1. If you want to get a 2% real raise at work so that you can buy 2% more of the things you like, and you expect the inflation rate to be around 3% in the future, you will have to ask for a
5% raise in your salary.
2. Assume that you observe the following rates on the following 20 year bonds:
U.S. Treasury bonds = 4.15 percent
AAA Corporate bonds = 6.2 percent
BBB Corporate bonds = 7.15 percent
The main reason for the differences in the interest rates is:
Default risk premium
3. Which of these is the interest rate that is actually observed in financial markets?
Nominal interest rates.
4. This is the risk that a security issuer will miss an interest or principal payment or continue to miss such payments.
default risk
5. The real interest rate is:
the rate that a security would pay if no inflation were expected over its holding period.
6. Assume the interest rate demanded on a bond issued by Ford is 7%. If the risk premium on this bond is equal to 5%, we would conclude that the risk-free rate is equal to
2%
7. Which of these statements is true?
The higher the liquidity risk, the higher the interest rate that security buyers will demand.
8. Which of the bonds below would be the most liquid?
A bond issued by the United States government.
9. An example of an illiquid asset is:
common stock issued by a small but financially strong firm.
10. Assume you borrow 100 apples and in 1 year you return 107 apples. Also assume inflation rate of 3%. Which of the below would be correct?
The real rate of interest on the loan is equal to 4%.
11. Dakota Corporation 15-year bonds have an equilibrium rate of return of 9 percent. For all securities, the inflation risk premium is 1.95 percent and the real interest rate is 3.65 percent. The security’s liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the bond’s default risk premium.
2.10 percent
12. A corporation’s 10-year bonds are currently yielding a return of 7.75 percent. The expected inflation premium is 3.0 percent annually and the real interest rate is expected to be 3.00 percent annually over the next 10 years. The liquidity risk premium on the corporation’s bonds is 0.50 percent. The maturity risk premium is 0.25 percent on two-year securities and increases by 0.10 percent for each additional year to maturity. What is the default risk premium on the corporation’s 10-year bonds?
0.20 percent
13. Interest rates The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 6.75 percent, on 20-year Treasury bonds is 7.25 percent, and on a 20-year corporate bond is 8.50 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on a 10-year corporate bond is the same as that on the 20-year corporate bond, what is the current rate on a 10-year corporate bond.
8.00 percent
14. A particular security’s default risk premium is 3 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 4.2 percent. The security’s liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the security’s equilibrium rate of return.
10.25 percent
15. Which of the below is correct?
When market interest rates rise we will expect an increase in the yield to maturity on an already outstanding bond
16. Bonds are issued by which of the following?
All of these
17. Which of the following is an important advantage to the issuer of a bond with a call provision?
They allow for refinancing opportunities.
18. They allow for refinancing opportunities.
Zero coupon bond
19. All of the following items would need to be included in the bond’s indenture agreement EXCEPT:
the credit rating
20. Under which conditions will an investor demand a smaller return (yield) on a bond?
The bond issue is upgraded from A to AA
21. When market interest rates increase
Bond prices must decline at the same time.
22. Which of the following is NOT a factor that determines the coupon rate of a company’s bonds?
All of these are factors that determine the coupon rate of a company’s bonds.
23. Determine the interest payment for the following three bonds: 5.5 percent coupon corporate bond (paid semi-annually), 6.45 percent coupon Treasury note, and a corporate zero coupon bond maturing in 10 years. (Assume a $1,000 par value.)
$27.50, $32.25, $0, respectively
24. Consider the following three bond quotes; a Treasury note quoted at 87:25, and a corporate bond quoted at 102.42, and a municipal bond quoted at 101.45. If the Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par value of $5,000, what is the price of these three bonds in dollars?
$877.81, $1,024.20, $5,072.50, respectively
25. A 6 percent coupon bond with 12 years left to maturity is priced to offer a 6.5 percent yield to maturity. You believe that in one year, the yield to maturity will be 6.25 percent. What is the change in price the bond will experience in dollars? (Assume semi-annual interest payments and $1,000 par value.)
$21.55
26. Calculate the price of a 6.5 percent coupon bond with 27 years left to maturity and a market interest rate of 5 percent. (Assume interest payments are semiannual and par value is $1,000.)
$1,220.93
27. A corporate bond with a 5 percent coupon has 10 years left to maturity. It has had a credit rating of BBB and a yield to maturity of 8.0 percent. The firm has recently gotten into some trouble and the rating agency is downgrading the bonds to BB. The new appropriate discount rate will be 9 percent. What will be the change in the bond’s price in percentage terms? Assume interest payments are paid semi-annually and par value is $1,000.
-7.07%
28. A 5.75 percent coupon bond with 12 years left to maturity is offered for sale at $978.83. What yield to maturity is the bond offering? (Assume interest payments are paid semi-annually and par value is $1,000.)
6.00 percent
29. Assume you borrow 100 apples and in 1 year you return 107 apples. Also assume inflation rate of 3%. Which of the below would be correct?
The real rate of interest on the loan is equal to 4%
30. Assume the interest rate demanded on a bond issued by Ford is 7%. If the risk premium on this bond is equal to 5%, we would conclude that the risk-free rate is equal to
2%
31. Which of the bonds below would be the most liquid?
A bond issued by the United States government.
32. According to the Fisher Effect equation the nominal rate of interest is equal to
The real rate of interest plus the inflation rate.
33. Which of these refer to the ease with which an asset can be converted into cash?
Liquidity
34. The liquidity premium will be larger if
There is typically not much trading activity related to the security.
35. This is the risk that a security issuer will miss an interest or principal payment or continue to miss such payments.
default risk
36. An example of an illiquid asset is:
common stock issued by a small but financially strong firm.
37. Which of the following is the continual increase in the price level of a basket of goods and services?
Inflation
38. Assume that you observe the following rates on the following 20 year bonds:
U.S. Treasury bonds = 4.15 percent
AAA Corporate bonds = 6.2 percent
BBB Corporate bonds = 7.15 percent
The main reason for the differences in the interest rates is:
Default risk premium
39. Under which conditions will an investor demand a larger return (yield) on a bond?
The bond issue is downgraded from A to BBB.
40. Which of the following is NOT a factor that determines the coupon rate of a company’s bonds?
All of these are factors that determine the coupon rate of a company’s bonds.
41. Assume that a bond is quoted to be selling at a price equal to $93, per $100 of face value. This implies that
The bond is a discount bond.
42. If a bond is selling at a premium, then ________________________________.
its yield should be lower than its coupon rate.
43. Which of the following bonds makes no interest payments?
Zero coupon bond
44. If the coupon rate equals 7% then a corresponding $1,000 face value bond
Will pay $35 every six months.
45. All of the following items would need to be included in the bond’s indenture agreement EXCEPT:
the credit rating.
46. Rank the following bonds in order from lowest credit risk to highest risk all with the same time to maturity, by their yield to maturity: JM Corporate bond with yield of 12.25 percent, IB Corporate bond with yield of 4.49 percent, TC Corporate bond with yield of 8.76 percent, and B&O Corporate bond with a yield of 5.99 percent.
IB bond, B&O bond, TC bond, JM bond
47. Which of the following statements is correct?
All else the same, an investor will require more return to invest in a callable bond than one that is not callable.
48. Consider the following three bond quotes; a Treasury note quoted at 87:25, and a corporate bond quoted at 102.42, and a municipal bond quoted at 101.45. If the Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par value of $5,000, what is the price of these three bonds in dollars?
$877.81, $1,024.20, $5,072.50, respectively
49. A bond with 14 years to maturity is selling for $1,070 and has a yield to maturity of 10.06 percent. If this bond pays its coupon payments semi-annually and par value is $1,000, what is the bond’s annual coupon rate?
11.00 percent
50. A corporate bond with a 5.75 percent coupon has 15 years left to maturity. It has had a credit rating of BB and a yield to maturity of 6.25 percent. The firm has recently gotten more financially stable and the rating agency is upgrading the bonds to BBB. The new appropriate discount rate will be 6.00 percent. What will be the change in the bond’s price in dollars? (Assume interest payments are paid semi-annually and a par value of $1,000.)
increase $23.72
51. Calculate the price of a 6.5 percent coupon bond with 27 years left to maturity and a market interest rate of 5 percent. (Assume interest payments are semiannual and par value is $1,000.)
$1,220.93
52. A 6 percent coupon bond with 12 years left to maturity is priced to offer a 6.5 percent yield to maturity. You believe that in one year, the yield to maturity will be 6.25 percent. What is the change in price the bond will experience in dollars? (Assume semi-annual interest payments and $1,000 par value.)
$21.55
53. A two-year Treasury security currently earns 5.13 percent. Over the next two years, the real interest rate is expected to be 2.15 percent per year and the inflation premium is expected to be 1.75 percent per year. Calculate the maturity risk premium on the two-year Treasury security.
1.23 percent
54. Which of the following makes this a true statement: The current price of a bond is…?
the present value of the future interest and par value at maturity cash flows discounted at the prevailing market interest rate.
55. Determine the interest payment for the following three bonds: 5.5 percent coupon corporate bond (paid semi-annually), 6.45 percent coupon Treasury note, and a corporate zero coupon bond maturing in 10 years. (Assume a $1,000 par value.)
$27.50, $32.25, $0, respectively
56. If a bond’s market price is less than its par value, which of the following statements is likely to be correct?
The coupon rate is smaller than the yield to maturity.
57. Why are bonds known as a fixed-income security?
Because the cash flows that a bondholder gets from holding the bond, if the bond is held until maturity, are fixed.
58. A bond issued by a corporation on May 1, 1999, is scheduled to mature on May 1, 2019. If today is May 2, 2009, what is this bond’s time to maturity? (Assume annual interest payments.)
10 years
59. Which of the following bonds makes no interest payments?
Zero coupon bond
60. Which of the following is a legal contract that outlines the precise terms between the issuer and the bondholder?
Indenture
61. Which of the following is a true statement?
If interest rates fall, all bonds will enjoy rising values
62. Which of the debt contracts below would be associated with the biggest interest rate risk?
A 15-year Home Depot bond
63. Consider the following three bond quotes; a Treasury note quoted at 87:25, and a corporate bond quoted at 102.42, and a municipal bond quoted at 101.45. If the Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par value of $5,000, what is the price of these three bonds in dollars?
$877.81, $1,024.20, $5,072.50, respectively
64. When market interest rates increase
Bond prices must decline at the same time.
65. All of the following items would need to be included in the bond’s indenture agreement EXCEPT:
the credit rating.
66. Assume that a bond is quoted to be selling at a price equal to $106, per $100 of face value. This implies that
The bond is a premium bond.
67. Which of the following terms means that during periods when interest rates change substantially, bondholders experience distinct gains and losses in their bond investments?
Interest rate risk
68. When we say that a bondholder faces interest rate risk, we mean that the bondholder faces the possibility of a/an __________ in market interest rates and a/an _________ in the value of the bond as a result.
Increase; decline
69. When market interest rates decline
Bond prices must rise at the same time.
70. If a bond’s yield to maturity falls below its coupon rate
The bond must be selling for a price higher than its par value.
71. Assume that a bond is quoted to be selling at a price equal to $93, per $100 of face value. This implies that
The bond is a discount bond.
72. If a bond is selling at a premium, then ________________________________.
its yield should be lower than its coupon rate.
73. If a bond’s yield to maturity rises above its coupon rate
The bond must be selling for a price lower than its par value.
74. Which of these statements answers why bonds are known as fixed income securities?
Investors know how much they will receive in interest payments.
75. Bonds are issued by which of the following?
All of these
76. Which of the following statements is correct?
All else the same, an investor will require more return to invest in a callable bond than one that is not callable.
77. Which of the following terms means the chance that future interest payments will have to be reinvested at a lower interest rate?
Reinvestment rate risk
78. Consider the following three bond quotes; a Treasury note quoted at 87:25, and a corporate bond quoted at 102.42, and a municipal bond quoted at 101.45. If the Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par value of $5,000, what is the price of these three bonds in dollars?
$877.81, $1,024.20, $5,072.50, respectively
79. If a bond’s yield to maturity falls below its coupon rate
The bond must be selling for a price higher than its par value.
80. Regarding a bond’s characteristics, which of the following is the principal loan amount that the borrower must repay?
par or face value
81. Which of the below is correct?
When market interest rates rise we will expect an increase in the yield to maturity on an already outstanding bond.
82. Which of the following terms means that during periods when interest rates change substantially, bondholders experience distinct gains and losses in their bond investments?
Interest rate risk
83. If a bond’s yield to maturity rises above its coupon rate
The bond must be selling for a price lower than its par value.
84. Assume that a bond is quoted to be selling at a price equal to $93, per $100 of face value. This implies that
The bond is a discount bond.
85. The bond is a discount bond.
As a percentage of its par value.
86. Assume a bond has a coupon rate of 3%, par value of $1,000, and 1 year left to maturity. Assuming the bond indenture specifies semi-annual payments, what will be the cash flows to a buyer of the bond, provided the buyer pays $975 for the bond and holds it until it matures?
One payment of $15, and another payment of $1,015 when the bond matures.
87. Consider the following three bond quotes; a Treasury note quoted at 87:25, and a corporate bond quoted at 102.42, and a municipal bond quoted at 101.45. If the Treasury and corporate bonds have a par value of $1,000 and the municipal bond has a par value of $5,000, what is the price of these three bonds in dollars?
$877.81, $1,024.20, $5,072.50, respectively
88. Which of the following is NOT a factor that determines the coupon rate of a company’s bonds?
All of these are factors that determine the coupon rate of a company’s bonds.
89. Rank the following bonds in order from lowest credit risk to highest risk all with the same time to maturity, by their yield to maturity: JM Corporate bond with yield of 12.25 percent, IB Corporate bond with yield of 4.49 percent, TC Corporate bond with yield of 8.76 percent, and B&O Corporate bond with a yield of 5.99 percent.
IB bond, B&O bond, TC bond, JM bond
90. Which of the following is an important advantage to the issuer of a bond with a call provision?
They allow for refinancing opportunities.
91. Which of the following is a legal contract that outlines the precise terms between the issuer and the bondholder?
Indenture
92. Which of the below is correct?
When market interest rates rise we will expect an increase in the yield to maturity on an already outstanding bond.
93. When we say that a bondholder faces interest rate risk, we mean that the bondholder faces the possibility of a/an __________ in market interest rates and a/an _________ in the value of the bond as a result.
Increase; decline
94. Assume that a bond is quoted to be selling at a price equal to $106, per $100 of face value. This implies that
The bond is a premium bond.
95. Bond prices are usually quoted
As a percentage of its par value.
96. Which of the following is NOT a factor that determines the coupon rate of a company’s bonds?
All of these are factors that determine the coupon rate of a company’s bonds.
97. Which of the below is correct?
When market interest rates rise we will expect an increase in the yield to maturity on an already outstanding bond.
98. Which of the following is a legal contract that outlines the precise terms between the issuer and the bondholder?
Indenture
99. Which of these statements answers why bonds are known as fixed income securities?
Investors know how much they will receive in interest payments.
100. All of the following items would need to be included in the bond’s indenture agreement EXCEPT:
the credit rating.
101. Which of the following is an important advantage to the issuer of a bond with a call provision?
They allow for refinancing opportunities.
102. If Zeus Energy bonds are upgraded from BBB- to BBB+, which of the following statements is true?
The current bond price will increase and interest rates on new bonds issues will decrease.
103. Which of the debt contracts below would be associated with the biggest interest rate risk?
A 15-year Home Depot bond
104. Calculate the price of a zero coupon bond that matures in 10 years if the market interest rate is 6 percent. (Assume semi-annual compounding and $1,000 par value.)
$553.68
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