Question 1

"Cat" bonds are primarily designed to help:

Accepted Answer

"Cat" bonds, short for catastrophe bonds, are insurance-linked securities that allow insurance companies to transfer some of their risks to investors. In the event of a catastrophic event, such as a natural disaster, the insurance company can use the funds from the bond to cover excessive claims. Therefore, "cat" bonds are primarily designed to help insurance companies fund excessive claims.

Question 2

Which one of the following statements is correct?

Accepted Answer

The real rate of interest is adjusted for inflation, meaning it subtracts the inflation rate from the nominal (or stated) interest rate. If there is positive inflation, the real interest rate will indeed be less than the nominal rate, as inflation erodes the purchasing power of the money.

Question 3

Last year,you purchased a "TIPS" at par.Since that time,both market interest rates and the inflation rate have increased by 0.25 percent.Your bond has most likely done which one of the following since last year?

Accepted Answer

TIPS (Treasury Inflation-Protected Securities) are designed to protect investors from inflation, as they adjust the principal value of the bond to reflect changes in the inflation rate, ensuring a fixed real rate of return. Therefore, despite changes in market interest rates and inflation, the real rate of return for TIPS remains constant.

Question 4

Recently,you discovered a putable income bond that is convertible.If you purchase this bond,you will have the right to do which of the following?
I.force the issuer to repurchase the bond prior to maturity
II.choose when you wish to receive interest payments
III.convert the bond into a TIPS
IV.convert the bond into equity shares

Accepted Answer

According to the given information, the bond is a putable income bond that is convertible. This means that the holder of the bond has the right to sell it back to the issuer before maturity (i.e., putable), and they also have the right to convert it into equity shares (i.e., convertible). Therefore, options I and IV are correct, and the answer is B, which includes both options. Option II is incorrect because the question does not mention any flexibility in interest payments, and option III is incorrect because converting the bond into TIPS (Treasury Inflation-Protected Securities) is not mentioned as an option.

Question 5

Which two of the following factors cause the yields on a corporate bond to differ from those on a comparable Treasury security?
I.inflation risk
II.interest rate risk
III.taxability
IV.default risk

Accepted Answer

III and IV onlyCorporate bonds typically offer higher yields than comparable Treasury securities due to their taxability and the default risk associated with the issuing corporation. Inflation risk and interest rate risk affect both types of bonds similarly.

Question 6

A U.S.Treasury bond that is quoted at 100: 11 is selling:

Accepted Answer

A U.S. Treasury bond quote of "100:11" means that the bond is selling at 100 and 11/32nds percent of its face value. This is also known as a premium, since it is selling for more than its face value.

Question 7

Phil has researched TLM Technologies and believes the firm is poised to vastly increase in value.He wants to invest in this company.Phil has decided to purchase TLM Technologies bonds so that he can have a steady stream of interest income.However,he still wishes that he could share in the firm's success along with TLM's shareholders.Which one of the following bond features will help Phil fulfill his wish?

Accepted Answer

A warrant grants the holder the right to purchase a certain number of shares of the company's stock at a set price within a specified time period. By including a warrant as a feature of the bond, Phil will have the opportunity to participate in the company's success if the stock price increases.

Question 8

Which one of the following risks would a floating-rate bond tend to have less of as compared to a fixed-rate coupon bond?

Accepted Answer

Floating rate bonds tend to have less interest rate risk compared to fixed-rate coupon bonds because the coupon payments of floating rate bonds are periodically reset based on prevailing market interest rates, which means that the price of the bond is less sensitive to changes in interest rates. This helps to reduce interest rate risk for investors holding floating rate bonds.

Question 9

A zero coupon bond:

Accepted Answer

The answer of A zero coupon bond:
...

Question 10

Mary is a retired widow who is financially dependent upon the interest income produced by her bond portfolio.Which one of the following bonds is the least suitable for her to own?

Accepted Answer

Income bonds pay interest only if the issuer's income reaches certain levels, making them less suitable for someone dependent on consistent interest income, like Mary.

Question 11

A 6-year,$1,000 face value bond issued by Taylor Tools pays interest semiannually on February 1 and August 1.Assume today is October 1.What will the difference,if any,be between this bond's clean and dirty prices today?

Accepted Answer

The difference between a bond's clean and dirty prices is the accrued interest since the last interest payment. Since the last payment was on August 1 and today is October 1, two months' interest has accrued, making the difference between the clean and dirty prices equal to two months' interest.

Question 12

The collar of a floating-rate bond refers to the minimum and maximum:

Accepted Answer

The collar of a floating-rate bond refers to the minimum and maximum coupon rates. The coupon rate is the percentage of the bond's face value that the issuer pays the bondholder as interest. The collar is a range that determines the variability of the coupon rate, typically based on a benchmark rate such as LIBOR. As the benchmark rate changes, the coupon rate on the bond will adjust within the collar range.

Question 13

The Fisher Effect primarily emphasizes the effects of _____ on an investor's rate of return.

Accepted Answer

The Fisher Effect states that the nominal interest rates are the sum of the real interest rates and the expected rate of inflation. Therefore, a change in inflation will directly impact the nominal interest rate and ultimately affect an investor's rate of return.

Question 14

The bonds issued by Stainless Tubs bear an 8 percent coupon,payable semiannually.The bonds mature in 11 years and have a $1,000 face value.Currently,the bonds sell for $952.What is the yield to maturity?

Accepted Answer

This cannot be solved directly, so it's easiest to just use the calculator method to get an answer. You can then use the calculator answer as the rate in the formula just to verify that your answer is correct.

Question 15

Which of the following statements is correct concerning the term structure of interest rates?
I.Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates.
II.The term structure of interest rates includes both an inflation premium and an interest rate risk premium.
III.The real rate of return has minimal,if any,affect on the slope of the term structure of interest rates.
IV.The term structure of interest rates and the time to maturity are always directly related.

Accepted Answer

The answer of Which of the following statements is correct...

Question 16

Al is retired and enjoys his daily life.His one concern is that his bonds provide a steady stream of income that will continue to allow him to have the money he desires to continue his active lifestyle without lowering his present standard of living.Although he has sufficient principal to live on,he only wants to spend the interest income provided by his holdings and thus is concerned about the purchasing power of that income.Which one of the following bonds should best ease Al's concerns?

Accepted Answer

The best choice for Al would be a bond that protects against inflation, as this would help maintain the purchasing power of his interest income. TIPS (Treasury Inflation-Protected Securities) are designed to do just that by adjusting the principal value of the bond to keep pace with inflation. Of the options listed, the 5-year TIPS bond would provide the closest match to Al's desired investment horizon. The other options do not offer the same level of inflation protection or may have other risks or complexities that may not be suitable for Al's needs.

Question 17

Which of the following correctly describe U.S.Treasury bonds?
I.have a "tick" size of 1/32
II.highly liquid
III.quoted in dollars and cents
IV.quoted at the dirty price

Accepted Answer

U.S. Treasury bonds have a tick size of 1/32 and are highly liquid. They are quoted in dollars and cents, but are typically quoted at the clean price rather than the dirty price. Therefore, statement IV is not accurate.

Question 18

Today,June 15,you want to buy a bond with a quoted price of 98.64.The bond pays interest on January 1 and July 1.Which one of the following prices represents your total cost of purchasing this bond today?

Accepted Answer

The total cost of purchasing the bond today includes the quoted price plus any accrued interest since the last coupon payment. This is referred to as the "dirty price." Option A (clean price) only includes the quoted price and does not account for accrued interest. Option C (asked price) and option E (bid price) are not relevant as they pertain to the price at which the bond is being offered for sale by a trader. Option D (quoted price) is simply the price at which the bond is being quoted in the market and does not include any additional costs. Therefore, the best choice is B (dirty price).

Question 19

You are trying to compare the present values of two separate streams of cash flows which have equivalent risks.One stream is expressed in nominal values and the other stream is expressed in real values.You decide to discount the nominal cash flows using a nominal annual rate of 8 percent.What rate should you use to discount the real cash flows?

Accepted Answer

To compare the present values of two separate streams of cash flows, both should be discounted at a comparable risk-adjusted rate. As one stream is expressed in real values, the comparable rate to discount the cash flows should be a real rate. Therefore, the best choice is to discount the real cash flows using a comparable real rate. Option D is the most appropriate choice as it discounts the real cash flows at a rate that reflects the inflation risk.

Question 20

Which one of the following rates represents the change,if any,in your purchasing power as a result of owning a bond?

Accepted Answer

The real rate represents the change in purchasing power as it takes into account inflation. The nominal rate includes inflation but does not reflect the actual change in purchasing power. The risk-free rate and realized rate do not specifically relate to purchasing power, and there is no reference to a specific "current rate" in the question.

Quiz 7: Interest Rates and Bond Valuation