond issuing company which would return an interest payment.

Accepted Answer

This is the true origin of the term coupon.

Question 5

A bond selling at par will have a yield to maturity equal to its current yield.

Accepted Answer

When a bond is selling at par, it means that its price is equal to its face value, and therefore its coupon rate (which determines the current yield) is equal to its yield to maturity. Hence, the statement is true.

Question 6

The call premium is also known as call protection.

Accepted Answer

The call premium is the amount paid by the issuer to call (redeem) a security before its scheduled maturity. Call protection refers to a provision in a security that limits the issuer's ability to call the security early.

Question 7

Due to the mechanics of printing and issuing bonds, bond coupon rates do not always equal current market interest rates.

Accepted Answer

Bond coupon rates are set when the bond is issued and usually remain fixed until maturity, regardless of changes in current market interest rates. Therefore, when market interest rates rise or fall, the bond's coupon rate may not be equal to the current market interest rate.

Question 8

Valuation is a systematic process through which we establish the prices at which stocks and bonds should sell.

Accepted Answer

Valuation involves analyzing financial and economic factors to determine the intrinsic value of a security and establish its fair market price. This process is used to guide investors and traders in making informed decisions about buying, selling, or holding securities.

Question 9

Assuming a one year investment, the formulation for arriving at return is either FV₁ = PV + kPV or FV₁ = PV(1+k).

Accepted Answer

Both of these formulas are correct for calculating return on a one year investment. The first formula, FV₁ = PV + kPV, breaks down the future value (FV) of your investment (PV) plus the interest earned (kPV) over the course of one year. The second formula, FV₁ = PV(1+k), multiplies the initial investment (PV) by the growth factor of 1 plus the interest earned (k) to arrive at the future value (FV) after one year.

Question 10

Coupon rates and payments are generally fixed throughout the life of a bond regardless of the economic or market conditions.

Accepted Answer

Coupon rates and payments are set when the bond is issued and are generally fixed throughout the life of the bond, regardless of any changes in market conditions.

Question 11

Determining the market price of a financial asset depends principally on identifying the future cash flows associated with its ownership.

Accepted Answer

The market price of a financial asset is determined by the present value of its expected future cash flows. Therefore, identifying, estimating, and forecasting the cash flows associated with the asset's ownership is essential in determining its market price.

Question 12

Call provisions are most likely exercised by the borrower when interest rates are falling.

Accepted Answer

Call provisions allow the borrower to repay the bond before its maturity date, typically to refinance at a lower interest rate, making them more likely to be exercised when interest rates are falling.

Question 13

The term "yield" relates only to investments whose holding period extends beyond one year, whereas "rate of return" typically relates to shorter-term investments.

Accepted Answer

The statement is false. Yield and rate of return can both apply to investments of any length of time. Yield generally refers to the income generated by an investment, while rate of return measures the overall gain or loss of an investment over a certain period of time. Both terms can be used for long-term and short-term investments.

Question 14

Bonds are referred to as amortized debt due to fact that interest and principal payments are made to the lender until maturity.

Accepted Answer

The answer of Bonds are referred to as amortized debt...

Question 15

Because stocks rely on dividends as the principal source of cash flow, ascertaining stock prices is an easier and more precise process than the valuation of bonds, which relies on variable coupon payments.

Accepted Answer

Valuing stocks is often considered more complex than valuing bonds because stocks do not guarantee cash flows like bonds do with their fixed coupon payments. Stocks' dividends can vary and are not guaranteed, making their future cash flows more uncertain and their valuation more challenging.

Question 16

The word "term" refers to the bond's lifetime when it is first issued.

Accepted Answer

The term of a bond refers to the length of time until the bond matures, or the lifetime of the bond from when it is first issued.

Question 17

The rate of return offered by a security is the interest rate that makes the present value of the security's future cash flows equal to its selling price.

Accepted Answer

The statement accurately describes the concept of the rate of return. It reflects the relationship between the cash flows an investment generates over time and the initial investment required to acquire the security.

Question 18

The vehicle for an equity investment is generally a bond, while for a debt investment it is a share of stock.

Accepted Answer

The statement is incorrect. The vehicle for an equity investment is a share of stock, while for a debt investment it is a bond.

Question 19

A security's value is equal to the present value of its expected future cash flows discounted by an appropriate rate of return.

Accepted Answer

This statement describes the concept of discounted cash flow analysis, which is a common method used to value securities and other financial instruments. By calculating the present value of expected future cash flows and discounting them based on an appropriate rate of return, investors can determine the fair value of a security and decide whether it is overvalued or undervalued in the market.

Question 20

A bond's yield and coupon rate vary over time depending on market and economic conditions.

Accepted Answer

A bond's coupon rate is fixed and does not change over time; however, its yield can vary depending on market and economic conditions.

Quiz 7: The Valuation and Characteristics of Bonds