Question 1

The unbiased expectations theory is alternatively known as the ____ theory.

Accepted Answer

This theory suggests that the long-term interest rates are determined solely by the expected future short-term interest rates without any premium for holding long-term bonds. This means that investors do not prefer one maturity date over another, and they expect the same return from both short-term and long-term bonds, assuming similar levels of risk. Therefore, it is also commonly referred to as the pure expectations theory. Option B) interest rate risk theory suggests that investors will typically require an additional premium to compensate for the risk associated with longer maturity bonds. Option C) efficient expectations theory assumes that the markets are efficient and all available information is already built into the current bond prices. Option D) preferred habitat theory argues that investors have a preference for a particular maturity based on their investment needs or constraints.

Question 2

The assumption that all bond interest income can be reinvested at the yield-to-maturity assumes the yield curve

Accepted Answer

The assumption that all bond interest income can be reinvested at the yield-to-maturity is only valid if the yield curve is flat. In a flat yield curve, all maturities have the same yield and thus the interest earned can be reinvested at the same yield. In a positively sloped or negatively sloped yield curve, long term bonds have higher yields than short-term bonds making it difficult to reinvest the interest earned at the same yield. A yield curve with an increasing rate of growth is not a common shape for a yield curve.

Question 3

The pattern of interest rates appropriate for discounting cash flows of various maturities is known as the

Accepted Answer

The term structure of interest rates refers to the pattern or relationship between interest rates of different maturities. It helps determine the appropriate discount rates for cash flows with different time horizons. The other options are not related to this concept.

Question 4

Empirical evidence of liquidity premiums indicates

Accepted Answer

The answer of Empirical evidence of liquidity premiums indicates
...

Question 5

The current real return on an investment is 3%.  If the nominal rate of return is 7.9%, what is the expected rate of inflation?

Accepted Answer

The expected rate of inflation can be calculated by subtracting the real rate of return from the nominal rate of return. Assuming the real rate of return is around 3%, the expected rate of inflation would be 4.9% (7.9% - 3%). Therefore, the answer is choice D.

Question 6

The yield-to-maturity for corporate bonds is typically done assuming compounding that is

Accepted Answer

The yield-to-maturity for corporate bonds is typically calculated assuming semi-annual compounding, which means interest is calculated and added to the principal twice a year. This is the industry standard for corporate bonds.

Question 7

For a particular fixed-income security, the single interest rate that, if paid by a bank on the amount invested in the security, would enable the investor to obtain all the payments made by that security is referred to as the

Accepted Answer

The yield-to-maturity (YTM) is the interest rate that makes the present value of all future cash flows from a fixed-income security equal to its current market price. This includes all interest payments and the repayment of the principal at maturity. It is a comprehensive measure of the total return earned on a bond if it is held until maturity, and is therefore the single interest rate that would enable the investor to obtain all the payments made by the security. A, B, and C are not as comprehensive measures of the total return earned on a bond.

Question 8

Federal Truth-In-Lending requires a lender to disclose the

Accepted Answer

Federal Truth-In-Lending requires a lender to disclose the annual percentage rate (APR). This is the standardized measure of the cost of borrowing, which takes into account the interest rate and any additional fees or charges over the course of a year.

Question 9

The most common measure of return on a callable bond would be its

Accepted Answer

The yield-to-call is the most relevant measure of return for a callable bond. This is because callable bonds give the issuer the option to call the bond at a specific time and price, which can significantly impact the bondholder's return. Therefore, calculating the yield-to-call can provide a more accurate representation of the potential return on a callable bond. The current yield just measures the annual interest payments divided by the current price, while the yield-to-maturity assumes the bond will not be called before maturity. The return on average investment is a more general term that can refer to any investment, not just bonds.

Question 10

Yield curves

Accepted Answer

Yield curves are generally upward sloping because longer-term investments typically require higher yields to compensate for the increased risk and time commitment compared to shorter-term investments.

Question 11

The theory that states yield curve shape is formed by the relationship of supply and demand curves for various security maturities is

Accepted Answer

Market segmentation theory suggests that the shape of the yield curve is determined by supply and demand forces within each segment of the maturity spectrum, without assuming that securities of different maturities are substitutes.

Question 12

A yield curve is developed using the yield-to-maturities on

Accepted Answer

A yield curve is a graph showing the relationship between the yield on bonds of the same credit quality but different maturities. Treasury issues are considered the most creditworthy securities, so their yields are used to create the yield curve. The yield curve is used to analyze interest rate trends, predict economic conditions, and assist with investment decisions.

Question 13

The liquidity preference theory states that an investor

Accepted Answer

The liquidity preference theory states that investors prefer more liquid assets and wish to reduce price risk. This theory suggests that investors will prefer short-term investments that are more liquid and have less price risk. The theory does not make assumptions about interest rate risk or yield curves, nor does it suggest a preference for a maturity to a rollover strategy.

Question 14

The _____ factor is the present value of $1 to be received in a specified number of years.

Accepted Answer

The answer of The _____ factor is the present value...

Question 15

The ____ is the current interest rate appropriate for discounting a cash flow of some given maturity.

Accepted Answer

The spot rate is the current interest rate used to discount a cash flow that is expected at some future date. It is the appropriate rate for discounting a cash flow of a given maturity. The forward rate is the expected interest rate applicable for a future time period, and the future spot rate and futures rate are not commonly used in the calculation of present values.

Question 16

The yield-to-maturities on treasury issues do not give a direct reading of future spot rates as

Accepted Answer

The coupon rates on Treasury issues create cash flows that affect yield-to-maturities, making it difficult to directly estimate future spot rates. Therefore, choice C is correct. Choices A, B, and D are not relevant and do not provide an accurate explanation for why Treasury yields do not give a direct reading of future spot rates.

Question 17

______ curves are a visual representation of the term structure of interest rates.

Accepted Answer

Yield curves plot the interest rates of bonds with different maturities, providing a graphical depiction of the term structure of interest rates. The slope and shape of the yield curve can indicate expectations about future economic activity and inflation, and can also affect borrowing and lending decisions. Choices A, B, and D are not directly related to the term structure of interest rates or yield curves.

Question 18

Finding a bond's yield-to-maturity is the same as finding its

Accepted Answer

Yield-to-maturity (YTM) is the total return anticipated on a bond if the bond is held until it matures. It is a measure of the bond's profitability, and is calculated by taking into account the bond's current market price, the face value of the bond, the number of years to maturity, and the coupon rate paid by the bond. The formula for yield-to-maturity is a complex equation that requires trial and error or more often the use of specialized software or spreadsheet programs. IRR or internal rate of return is a calculation used primarily for evaluating investments rather than bonds. NPV or net present value is another way of measuring an investment's profitability while PI or profitability index shows the relationship between the costs and benefits of an investment. Therefore, the choice is (C).

Question 19

The bond matures in one year.  The annual rate is 8%, the par value is $1,000, and the market price is $990.  What is the yield to maturity?

Accepted Answer

The yield to maturity (YTM) can be calculated as the total annual return expected on a bond if the bond is held until it matures. In this case, the bond will pay $80 in interest (8% of $1,000) and will also result in a gain of $10 at maturity ($1,000 - $990). The total gain is $90 ($80 + $10), and the initial investment is $990. Thus, the YTM is ($90 / $990) * 100% = 9.09%.

Question 20

The types of securities priced in accord with the set of spot rate are

Accepted Answer

Spot rates are often used to determine the fair value of fixed income securities based on their cash flows. Treasury issues are fixed income securities issued by the government and are therefore directly tied to the spot rate. Municipal bonds, common stocks, and preferred stocks are not directly tied to the spot rate and are priced differently.

Quiz 20: Fundamentals of Bond Valuation