Deck 18: Valuation of Debt Contracts and Their Price Volatility Characteristics

Question 1

The rate earned on federal government debt instruments is usually characterized as the:

A) Nominal rate.
B) Riskless rate.
C) Real rate of interest.
D) Gross rate.
E) None of the above.

Answer 1

Riskless rate.

Question 2

When the entire principal can be repaid at the maturity date, the debt contract is said to have a:

A) Maturity.
B) Bullet maturity.
C) Par value.
D) Face value.
E) None of the above.

Answer 2

Bullet maturity.

Question 3

Debt contracts with no periodic interest payments made to owners during the life of the contract are called:

A) Fixed income bonds.
B) Straight coupon bonds.
C) Zero coupon bonds.
D) Perpetual bonds.
E) Discount bonds.

Answer 3

Zero coupon bonds.

Question 4

The price of a debt instrument must equal the sum of the:

A) Present value of the payments that the debtor is required to make until maturity.
B) Present value of all expected cash dividends.
C) Present value of the maturity value.
D) Future value of all expected future cash flows.
E) None of the above.

Question 5

The yield to maturity is the discount rate that makes the present value of the cash flows of a bond equal to its:

A) Par value.
B) Redeemable value.
C) Market value.
D) Coupon rate.
E) None of the above.

Question 6

If interest rates in the economy increase because of Fed policy, the price of a bond will:

A) Increase.
B) Decrease.
C) Remain unchanged.
D) Change.
E) None of the above.

Question 7

The value of a bond depends on:

A) The issuer.
B) The coupon rate.
C) The maturity of the bond.
D) Market interest rates.
E) b, c, and d only.

Question 8

Which of the following statements is most correct?

A) The price of a bond will approach its par value as it moves toward its maturity.
B) Over time, the price of a discount bond will rise if interest rate do not change.
C) The price of a bond will rise if the perceived credit quality of the issuer deteriorates.
D) a and b only.
E) All of the above.

Question 9

If the Treasury rates does not change, but the yield spread between Treasury and non-Treasury securities changes, the price of a non-Treasury security will:

A) Increase.
B) Decrease.
C) Change.
D) Remain unchanged.
E) None of the above.

Question 10

If the market price of a bond is less than the par value, then the coupon rate is:

A) Less than the par yield.
B) Greater than the required yield to maturity.
C) Equal to the market interest rate.
D) Below the riskless rate.
E) None of the above.

Question 11

The yield to maturity takes into account:

A) The coupon income.
B) Any cash dividends.
C) Any capital gains or losses.
D) a and c only.
E) All of the above.

Question 12

A bond investor will realize the yield to maturity at the time of purchase only if:

A) The bond is held to maturity.
B) All coupon payments are reinvested at the yield to maturity.
C) The bond is sold prior to maturity.
D) a and b only.
E) All of the above.

Question 13

If a bond will have to be sold at a loss, it is said to have:

A) Reinvestment risk.
B) Interest rate risk.
C) Price risk.
D) a and c only.
E) b and b only.

Question 14

The relationship between price and yield for any option-free bond is:

A) Linear.
B) Convex.
C) Concave.
D) Curvilinear.
E) None of the above.

Question 15

Which of the following statements is false?

A) For a given yield and coupon rate, the longer the maturity, the greater the price volatility.
B) Fore a given yield and maturity, price volatility is greater, the higher the coupon rate.
C) A bond's price volatility is affected by its maturity and coupon rate.
D) There is an inverse relationship between the price and yield of a bond.
E) None of the above.

Question 16

A measure of price volatility that relates to coupon and maturity is:

A) Duration.
B) Convexity.
C) Yield spread.
D) Yield to maturity.
E) None of the above.

Question 17

Which of the following statements about duration is most correct?

A) Duration for a coupon bond is greater than its maturity.
B) For a zero-coupon bond, the duration is equal to its maturity.
C) For bonds with the same maturity and selling at the same yield, the lower the coupon rate, the greater a bond's duration and volatility.
D) For bonds with the same coupon rate and selling at the same yield, the longer the maturity, the larger the duration and price sensitivity.
E) b, c, and d only.

Question 18

Dollar duration of a bond measures the:

A) Dollar price change.
B) Percentage price change.
C) Average price change.
D) Change in yield.
E) None of the above.

Question 19

The convexity measure of a security refers to:

A) Price volatility that relates maturity and coupon.
B) The approximate change in price that is not explained by duration.
C) The shape of the price/yield relationship.
D) The approximate percentage price change of a bond for a 100 basis point change in interest rates.
E) None of the above.

Question 20

For all option-free bonds, the approximate percentage price change that is not explained by duration will have a:

A) Positive value.
B) Negative value.
C) Unchanged value.
D) Changed value.
E) None of the above.

Question 21

If the par value relation is equal to one, the bonds sell at par.

Question 22

The cash flow from a bond consists of periodic coupon interest payments and the repayment of the principal at maturity.

Question 23

The yield to maturity measure is used as an index to compare the rate of return of instruments having different cash flows and different maturities.

Question 24

The prices of all option-free bonds move in the same direction of the change in yields.

Question 25

Effective convexity gives recognition that the cash flows of a bond do change when yields change.

Question 26

Explain the difference between reinvestment risk and interest rate risk.

Question 27

Discuss the factors that cause the price of a bond to change.

Question 28

Explain why the price/yield relationship of an option-free bond is convex.