Question 1

The current yield is the best measure of an investor's return from holding 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 reinvestment rates, which are also important for the overall return.

Question 2

When the lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date,along with an additional payment for the interest,it is called a ________.

Accepted Answer

This is the definition of a simple loan, where the borrower receives a lump sum of funds that must be repaid with interest at the maturity date. A fixed-payment loan typically has the same payment amount each period and includes both principal and interest, and a discount loan involves the lender discounting the principal upfront and the borrower repays the full principal amount at maturity.

Question 3

The current yield is the yearly coupon payment divided by the current market price.

Accepted Answer

The current yield is calculated by dividing the annual interest or coupon payment by the current market price of the bond.

Question 4

The return on a bond is equal to the yield to maturity when

Accepted Answer

The yield to maturity is the interest rate that equates the present value of future cash flows from the bond to its current market price. Therefore, if the holding period is equal to the maturity of the bond, then all future cash flows (i.e. interest payments and principal repayment) will be received, and the yield to maturity will reflect the total return for the entire holding period. If the holding period is shorter or longer than the maturity of the bond, the realized return will differ from the yield to maturity due to reinvestment risk or interest rate risk.

Question 5

The riskiness of an asset's return that results from interest rate changes is called

Accepted Answer

Interest-rate risk refers to the variability in an asset's return due to changes in interest rates. When interest rates rise, the value of fixed-income securities (such as bonds) usually goes down, leading to a decrease in their returns. Therefore, interest-rate risk is a significant concern for investors who own fixed-income securities.

Question 6

The change in the bond's price relative to the initial purchase price is

Accepted Answer

The rate of capital gain is the change in the bond's price relative to the initial purchase price. Option A, current yield, is the bond's annual coupon payment divided by its current market price. Option B, coupon payment, is the fixed amount of interest paid by the bond issuer to the bondholder. Option C, yield to maturity, is the total return anticipated on a bond if held until it matures, including all interest and principal payments.

Question 7

Prices for long-term bonds are more volatile than for shorter-term bonds.

Accepted Answer

Long-term bonds are vulnerable to changes in interest rates and inflation, which can negatively affect their value and result in greater price fluctuations than shorter-term bonds that are less sensitive to such changes.

Question 8

The duration of a ten-year,10 percent coupon bond when the interest rate is 10 percent is 6.76 years.What happens to the price of the bond if the interest rate falls to 8 percent?

Accepted Answer

The price of a bond is inversely related to its yield. When the interest rate falls from 10% to 8%, the yield on the bond decreases. Using the formula for duration, we can calculate the approximate percentage change in price for a 1% decrease in yield:

% Change in price = -Duration x % Change in yield

% Change in price = -6.76 x (-2%)

% Change in price = 13.52%

Therefore, the price of the bond would rise by approximately 12.3% (rounded to one decimal place) when the interest rate falls from 10% to 8%.

Question 9

Bonds whose term to maturity is shorter than the holding period are also subject to

Accepted Answer

Bonds whose term to maturity is shorter than the holding period are subject to reinvestment risk. This occurs because the investor must reinvest the principal at a lower interest rate once the bond matures, leading to a lower overall return. There is no default risk involved in this scenario.

Question 10

A ________ is a type of loan that has the same cash flow payment every year throughout the life of the loan.

Accepted Answer

A fixed-payment loan is a type of loan where the borrower makes the same cash flow payment every year throughout the life of the loan. This type of loan is also known as an installment loan or a term loan. The fixed payments include both interest and principal, so the loan is gradually paid off over time.

Question 11

The real interest rate is actually the ex ante real interest rate because it is adjusted for ________ changes in the price level.

Accepted Answer

The ex ante real interest rate is adjusted for expected changes in the price level, not actual changes that have already occurred. The nominal interest rate, on the other hand, is not adjusted for changes in the price level at all. The real interest rate is adjusted for changes in the price level based on actual inflation, but this question specifically refers to the ex ante real interest rate.

Question 12

The interest rate that is adjusted for actual changes in the price level is called the

Accepted Answer

The ex post real interest rate is adjusted for changes in the price level that have actually occurred. The ex ante real interest rate refers to the expected real interest rate at the time a loan or investment is made, which may not reflect actual changes in the price level. Choice B, expected interest rate, does not take into account actual changes in the price level. Choice D, none of the above, is not a correct answer as the correct option has been discussed above.

Question 13

An ex post real interest rate is adjusted for ________ changes in the price level.

Accepted Answer

Ex post real interest rates are adjusted for actual changes in the price level, reflecting the true purchasing power of interest earnings after inflation has occurred.

Question 14

(I)The average lifetime of a debt security's stream of payments is called duration.
(II)The duration of a portfolio is the weighted average of the durations of the individual securities,with the weights reflecting the proportion of the portfolio invested in each.

Accepted Answer

Both statements are true. Duration is a measure of the average life of a debt security's stream of payments, taking into account the timing of the payments and the present value of the payments. The duration of a portfolio is the weighted average of the durations of the individual securities, with the weights reflecting the proportion of the portfolio invested in each. This is an important metric for managing interest rate risk in fixed income portfolios.

Question 15

Unless a bond defaults,an investor cannot lose money investing in bonds.

Accepted Answer

While it is true that default is a significant risk for bond investors, there are other factors that can cause a bond to lose value, such as changes in interest rates or market conditions. Therefore, there is always a risk of losing money when investing in bonds.

Question 16

If an investor's holding period is longer than the term to maturity of a bond,he or she is exposed to

Accepted Answer

Reinvestment risk is the risk that the investor will have to reinvest the principal and interest at a lower rate than the original investment. If the holding period is longer than the bond's term to maturity, the investor will need to reinvest the proceeds from the bond when it matures, potentially at lower interest rates.

Question 17

A discount bond

Accepted Answer

A discount bond is also called a zero-coupon bond because it is sold at a price below its face value (or par value) and doesn't pay any periodic interest (or coupon) payments.

Question 18

Discounting the future is the procedure used to find the future value of a dollar received today.

Accepted Answer

Discounting the future is actually the procedure used to find the present value of a dollar received in the future. It involves applying a discount rate to adjust for the time value of money.

Question 19

A bond's current market value is equal to the present value of the coupon payments plus the present value of the face amount.

Accepted Answer

This statement is true. The current market value of a bond is the sum of the present value of its future cash flows, which include the coupon payments and the face amount (also known as the par value or principal).

Question 20

Reinvestment risk is the risk that

Accepted Answer

Reinvestment risk refers to the risk that future coupon payments from a bond may have to be reinvested at a rate lower than the bond's yield to maturity. This results in a lower return for the investor. Therefore, choice B is the correct answer. The other choices (A, C, and D) do not accurately describe reinvestment risk.

Quiz 3: What Do Interest Rates Mean and What Is Their Role in Valuation?