Question 1

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 a bond includes both the quoted price (which represents the face value of the bond) and the accrued interest. Since the bond pays interest on July 1, and today is June 15, some interest has already accrued. The dirty price takes into account this accrued interest, while the clean price does not. Therefore, the dirty price represents the total cost of purchasing the bond today.

Question 2

"Cat" bonds are primarily designed to help:

Accepted Answer

"Cat" bonds, also known as catastrophe bonds, are primarily designed to help insurance companies fund excessive claims resulting from natural disasters such as hurricanes, earthquakes, and floods. The bonds transfer the risk of these catastrophic events from the insurance companies to investors. If a catastrophic event does not occur, investors receive interest payments; however, if a catastrophe does occur, the investors may lose some or all of their principal investment.

Question 3

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 4

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 option for Al would be a bond that provides inflation protection, which is where TIPS come in. TIPS, or Treasury Inflation-Protected Securities, are indexed to inflation and provide a fixed interest rate that adjusts with changes in inflation. This means that Al's purchasing power would be protected from inflation, and he could continue to receive a steady stream of income without worrying about it losing value over time. The other bonds do not provide this same level of protection.

Question 5

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

Accepted Answer

A Treasury bond quoted at 100:11 is trading at 100 and 11/32nds percent of face value, which is slightly above par value. Therefore, the correct answer is (E).

Question 6

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 is a bond feature that allows the holder to purchase additional shares of the underlying company's stock at a predetermined price, thus enabling the bondholder to share in the potential success of the company along with its shareholders. This would allow Phil to earn interest income from holding TLM Technologies bonds while also having the option to purchase additional shares, which could increase his potential return on investment if the company does well.

Question 7

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 the two streams of cash flows, we need to discount them using the same rate. Since the nominal cash flows are already discounted using a nominal rate, we should use a comparable real rate to discount the real cash flows. The comparable real rate is the nominal rate minus the expected inflation rate. Therefore, the best choice is D, a comparable real rate.

Question 8

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 9

A zero coupon bond:

Accepted Answer

The answer of A zero coupon bond:
...

Question 10

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

Accepted Answer

The Fisher Effect describes the relationship between inflation and both nominal and real interest rates. It emphasizes how inflation reduces the real return on investments if nominal rates do not adjust for the inflation rate.

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 bond pays interest semiannually on February 1 and August 1. Therefore, the last coupon payment was made on August 1, which means that the bond is dirty (accrued interest) until the next payment date on February 1. Today is October 1, which is 4 months before the next payment date. Thus, the difference in price will be equal to two months' interest, which is the time period from the last payment date to today. Therefore, the answer is C.

Question 12

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 13

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 takes into account the inflation rate, which affects your purchasing power. If the nominal rate on a bond is higher than the inflation rate, then you will benefit from owning the bond as it will increase your purchasing power. However, if the inflation rate is higher than the nominal rate, then owning a bond will decrease your purchasing power. Therefore, the real rate is the rate that represents the change in your purchasing power as a result of owning a bond.

Question 14

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

A floating-rate bond tends to have less interest rate risk as compared to a fixed-rate coupon bond. This is because the coupon payments of a floating-rate bond are adjusted periodically based on the prevailing interest rate levels, thereby mitigating the effect of interest rate changes on the bond's value. Conversely, the coupon payments of a fixed-rate coupon bond remain constant throughout its life, making it more vulnerable to interest rate movements.

Question 15

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 16

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, making choice I correct. They are also highly liquid, which makes choice II correct. They are not quoted in dollars and cents (III is incorrect) but in percent of par value in thirty-seconds of a percent. They are quoted at the clean price, not the dirty price, which includes accrued interest (IV is incorrect).

Question 17

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 18

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, which are usually tied to a benchmark or index such as LIBOR. The collar sets a boundary for the potential coupon payments, and provides some protection to both the issuer and investor against extreme fluctuations in interest rates.

Question 19

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 20

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.

Quiz 7: Interest Rates and Bond Valuation