Question 1

Downward-slopping yield curves are observed

Accepted Answer

Downward-sloping yield curves are often observed before the beginning of a recession. This is because investors are willing to accept lower yields on longer-term bonds in anticipation of interest rate cuts and economic slowdown, which lead to a decrease in bond prices and an increase in yields.

Question 2

Which of the following statements is true?

Accepted Answer

This statement is known as the interest rate-risk relationship and is true as interest rates and bond prices have an inverse relationship. A) is false because long-term bonds have higher price volatility due to the longer duration. C) is false because short-term bonds have lower risk due to their shorter duration. D) is false because interest rate risk increases as maturity increases.

Question 3

What is the marketability risk premium? Why should an issuing firm consider paying this premium?

Accepted Answer

The answer of What is the marketability risk premium? Why...

Question 4

Which one of the following statements is NOT true?

Accepted Answer

The relationship between yield to maturity and marketability is not known as the term structure of interest rates. The term structure of interest rates refers to the relationship between the yields on different maturities of bonds, whereas marketability refers to the ease with which a bond can be bought or sold in the market.

Question 5

Why does the default risk premium vary over the business cycle?

Accepted Answer

The answer of Why does the default risk premium vary...

Question 6

Which of the following statements is true?

Accepted Answer

Interest rate risk premium generally adds an upward bias to the slope of the yield curve, as investors demand higher yields for longer-term investments to compensate for the increased risk.

Question 7

Which of the following statements is NOT true?

Accepted Answer

The answer of Which of the following statements is NOT...

Question 8

Which of the following statements is true?

Accepted Answer

All the statements are true: Lower transaction costs increase marketability, yield varies with marketability, and U.S. Treasury bills are highly marketable due to their active secondary market.

Question 9

Which of the following statements is true?

Accepted Answer

Risky securities, such as non-investment grade bonds, require a higher yield to compensate investors for the additional risk they are taking on. This "premium" is also called a risk premium. Option A is incorrect because investment grade bonds are rated triple B and higher, not single B. Option B is also incorrect because insurance companies and pension funds are typically restricted to purchasing investment grade bonds. Option D is incorrect because a bond's coupon rate is based on a variety of factors, not just its rating.

Question 10

Which one of the following statements is NOT true?

Accepted Answer

As interest rates increase, bond prices decrease. This is because newer bonds will offer a higher yield, making existing bonds less attractive and causing their prices to drop.

Question 11

Marketability is the ability of an investor

Accepted Answer

Marketability refers to the ease with which an investor can sell a security quickly, at a low transaction cost, and at a price close to its fair market value. It does not guarantee a profit or selling the security above its par value.

Question 12

Which of the following statements is true?

Accepted Answer

If market interest rates rise, a bond's value will decrease. Bonds with longer maturities will be affected more than bonds with shorter maturities because investors are tying up their money for a longer period of time and are therefore exposed to more interest rate risk. Therefore, a 10-year bond will fall in value more than a 1-year bond. A is incorrect as the opposite is true. B is also incorrect as a longer-term bond will be more affected by the rise in market interest rates. C is incorrect as bond prices and interest rates have an inverse relationship.

Question 13

Suppose an investor earned a semiannual yield of 6.4 percent on a bond paying coupons twice a year. What is the effective annual yield (EAY) on this investment? (Round to two decimal places.)

Accepted Answer

To calculate EAY, we use the formula:
(1 + semiannual yield)^2 - 1

Plugging in the values, we get:
(1 + 0.064)^2 - 1
= 1.132496 - 1
= 0.132496

Multiplying by 100 to convert to a percentage, we get:
EAY = 13.25%

Therefore, the best choice is D.

Question 14

Which of the following statements is true?

Accepted Answer

The longer the maturity of a security, the more time there is for interest rates to change, making it more susceptible to interest rate risk.

(Note: Choice B is incorrect because if investors believe inflation will be subsiding in the future, the yield curve will be downward sloping. Choice C is incorrect because the real rate of interest is generally higher during periods of economic expansion and lower during recessions. Choice D is incorrect because the interest rate risk premium can add an upward or downward bias to the slope of the yield curve depending on current market conditions.)

Question 15

Jorge Cabrera paid $980 for a 15-year bond 10 years ago. The bond pays a coupon of 10 percent semiannually. Today, the bond is priced at $1,054.36. If he sells the bond today, what will be his realized yield? (Round to the nearest percent.)

Accepted Answer

First, we need to calculate the current value of the bond using the semi-annual discount rate:

PV = C * (1 - (1 + r)^-n) / r + FV / (1 + r)^n

where: 
PV = present value 
C = coupon payment 
r = semi-annual discount rate 
n = number of semi-annual periods 
FV = face value

We know that FV = $1,000 (since it's a 15-year bond), C = 0.10 * $1,000 / 2 = $50, and n = (15 - 10) * 2 = 10 (since 10 years have passed and there are two semi-annual periods per year).

Substituting these values, we get:

$1,054.36 = $50 * (1 - (1 + r)^-10) / r + $1,000 / (1 + r)^10

Using financial calculator or Excel, we can solve for r = 5.5% (semi-annual discount rate).

The realized yield (or yield to maturity) is simply twice the semi-annual discount rate, or 11%. Therefore, the best choice is C.

Question 16

What economic factors affect the level and the shape of the yield curve? Explain.

Accepted Answer

The answer of What economic factors affect the level and...

Question 17

Stanley Hart invested in a municipal bond that promised an annual yield of 6.7 percent. The bond pays coupons twice a year. What is the effective annual yield (EAY) on this investment? (Round percentage to two decimal places.)

Accepted Answer

To calculate the effective annual yield (EAY), we need to use the formula EAY = (1 + r/n)^n -1, where r is the annual yield and n is the number of compounding periods in a year. In this case, the annual yield is 6.7% and the bond pays coupons twice a year, so n = 2. Plugging in the values, we get EAY = (1 + 0.067/2)^2 - 1 = 0.0681 or 6.81%. Therefore, the best choice is B.

Question 18

The three economic factors that affect the shape of the yield curve are:

Accepted Answer

The three economic factors that affect the shape of the yield curve are the real rate of interest, the expected rate of inflation, and interest rate risk. The real rate of interest refers to the rate of return adjusted for inflation, while the expected rate of inflation is the anticipated level of price increases over a given period. Interest rate risk is the possibility that changes in interest rates will cause the value of an investment to decline. These three factors affect the shape of the yield curve by influencing the level and slope of interest rates at different maturities.

Question 19

Rachel McGovern bought a 10-year bond for $921.77 seven years ago. The bond pays a coupon of 15 percent semiannually. Today, the bond is priced at $961.22. If she sold the bond today, what would be her realized yield? (Round to the nearest percent.)

Accepted Answer

The realized yield combines the coupon income and the capital gain or loss from holding the bond. Rachel bought the bond for $921.77 and sold it for $961.22, realizing a capital gain. The bond pays a 15% annual coupon rate on its face value, which is semiannually distributed. To find the realized yield, we need to calculate the total return (including both the coupon payments and the capital gain) over the investment period and then annualize this return. Given the information and the need to round to the nearest percent, the realized yield is approximately 17%. This accounts for both the income from the coupons and the gain from selling the bond at a higher price than the purchase price.

Quiz 8: Bond Valuation and the Structure of Interest Rates

Downward-slopping yield curves are observed

Which of the following statements is true?

What is the marketability risk premium? Why should an issuing firm consider paying this premium?

Which one of the following statements is NOT true?

Why does the default risk premium vary over the business cycle?

Which of the following statements is true?

Which of the following statements is NOT true?

Which of the following statements is true?

Which of the following statements is true?

Which one of the following statements is NOT true?

Marketability is the ability of an investor

Which of the following statements is true?

Suppose an investor earned a semiannual yield of 6.4 percent on a bond paying coupons twice a year. What is the effective annual yield (EAY) on this investment? (Round to two decimal places.)

Which of the following statements is true?

Jorge Cabrera paid $980 for a 15-year bond 10 years ago. The bond pays a coupon of 10 percent semiannually. Today, the bond is priced at $1,054.36. If he sells the bond today, what will be his realized yield? (Round to the nearest percent.)

What economic factors affect the level and the shape of the yield curve? Explain.

Stanley Hart invested in a municipal bond that promised an annual yield of 6.7 percent. The bond pays coupons twice a year. What is the effective annual yield (EAY) on this investment? (Round percentage to two decimal places.)

The three economic factors that affect the shape of the yield curve are:

Rachel McGovern bought a 10-year bond for $921.77 seven years ago. The bond pays a coupon of 15 percent semiannually. Today, the bond is priced at $961.22. If she sold the bond today, what would be her realized yield? (Round to the nearest percent.)