Question 1

The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,100 one year later is

Accepted Answer

The answer of The return on a 5 percent coupon...

Question 2

The nominal interest rate minus the expected rate of inflation

Accepted Answer

The nominal interest rate minus the expected rate of inflation defines the real interest rate, which is a more accurate measure of the incentives to borrow and lend. It also provides a better indication of the tightness of credit market conditions than the nominal interest rate alone. Therefore, option D, all of the above, is the correct answer.

Question 3

If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding?

Accepted Answer

A bond with one year to maturity would be the best choice in this scenario because it has the shortest amount of time until maturity. As interest rates rise, bond prices fall, but short-term bonds are less affected by interest rate changes compared to long-term bonds. Therefore, if you were holding a bond with a longer maturity, such as five, ten, or twenty years, the value of the bond would drop more significantly and it would take longer to recover.

Question 4

Which of the following are generally true of all bonds?

Accepted Answer

All the statements provided are generally true regarding bonds. Statement A is correct because if a bond is held to its maturity, its return will indeed equal the initial yield to maturity, assuming no default. Statement B is accurate as bond prices and interest rates have an inverse relationship, meaning when interest rates rise, bond prices fall, which can lead to capital losses if the bond is sold before maturity. Statement C is also true because bonds with longer maturities are more sensitive to interest rate changes, leading to larger price fluctuations for a given change in interest rates.

Question 5

Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding?

Accepted Answer

The bond has a fixed coupon rate of 5 percent, regardless of changes in interest rates. However, the yield to maturity and the one-year interest rate have increased from 15 percent to 20 percent. As a result, the bond's price would have decreased over the year, leading to a capital loss. The total return on the bond would be the sum of coupon interest and capital gain/loss. In this case, the capital loss from the increase in interest rates offset the coupon interest, resulting in a total return of 15 percent (yield to maturity).

Question 6

(I)Prices of longer-maturity bonds respond more dramatically to changes in interest rates. (II)Prices and returns for long-term bonds are less volatile than those for short-term bonds.

Accepted Answer

This is because the longer the time until maturity, the more affected the bond's price will be by fluctuations in interest rates. On the other hand, long-term bonds have less volatility because they are less sensitive to changes in interest rates.

Question 7

In which of the following situations would you prefer to be borrowing?

Accepted Answer

The answer of In which of the following situations would...

Question 8

The nominal interest rate minus the expected rate of inflation

Accepted Answer

The nominal interest rate minus the expected rate of inflation defines the real interest rate, which reflects the true cost or benefit of borrowing or lending after accounting for inflation. It is a more accurate measure of the incentives to borrow and lend than the nominal interest rate alone, which does not take inflation into account. It is also a useful indicator of the tightness of credit market conditions, as high real interest rates indicate tight credit market conditions, while low real interest rates suggest a more accommodative stance. The discount rate, on the other hand, is the interest rate at which banks can borrow from the central bank or other lenders of last resort.

Question 9

The Fisher equation states that

Accepted Answer

The Fisher equation posits that the nominal interest rate is the sum of the real interest rate and the expected inflation rate, which is statement A. It also implies that the real interest rate can be derived by subtracting the expected inflation rate from the nominal interest rate, which is statement B. Therefore, both A and B are correct interpretations of the Fisher equation.

Question 10

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 one year later?

Accepted Answer

The answer of What is the return on a 5...

Question 11

The return on a 10 percent coupon bond that initially sells for $1,000 and sells for $900 one year later is

Accepted Answer

The answer of The return on a 10 percent coupon...

Question 12

If a $5,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is

Accepted Answer

A bond selling at par value (in this case, $5,000) has a yield to maturity equal to its coupon rate, which is zero for a discount bond. Therefore, the yield to maturity is 0 percent.

Question 13

If you expect the inflation rate to be 5 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

Accepted Answer

The real interest rate can be approximated using the Fisher equation: real interest rate ≈ nominal interest rate - inflation rate. Therefore, 7% - 5% = 2%.

Question 14

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 one year later?

Accepted Answer

The answer of What is the return on a 5...

Question 15

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 16

Which of the following are true concerning the distinction between interest rates and return?

Accepted Answer

Option A is true because the rate of return on a bond is affected by factors such as changes in the bond's price, which may not necessarily be reflected in its interest rate. Option B is also true because the return on a bond can be broken down into its current yield, which is the interest income earned, and the rate of capital gains or losses due to changes in the bond's price. Option C is false because if the price of a bond falls, the rate of return on the bond will be lower than its interest rate, not higher.

Question 17

(I)Prices of longer-maturity bonds respond less dramatically to changes in interest rates. (II)Prices and returns for long-term bonds are less volatile than those for shorter-term bonds.

Accepted Answer

The answer of (I)Prices of longer-maturity bonds respond less dramatically...

Question 18

If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

Accepted Answer

The real interest rate formula is nominal interest rate minus inflation rate. Therefore, the real interest rate on this bond is 7% - 15% = -8%.

Question 19

In which of the following situations would you prefer to be making a loan?

Accepted Answer

In this situation, the real interest rate (interest rate - inflation rate) is positive, which means that the purchasing power of the money lent will increase over time. In the other situations, the real interest rate is negative, which means that the purchasing power will decrease over time. Therefore, B is the best choice.

Question 20

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

Accepted Answer

Interest-rate risk is the risk that the value of an asset will decrease due to changes in interest rates. This applies to bonds and other fixed-income securities, as changes in interest rates can affect the present value of future cash flows. Coupon-rate risk refers to the risk associated with the fact that the coupon rate on a bond may be higher or lower than the market interest rate, which can affect the market value of the bond. Reinvestment risk refers to the risk that future cash flows may need to be reinvested at a lower rate than the original investment, reducing overall returns. Yield-to-maturity (YTM) risk is not a commonly used term and is less precise than interest-rate risk, as YTM measures the total return of a bond assuming it is held until maturity and does not take into account changes in interest rates during the holding period.

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

The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,100 one year later is

The nominal interest rate minus the expected rate of inflation

If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding?

Which of the following are generally true of all bonds?

Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding?

(I) Prices of longer-maturity bonds respond more dramatically to changes in interest rates. (II) Prices and returns for long-term bonds are less volatile than those for short-term bonds.

In which of the following situations would you prefer to be borrowing?

The nominal interest rate minus the expected rate of inflation

The Fisher equation states that

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 one year later?

The return on a 10 percent coupon bond that initially sells for $1,000 and sells for $900 one year later is

If a $5,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is

If you expect the inflation rate to be 5 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 one year later?

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

Which of the following are true concerning the distinction between interest rates and return?

(I) Prices of longer-maturity bonds respond less dramatically to changes in interest rates. (II) Prices and returns for long-term bonds are less volatile than those for shorter-term bonds.

If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

In which of the following situations would you prefer to be making a loan?

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