Question 1

A bond with semi-annual interest payments,all else equal,would be priced _________ than one with annual interest payments.

Accepted Answer

The price of a bond is inversely related to its yield. The yield on a bond with semi-annual interest payments is lower than the yield on a bond with annual interest payments, because the semi-annual interest payments are more frequent. Therefore, the price of a bond with semi-annual interest payments is higher than the price of a bond with annual interest payments.

Question 2

The newly issued bonds of the Cain Corp. offer a 6% coupon with semiannual interest payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be:

Accepted Answer

The effective annual rate (EAR) is calculated by considering the compounding effect of the semiannual payments. Since the bonds offer a 6% annual coupon rate with semiannual payments, the semiannual rate is 3%. The EAR is calculated as (1 + 0.03)^2 - 1, which is approximately 6.09%, thus greater than 6% but less than 7%.

Question 3

The _____ premium is that portion of a nominal interest rate or bond yield that represents compensation for expected future overall price appreciation.

Accepted Answer

The inflation premium reflects the expected future overall price appreciation, which is a result of inflation. As inflation erodes the purchasing power of money, investors demand higher interest rates to compensate for the loss in value.

Question 4

The stated interest payment,in dollars,made on a bond each period is called the bond's:

Accepted Answer

The interest payment made on a bond each period is called the coupon.

Question 5

The annual coupon of a bond divided by its face value is called the bond's:

Accepted Answer

The annual coupon of a bond divided by its face value is called the bond's coupon rate.

Question 6

A bond with a 6% coupon that pays interest semi-annually and is priced at par will have a market price of _____ and interest payments in the amount of _____ each.

Accepted Answer

A bond priced at par is priced at $1,000. A 6% annual coupon rate with semi-annual payments results in $30 payments each period.

Question 7

A bond with a face value of $1,000 that sells for $1,000 in the market is called a _____ bond.

Accepted Answer

A bond with a face value of $1,000 that sells for $1,000 in the market is called a par value bond. This means that the bond is being sold at its face value, which is also its original price. Bonds may sell at a discount (for less than their face value) or at a premium (for more than their face value), depending on market conditions and other factors. A zero coupon bond is one that does not pay interest but is sold at a discount and redeemed at face value. A floating rate bond is one whose interest rate varies over time.

Question 8

The specified date on which the principal amount of a bond is repaid is called the bond's:

Accepted Answer

The specified date on which the principal amount of a bond is repaid is called the bond's maturity. A bond's face value is the amount that the issuer agrees to pay the bondholder at maturity, but it is not the date itself. A coupon is the interest payment that the bond issuer pays to the bondholder periodically, not the date of maturity. Yield to maturity is the total return anticipated on a bond if it is held until it matures, and coupon rate is the annual interest rate that the bond issuer promises to pay the bondholder.

Question 9

A bond that makes no coupon payments and is initially priced at a deep discount is called a _____ bond.

Accepted Answer

A bond that makes no coupon payments and is initially priced at a deep discount is called a zero coupon bond.

Question 10

The relationship between nominal interest rates on default-free,pure discount securities and the time to maturity is called the:

Accepted Answer

The relationship between nominal interest rates on default-free, pure discount securities and the time to maturity is referred to as the term structure of interest rates. This relationship is also known as the yield curve, which plots the interest rate against the time to maturity of a bond or other fixed-income securities. The term structure provides an insight into the market’s perception of economic conditions and future interest rates.

Question 11

You own a bond that has a 7% coupon and matures in 12 years. You purchased this bond at par value when it was originally issued. If the current market rate for this type and quality of bond is 7.5%,then you would expect:

Accepted Answer

When market interest rates increase above a bond's coupon rate, the bond's market value will decline, resulting in a capital loss if the bond is sold at current market prices. In this case, since the bond was purchased at par and the current market rate is higher than the coupon rate, the bond's current market price will be less than its face value, resulting in a capital loss if sold. The yield to maturity would also be higher than the coupon rate, but it is not relevant to the expectation of a capital loss. The bond issuer is not likely to increase the interest payments because the coupon rate is fixed at issuance. The current yield would also be higher than 7%, not lower. Therefore, the correct answer is choice C.

Question 12

The relationship between nominal rates,real rates,and inflation is known as the:

Accepted Answer

The relationship between nominal rates, real rates, and inflation is known as the Fisher effect. The Fisher effect states that nominal interest rates will include expected inflation rates, so an increase in expected inflation will lead to an increase in nominal interest rates. Real interest rates, on the other hand, are adjusted for inflation and do not include expected inflation rates.

Question 13

The principal amount of a bond that is repaid at the end of the loan term is called the bond's:

Accepted Answer

The face value of a bond is the principal amount that will be repaid at the end of the loan term. This is also known as the bond's par value or nominal value. The coupon is the interest payment made periodically on the bond, and the yield to maturity is the effective interest rate earned on the bond assuming that it is held until maturity. The coupon rate is the fixed percentage of the face value that is paid as interest. The maturity refers to the time period after which the bond reaches its face value and is repaid.

Question 14

The market price of a bond is equal to the present value of the:

Accepted Answer

The market price of a bond is equal to the present value of the face value plus the present value of the annuity payments. This is because the bond represents a stream of cash flows consisting of periodic interest payments (the annuity payments) and the return of the principal (the face value) at maturity. The market price of the bond reflects the time value of money, which means that future cash flows are worth less than current cash flows. By discounting the future cash flows at the appropriate discount rate, we can arrive at the present value of the bond.

Question 15

An asset characterized by cash flows that increase at a constant rate forever is called a:

Accepted Answer

A growing perpetuity is a type of cash flow stream that increases by a constant rate over an infinite period of time. This is used to value investments that provide a constant stream of cash flows that are expected to grow at a constant rate, like dividend payments from stocks. The formula for the present value of a growing perpetuity is P = C / (r - g), where P is the present value, C is the constant cash flow, r is the discount rate, and g is the growth rate.

Question 16

A bond with a face value of $1,000 that sells for less than $1,000 in the market is called a _____ bond.

Accepted Answer

A bond that sells for less than its face value is called a discount bond.

Question 17

The rate of return required by investors in the market for owning a bond is called the:

Accepted Answer

The rate of return required by investors in the bond market is referred to as the yield to maturity. It is the total return expected by the investor when they purchase the bond and hold it until maturity. It takes into account the bond's coupon rate, current market price, and time to maturity.

Question 18

All else constant,a bond will sell at _____ when the yield to maturity is _____ the coupon rate.

Accepted Answer

When the yield to maturity is higher than the coupon rate, investors can earn a higher return by investing in new bonds that offer higher coupon rates. As a result, the price of existing bonds will decrease, causing them to sell at a discount.

Question 19

Aspens is preparing a bond offering with an 8% coupon rate. The bonds will be repaid in 10 years. The company plans to issue the bonds at par value and pay interest semiannually. Given this,which of the following statements are correct?
I. The initial selling price of each bond will be $1,000.
II. After the bonds have been outstanding for 1 year,you should use 9 as the number of compounding periods when calculating the market value of the bond.
III. Each interest payment per bond will be $40.
IV. The yield to maturity when the bonds are first issued is 8%.

Accepted Answer

The bonds are issued at par value, so the initial selling price is $1,000 (I). Each interest payment is $40 because the 8% annual coupon rate is divided into two semiannual payments (III). The yield to maturity at issuance is the same as the coupon rate, 8%, since they are issued at par (IV).

Question 20

All else constant,a coupon bond that is selling at a premium,must have:

Accepted Answer

A coupon bond selling at a premium means its market price is higher than its par value, which occurs when its coupon rate is higher than the yield to maturity. This is because investors are willing to pay more for a bond that offers coupon payments higher than what is currently available in the market.

Quiz 8: Interest Rates and Bond Valuation