Question 1

The compounding period is the amount of time that passes when interest is no longer accumulating.

Accepted Answer

The compounding period is actually the amount of time between interest calculations - in other words, how often the interest is added to the principal balance. Interest may continue to accumulate during the time between compounding periods.

Question 2

Shorter maturity bonds have greater default risk.

Accepted Answer

Shorter maturity bonds generally have lower default risk compared to longer maturity bonds because there is less time for economic and financial market conditions to change and impact the issuer's ability to meet its obligations. This is why shorter maturity bonds usually have lower yields compared to longer maturity bonds.

Question 3

For a coupon bond, if the price is greater than the face value, then the coupon rate must be greater than the yield to maturity.

Accepted Answer

True

Question 4

The real interest rate is a more accurate measure of the cost of borrowing than the nominal rate.

Accepted Answer

The real interest rate takes into account inflation and reflects the true cost of borrowing or the return on investment. The nominal rate, on the other hand, does not consider inflation and can be misleading in terms of the actual cost of borrowing.

Question 5

The current yield and the yield to maturity for a consol are the same.

Accepted Answer

This is true for consols because they have no maturity date and therefore have a perpetuity of coupon payments. The current yield is calculated as the annual coupon payment divided by the current market price, and the yield to maturity takes into account the present value of all future coupon payments and the principal payment (which is assumed to be infinite for a consol). Since the coupon payments for a consol are perpetuity, the current yield and yield to maturity will be the same.

Question 6

The annual rate of return on a one-year bond is the same as the yield.

Accepted Answer

The yield on a bond represents the total return on the investment, including interest, dividends, and changes in the value of the bond. The annual rate of return on a one-year bond is equivalent to the yield because there is no compounding of interest.

Question 7

The current yield is the most accurate measure of the return on a bond.

Accepted Answer

The current yield only considers the annual interest payments in relation to the bond's current market price, ignoring potential capital gains or losses and the time value of money, making it less comprehensive than measures like yield to maturity or yield to call.

Question 8

The present value of a future payment is always greater than the payment.

Accepted Answer

The present value of a future payment is actually less than or equal to the payment, depending on the discount rate used to calculate the present value.

Question 9

Rates of return are always positive.

Accepted Answer

Rates of return can be negative if the investment has incurred a loss.

Question 10

A discount bond with three years to maturity makes three future payments.

Accepted Answer

A discount bond is sold below its face value, meaning that the investor receives the face value at maturity and no periodic coupon payments. Therefore, there are no future payments until the maturity date.

Question 11

Yield to maturity is the most accurate measure of the return on a bond.

Accepted Answer

Yield to maturity takes into account the current market price of the bond, the coupon rate, the time left until maturity, and the face value of the bond. Therefore, it provides a more comprehensive and accurate measure of the return on a bond compared to other measures such as current yield or coupon rate.

Question 12

The present value of a future payment depends on the period of time until the payment.

Accepted Answer

The present value of a future payment is influenced by factors such as the amount of the payment, the interest rate, and the period of time until the payment. The longer the period of time until the payment, the lower the present value will be due to the effects of inflation and the opportunity cost of not being able to invest that money elsewhere in the meantime. Therefore, the period of time until the payment is an important factor in determining its present value.

Question 13

If the nominal interest rate is less than expected inflation, the real interest rate is positive.

Accepted Answer

If the nominal interest rate is less than expected inflation, the real interest rate is negative. This means that the purchasing power of the amount invested is decreasing over time.

Question 14

Yield to maturity and rate of return on a bond always move in the same direction.

Accepted Answer

Yield to maturity (YTM) and the rate of return on a bond can move in opposite directions because the rate of return is influenced by the bond's price fluctuations in the market after it is issued, while YTM is a calculation based on the bond's price, coupon payments, and time to maturity at the point of purchase.

Question 15

A falling real interest rate means nominal rates are falling as well.

Accepted Answer

A falling real interest rate does not necessarily mean nominal rates are falling as well. Real interest rates are adjusted for inflation, so they can fall if inflation increases, even if nominal rates stay the same or increase.

Question 16

Deflation (falling prices) means that real rates are greater than nominal rates.

Accepted Answer

Deflation means that the general price level is falling, so the real value of money is increasing. If nominal interest rates do not adjust to this, then real interest rates will increase, meaning that the purchasing power of saved money will also increase. Thus, real rates will be greater than nominal rates.

Question 17

The present value of a future payment is higher the longer the period of time until the payment, ceteris paribus.

Accepted Answer

This is because the longer the period of time until the payment, the more time there is for interest to accrue on the invested funds. Therefore, the present value of the future payment must be higher in order to account for the interest that can be earned over time.

Question 18

Longer maturity bonds have greater interest rate risk.

Accepted Answer

Longer maturity bonds have greater exposure to changes in interest rates over time, which increases their interest rate risk. This is because the longer the time until maturity, the more opportunities there are for interest rates to fluctuate, which can affect the value of the bond.

Question 19

Interest is the opportunity cost of money.

Accepted Answer

Interest represents the cost of using money that could have been used for other purposes, which is known as the opportunity cost.

Question 20

The accuracy of the current yield increases with the time to maturity of a bond.

Accepted Answer

This is because the current yield calculation is based on dividing the annual coupon payment by the current market price, and as the bond approaches maturity, the final payment is known with more certainty, leading to a more accurate calculation of the current yield.

Quiz 4: Interest Rates