Chapter 07

Chapter 7 Interest Rates and Bond Valuation Valuation

1. Assume you are considering considering two bonds identical in every way but for for coupon freuency ! bond A pays interest annually" and bond B pays interest interest semiannually. #hen" if they have the same price" the yield!to! maturity on bond A will always be greater than that on bond B. Ans$ %alse

&evel$ Basic

'ub(ect$ Bond Valuation Valuation

#ype$ #ype$ Concepts

). Any regular coupon bond of any maturity will sell for its face value value if the coupon rate is the same as the mar*et rate of interest. Ans$ #rue

&evel$ Basic

'ub(ect$ +ield to ,aturity


-. %or a bond" total return return  yield!to!maturity yield!to!maturity  mar*et/s reuired return. return. Ans$ #rue

&evel$ Basic

'ub(ect$ Bond +ields


0. ebt can be subord subordinated inated to euity euity.. Ans$ %alse

&evel$ Basic

'ub(ect$ 'ubordinated ebt


2. A sin*ing sin*ing fund is used used to pay off off portions of debt each year. year. Ans$ #rue

&evel$ Basic

'ub(ect$ 'in*ing %und


3. A call provision" provision" unli*e a sin*ing fund" allows a company to retire its debt early for a specified price. Ans$ %alse

&evel$ Basic

'ub(ect$ Call 4rovision


7. #he call premium generally starts at at 156 of par and decreases decreases to ero with the passage passage of time. Ans$ %alse

&evel$ Basic

'ub(ect$ Call 4remium


8. #he ominion Bond Rating 'ervice 9BR': primarily primarily considers interest rate ris* rather than default ris* when they rate debt. Ans$ %alse

&evel$ Basic

'ub(ect$ Bond Ratings


;. Bond ratings ratings issued by BR' specifica specifically lly account account for default ris*. ris*. Ans$ #rue

&evel$ Basic

'ub(ect$ efault Ratings


15. 4rior to 1;85" few few firms raised funds directly by issuing (un* bonds. Ans$ #rue

&evel$ Basic

'ub(ect$

11. +our +our firm see*s see*s to obtain a short!term loan from from a local ban*. #he ban*er uotes uotes you a rate rate of ;6. #his is a real rate. Ans$ %alse

&evel$ Basic

'ub(ect$ =ominal Returns


Copyright > )552 ,c?raw!@ill Ryerson &imited.

4age 1


1). #he stated interest payment" in dollars" made on a bond each each period is called the bond/s$ A: Coupon. B: %ace value. C: ,aturity. : +ield to to ma maturit y. y. : Coupon rate. Ans$ A

&evel$ Basic

'ub(ect$ Coupon

#ype$ #ype$ efinitions

1-. #he principal amount of a bond that that is repaid at the end of the loan term is called the bond/s$ A: Coupon. B: %ace value. C: ,aturity. : +ield to to ma maturit y. y. : Coupon rate. Ans$ B

&evel$ Basic

'ub(ect$ %ace Value Value


10. #he annual coupon of a bond divided by its face face value is called called the bond/s$ A: Coupon. B: %ace value. C: ,aturity. : +ield to to ma maturit y. y. : Coupon rate. Ans$ 

&evel$ Basic

'ub(ect$ Coupon Rate


12. #he specified date on which the principal principal amount of a bond is repaid repaid is called the bond/s$ A: Coupon. B: %ace value. C: ,aturity. : +ield to to ma maturit y. y. : Coupon rate. Ans$ C

&evel$ Basic

'ub(ect$ ,aturity


13. #he rate of return reuired reuired by investors in the mar*et mar*et for owning a bond is called called the$ A: Coupon. B: %ace value. C: ,aturity. : +ield to to ma maturit y. y. : Coupon rate. Ans$ 

&evel$ Basic




4age )


17. A bond with face face value 1"555 that sells for 1"555 in the mar*et is called a   bond. A: par B: discount C: premium : ero coupon : floating ra rate Ans$ A

&evel$ Basic

'ub(ect$ 4ar Bonds


18. A bond with face face value 1"555 that sells for less than 1"555 in the mar*et is called called a$ A: 4ar bond. B: iscount bo bond. C: 4remium bond. : Dero coupon bond. : %loating rate bond. Ans$ B

&evel$ Basic

'ub(ect$ iscount Bonds


1;. A bond with face face value 1"555 that sells for more than 1"555 in the mar*et is called called a$ A: 4ar bond. B: iscount bo bond. C: 4remium bond. : Dero coupon bond. : %loating rate bond. Ans$ C

&evel$ Basic

'ub(ect$ 4remium Bonds


)5. #he written" legally binding agreement agreement between the corporate borrower and the lender detailing the terms of a bond issue is called the$ A: Indenture. B: Covenant. C: #erms of trade. : %orm 2105. : Call provision. Ans$ A

&evel$ Basic

'ub(ect$ Indenture


)1. #he written agreement between between the corporation corporation and its bond creditors is called aEan A: bond B: protec tectiv tive covenant C: indenture : security agreement : contract Ans$ C

&evel$ Basic

'ub(ect$ Bond Indenture



4age -


)). #he form of bond issue in which the registrar of the company company records ownership ownership of each bond" with relevant payments made directly to the owner of record" is called$ A: =ew!issue fo form. B: Registered form. C: Bearer form. : ebenture fo form. : Collateral fo form. Ans$ B

&evel$ Basic

'ub(ect$ Registered Bonds


)-. #he form of bond issue in which the bond is issued without record record of the owner/s name" with relevant relevant payments made directly to whoever physically holds the bond" is called$ A: =ew!issue fo form. B: Registered form. C: Bearer form. : ebenture fo form. : Collateral fo form. Ans$ C )0. AEan A: B: C: : :

&evel$ Basic

'ub(ect$ Bearer Bonds


 bond is issued without record record of the purchaser/s purchaser/s name. straight unfunded registered bearer income

Ans$ 

&evel$ Basic

'ub(ect$ Bearer Bonds


)2. #he unsecured debts of a firm with maturities greater greater than 15 years years are most literally called$ A: Fnfunded lia liabilit lities ies. B: 'in*ing fu funds. C: Bonds. : =otes. : ebentures. Ans$ 

&evel$ Basic

'ub(ect$ ebentures


)3. A general general claim on property property that is not otherwise pledged is called a A: collateral bo bond B: debenture C: mortgage bond : registered bo bond : bearer bond Ans$ B

&evel$ Basic

'ub(ect$ ebenture



4age 0


)7. AEan  is secured only by the reputation of the issuing firm. A: unfunded bo bond B: straight bond C: bearer bond : registered bo bond : debenture Ans$ 

&evel$ Basic

'ub(ect$ ebentures


)8. #he unsecured debts of a firm with maturities less than 15 years are most literally called$ called$ A: Fnfunded lia liabilit lities ies. B: 'in*ing fu funds. C: Bonds. : =otes. : ebentures. Ans$ 

&evel$ Basic

'ub(ect$ =otes


);. In the event of default"   debt holders must give preference preference to more   debt holders in the priority of repayment distributions. A: shor short! t!te term rmGG long long!!ter term B: long!ter termG sho short!te t!terrm C: seniorG (u (unior : seniorG sub subordina inated ted : subordina inated tedG senior ior Ans$ 

&evel$ Basic

'ub(ect$ 'eniority


-5. An account managed by the bond trustee for early early bond redemption payments is called a$ A: 'in*ing fund. B: Coll Collaatera terall pay payment ment acc accou ount nt.. C: eed in in tr trust ac account. : Call pr provision. : 4ar value fund. Ans$ A

&evel$ Basic



-1.  is an account account into which periodic payments are made for the purpose of retiring a bond issue. A: An indenture B: A debenture C: A covenant : A call op option : A sin*ing fund Ans$ 

&evel$ Basic




4age 2


-). An agreement giving the bond issuer the option to repurchase the bond at a specified price prior to maturity is the  provision. A: sin*ing fu fund B: call C: seniority : collateral : trustee Ans$ B

&evel$ Basic



--. #he amount by which the call price eHceeds eHceeds the bond/s par value is the$ A: Coupon ra rate. B: Redemption value. C: Call premium. : rig rigin inaal!is l!isssue dis disccount ount.. : Call rate. Ans$ C

&evel$ Basic



-0. A deferre deferred d call provision provision refers refers to$ A: #he open open mar*e mar*ett price price of a callab callable le bond bond on a certai certain n date. date. B: #he seniority seniority of callable callable bonds to noncal noncallable lable bonds in the the event event of of corpora corporate te default. default. C: #he prohib prohibitio ition n of a compa company ny from from ever ever redeem redeeming ing call callabl ablee bonds bonds.. : #he proh prohibit ibition ion of a compa company ny from from redeem redeeming ing calla callable ble bonds bonds prio priorr to a certain certain date. date. : #he amou amount nt by whic which h the call call pric pricee for for a callab callable le bond bond eHce eHceeds eds its its par par value. value. Ans$ 

&evel$ Basic

'ub(ect$ eferred Call 4rovision


-2.  included in the bond indenture indenture to protect bondholders from from certain actions by the company. company. A: Indentures are B: ebentures are C: Covenants are : Arti Articl cles es of inco incorp rpor orat atio ion n are are : A des descr crip ipti tion on of of ded dedic icat ated ed cap capit ital al is is Ans$ C

&evel$ Basic

'ub(ect$ Covenants


-3. 4arts of the indenture limiting certain actions actions that might be ta*en during the term of the loan 9usually to protect the interests of the lender: are called$ A: #ruste usteee rela relati tion onsships ips. B: 'in*i in*ing ng fun funds pro provis visions ions.. C: Bond ratings. : efe eferrred red ca call pr provis ovisio ions ns.. : 4rotective ive co covenants. Ans$ 

&evel$ Basic

'ub(ect$ 4rotective Covenant



4age 3


-7. A stri strippe pped d bond bond A: pays pays cou coupo pons ns at at regu regular lar inte interv rval alss un until til mat matur urity ity B: typi typica cally lly sells sells at a prem premiu ium m from from its its fac facee valu valuee C: incr increa ease sess in val value ue whe when n inte intere rest st rat rates es inc incre reas asee : pays pays no coup coupons ons"" thus thus it sell sellss at a deep deep discou discount nt from from face face value value : decr decrea ease sess in val value ue whe when n inte intere rest st rat rates es dec decre reas asee Ans$ 

&evel$ Basic

'ub(ect$ 'tripped Bonds


-8. A bond bond that ma*es no coupon payments 9and 9and thus is initially priced priced at a deep deep discount to par value: is called a  bond. A: #reasury B: municipal C: floating rate : (un* : ero coupon Ans$ 

&evel$ Basic

'ub(ect$ Dero Coupon Bonds


-;. A bond that pays pays a variable amount of coupon coupon interest over time is called a  bond. A: #reasury B: municipal C: floating rate : (un* : ero coupon Ans$ C

&evel$ Basic

'ub(ect$ %loating Rate Bonds


05. A bond which" which" at the election of the holder" can be swapped for a fiHed number of shares shares of common stoc* at any time prior to the bond/s maturity is called a  bond. A: ero coupon B: callable C: putable : convertible : warrant Ans$ 

&evel$ Basic

'ub(ect$ Convertible Bonds


01. +ou +ou want to own euity in a Russian Russian oil firm" but the firm does not have traded stoc*. If it had  outstanding you could purchase them and then trade them in for shares of stoc*. A: convertible bo bonds B: put bonds C: debentures : ero coupon bonds : subo suborrdina dinate ted d debe deben ntur tures Ans$ A

&evel$ Basic

'ub(ect$ Convertible Bonds



4age 7


0). A financial financial mar*et is ! if it is possible possible to easily observe its prices and trading volume. A: transparent B: open C: ordered : in euilibrium : chaotic Ans$ A

&evel$ Basic

'ub(ect$ 4rice #ransparency


0-. Interest rates or rates of return on investment that have have not been ad(usted for the effects effects of inflation are are called$ A: Coupon rates. B: 'tripped ra rates. C: ffective rates. : Real rates. : =ominal ra rates. Ans$ 

&evel$ Basic

'ub(ect$ =ominal Rates


00. Interest rates or rates of return on investment that have have been ad(usted for the effects effects of inflation are called$ A: Real rates. B: =ominal ra rates. C: ffective rates. : 'tripped ra rates. : Coupon rates. Ans$ A

&evel$ Basic

'ub(ect$ Real Rates


02. #he relationship between nominal rates" real rates" rates" and inflation is *nown as the$ A: ,ill ,iller er and and ,od ,odig igli lian anii the theor orem em.. B: %isher effect. C: ?ordon growth model. : #erm str struc uctu ture re of int inter eres estt rate rates. s. : Intere terest st rate ate ris ris* * pr premium mium.. Ans$ B

&evel$ Basic

'ub(ect$ %isher ffect


03. #he relationship between nominal interest rates on default!free" pure discount securities securities and the time to maturity is called the$ A: &iuidit y effect. B: %isher effect. C: #erm stru struct ctur uree of of inte intere rest st rate rates. s. : Inflati latio on premiu mium. : Intere terest st rate ate ris ris* * pr premium mium.. Ans$ C

&evel$ Basic

'ub(ect$ #erm #erm 'tructure f Interest Rates



4age 8


07. #he  premium premium is that portion of a nominal interest interest rate or bond yield that represents represents compensation for eHpected future inflation. A: default ri ris* B: taHability C: liuidity : inflation : interest rat e ris* Ans$ 

&evel$ Basic

'ub(ect$ Inflation 4remium


08. #he ! premium is that portion of a nominal interest interest rate or bond yield that represents represents compensation for the possibility of nonpayment by the bond issuer. A: default ri ris* B: taHability C: liuidity : inflation : interest rat e ris* Ans$ A

&evel$ Basic

'ub(ect$ efault Ris* 4remium


0;. #he face face value value of a bond$ bond$ A: Is defi define ned d as as the the curr curren entt mar* mar*et et pric price. e. B: Incl Includ udes es the the pri princ ncipa ipall plus plus the tota totall inter interes estt due. due. C: Is comm common only ly defi define ned d as as  15 15"5 "555 55.. : Is the prin princi cipa pall amou amount nt paid paid at matu maturi rity ty.. : Is defi defined ned as as the princi principal pal amou amount nt minus minus the inte interes restt due at matu maturity rity.. Ans$ 

&evel$ Basic

'ub(ect$ %ace Value Value


25. #he rate that is computed by dividing the annual interest payment by the face value of a bond is called called the$ A: iscount rate. B: +ield!to! to!maturity ity. C: Coupon rate. : +ield!to!call. : ,ar*et rate. Ans$ C

&evel$ Basic



21. #he legal document that includes the basic terms and details of of a bond is called the$ A: Inden dentur ture ag agreemen ment. B: Call provision. C: ebenture ag agreemen ment. : Registra tratio tion form. : ,ar*eting form. Ans$ A

&evel$ Basic

'ub(ect$ Indenture



4age ;


2). #he rate of return earned earned by an investor who purchases purchases a bond today and holds it for the remainder of the term is called the$ A: Coupon ra rate. B: Compound ra rate. C: +ield!to!mar*et. : +ield!to!call. : +ield!to! to!maturity ity. Ans$ 

&evel$ Basic

'ub(ect$ +ield #o ,aturity


2-. #he call call premi premium um is$ A: ua uall to the the par par val value ue but but pai paid d prior prior to mat matur urity ity.. B: Additio Additional nal compe compensa nsation tion paid paid to a bondh bondhold older er in eHcha eHchange nge for for an early early redemp redemption tion.. C: #he Jtho Jthou u shalts/ shalts/ that that must must be met met prior prior to the paymen paymentt of the face face valu valuee at matur maturity ity.. : #he addi addition tional al princ principa ipall paid when when a bond bond is is grante granted d an invest investmen mentt grade grade rating rating.. : #he #he same same as as the the face face val value ue but but pai paid d prior prior to mat matur urity ity.. Ans$ B

&evel$ Basic



20. #he limitations within a bond indenture agreement that prohibit certain actions actions by a firm are called$ A: 'in*i in*ing ng fun fund pr provis ovisio ions ns.. B: =egative ive covenants. ts. C: ebenture pro provisions. : Call provisions. : 'en 'enior iority ity reuir uireement mentss. Ans$ B

&evel$ Basic

'ub(ect$ =egative Covenant


22.
&evel$ Basic

'ub(ect$

23. A bond bond that pays no separate interest payments is called a9n:$ a9n:$ A: 4remium bond. B: Coupon bond. C:
&evel$ Basic

'ub(ect$ Dero Coupon Bond



4age 15


27. A floating!r floating!rate ate bond by definition definition has has a$ A: 4rinci 4rincipal pal amount amount that that vari varies es with the inflati inflation on rate. rate. B: 4rinci 4rincipal pal amount amount that that vari varies es with the time to maturi maturity ty.. C: Coupon Coupon payment payment that that vari varies es with with an an inter interest est rate rate inde indeH. H. : Coupon Coupon payment payment that that vari varies es with with the the time time to to matu maturity rity.. : Coupon Coupon payment payment that that varie variess with with the the amou amount nt of of debt debt outsta outstandi nding. ng. Ans$ C

&evel$ Basic

'ub(ect$ %loating Rate Bond


28. #he %isher %isher effect effect defines the relationsh relationship ip between$ between$ A: =omi =omina nall and and real real rate ratess o off ret retur urn. n. B: #he #he yie yield! ld!to to!m !mat atur urity ity and and the the yiel yield! d!to to!c !cal all. l. C: Infla Inflatio tion n and and the the yiel yield! d!to to!m !mat atur urity ity.. : #he #he mar mar*e *ett val value ue and and fac facee val value ue of a bon bond. d. : A bond bond/s /s ratin rating g and and its real real rate rate of retu return rn.. Ans$ A

&evel$ Basic



2;. A corporation corporation underta*ing an eHpansion pro(ect issues issues )5 year bonds to finance the pro(ect. Khich of the following is most li*ely trueL A: #he company company does not need need to to ma*e ma*e payments payments on the the bonds bonds unless unless it has positive positive earning earningss for the year. B: #he comp company any has has borro borrowed wed mone money y and must must pay pay inter interest est on on the amou amount nt borro borrowed wed.. C: #he comp company any did did not not have have any outsta outstandi nding ng bonds bonds when when it issue issued d the new new bonds bonds.. : #he bonds must have sold at a premium premium ssince ince eHpansion eHpansion pro(ects pro(ects are generally generally ris*y. ris*y. : If the the compa company ny could could have have issued issued pref preferr erred ed stoc* stoc* instea instead" d" they they would would have have.. Ans$ B

&evel$ Basic

'ub(ect$ Issuing ebt


35. Khich of the following following would would =# be listed listed on the face of a bondL bondL A: #he #he coupo oupon n int inteerest rest rate ate B: #he maturit y date C: #he #he ma mar*et r*et price rice of the the bon bond d : #he #he coup coupon on paym paymen entt to be made made : #he name of the the issuer Ans$ C

&evel$ Basic

'ub(ect$ Bond %ace


31. All else the same" if interest rates fall" then . . I. bond prices prices will rise II. coupon payments on floating rate bonds will fall III. the percentage percentage price price change change for long!term bonds bonds will be greater greater than than for short!term bonds bonds IV. the percentage percentage price change for for low coupon bonds will be greater than for high coupon bonds A: I and III only B: I and IV only C: II and IV only : I" III" and IV onl y : I" II" III" an and IV Ans$ 

&evel$ Basic

'ub(ect$ Bond 4rice vs. +ields



4age 11


3). A bond with a face value of 1"555 has has annual coupon payments of 155 and was issued seven seven years ago. #he bond currently sells for 1"555 and has eight years remaining to maturity. #his bond/s  must be 156. I. yield to maturity II. face value III. coupon rate A: I only B: I and III only C: III only : II and III only : I" II" and III Ans$ B

&evel$ Basic

'ub(ect$ Coupon Rate vs. +ield


3-. %or a premium premium bond" the reuired reuired return return is less than than the$ I. 4ar value. II. +ield to maturity. III. Coupon rate. A: I only B: I and II only C: II and III only : III only : I" II" and III Ans$ 

&evel$ Basic



30. #he yield to maturity on a semiannual payment payment bond is uoted as . A: an AR B: a siH!month rate C: an A4R : a compound rate : a current yield Ans$ C

&evel$ Basic



32. A bond bond with an annual coupon of 155 originally sold at par for 1"555. #he current mar*et mar*et interest rate on on this bond is ;6. Assuming no change change in ris*" this bond would sell at a  in order to compensate . A: premiu premiumG mG the purcha purchaser ser for the above above mar*et mar*et coupon coupon rate rate B: discou discountG ntG the purcha purchaser ser for the above above mar*et mar*et coupon coupon rate rate C: prem premiu iumG mG the the sel selle lerr for for the abov abovee mar mar*e *ett coup coupon on rate rate : discou discountG ntG the seller seller for the above above mar*et mar*et coupon coupon rate rate : disc discou ountG ntG the issu issuer er for for the the hig highe herr cos costt of borr borrow owing ing Ans$ C

&evel$ Basic

'ub(ect$ Bond 4remiums M iscounts



4age 1)


33. 'uppose you are trying to price a bond. Khich of the following is falseL A: #he lowe lowerr the disc discoun ountt rate" rate" the more more valu valuabl ablee the coup coupon on payment paymentss are today today.. B: Bonds with high high coupon coupon payments payments are are generally generally 9all else the same: more sensitive sensitive to change changess in interest rates than bonds with lower l ower coupon payments. C: Khen Khen mar*et mar*et inte interes restt rates rates rise rise"" bond bond prices prices will will fall fall"" all else else the the same. same. : Bonds with long long maturities maturities are generally generally 9all else the same: more sensitive sensitive to changes changes in interes interestt rates than bonds with shorter maturities. : All else else the the same" same" bonds bonds with with larg larger er coupo coupon n paymen payments ts will will have have a higher higher price price today today.. Ans$ B

&evel$ Basic

'ub(ect$ Bond 4ricing


37. +our +our bro*er offers offers you the opportunity to purchase purchase a bond with coupon payments payments of ;5 per year and and a face value of 1"555. If the yield to maturity on similar bonds is 86" this bond should$ A: 'ell 'ell for the same same price price as the the similar similar bond bond regar regardle dless ss of their their respe respecti ctive ve maturi maturities ties.. B: 'ell at at a premium. C: 'ell at a discount. : 'ell 'ell for eithe eitherr a premiu premium m or a disc discoun ountt but it/s it/s impo impossi ssible ble to to tell tell which. which. : 'ell for par value. Ans$ B

&evel$ Basic



38. Khen pricing bonds" if a bond/s bond/s coupon rate is less than than the reuired rate of return" return" then$ A: #he holder holder of the the bond bond is assured assured of of a profit profit regardle regardless ss of of when when the bond is eventua eventually lly sold. sold. B: #he holde holderr of the the bond bond will will reali realiee a capita capitall gain gain if the the bond bond is held held to to maturi maturity ty.. C: #he bond bond sells sells at par par because because the reuir reuired ed rate rate of return return is ad(usted ad(usted to to reflect reflect the discrepancy discrepancy.. : #he bond bond sells sells at at a premium premium if it has a long maturity" maturity" a discount discount if it has a short maturity. maturity. : #he bond bond sells sells at at a discou discount nt if it has has a long long maturity maturity"" a premium premium if it has has a short short maturity. maturity. Ans$ B

&evel$ Basic



3;. %or a bond selling at par" the yield to maturity must must be . A: great reater er tha than the the cou coupon pon ra rate B: less less than than the the coupo oupon n rate ate C: great reater er tha than the the face face valu valuee : grea greater ter than than the the reu reuir ired ed rate rate of retu return rn : eual to to th the co coupon ra rate Ans$ 

&evel$ Basic



75. If the reuired return on a bond does not change change from one year to the neHt" then  over the same period. 9Ignore changes in default ris*. : A: the the pri price ce of a per perpe petu tual al bond bond will will rise rise B: the the pri price ce of a pre premi mium um bond bond will will rise rise C: the the pri price ce of a dis disco coun untt bon bond d wil willl fal falll : the price price of a bond bond selling selling at par will remain remain unchan unchanged ged : the the pric pricee of a conv conver erti tibl blee bond bond wil willl rise rise Ans$ 

&evel$ Basic




4age 1-


71. Khich of the the following following is a true true statementL statementL I. All else the same" the value of a perpetual bond will remain unchanged from from one year to the neHt" unless mar*et interest rates change. II. All else the same" bond prices and coupon rates rates are inversely related. III. %or two bonds identical but for coupon" coupon" the mar*et price of the lower coupon bond will change more 9in percentage terms: than that of the higher coupon bond for a given change in mar*et interest rates. A: I only B: I and II only C: I and III only : II and III only : I" II" and III Ans$ C

&evel$ Basic



7). 'uppose you read that a bond bond with a face value of 1"555 1"555 and a coupon of 85 85 per year has a yield to maturity of eHactly 86. 86. @ow many years remain until maturityL I. ?reater than )5 years II. ?reater than 15 years but less than )5 III. &ess than 15 years A: I only B: II only C: III only : I" II II" or or III III may may be be co corre rrect : Cann Cannot ot be be calc calcula ulate ted d sinc sincee pri price ce is not not give given n Ans$ 

&evel$ Intermediate



7-. &iddy 4roducts" 4roducts" Inc. (ust issued issued 15!year" 15!year" 86 coupon coupon bonds bonds at par. utstanding &imbaugh &imbaugh Corp. bonds" which have a maturity of 15 years" sell at a premium to par and are viewed by investors as having the same ris* as the &iddy bonds. #herefore" it must be true that$ A: #he coup coupon on rate rate on the the &imba &imbaugh ugh bond bondss is eua euall to that that on the the &iddy &iddy bond bonds. s. B: #he coup coupon on rate rate on the the &imba &imbaugh ugh bond bondss is high higher er than than that that on the the &iddy &iddy bond bonds. s. C: #he coup coupon on payme payment nt on the the &imba &imbaugh ugh bon bonds ds is lowe lowerr than than that that on the the &iddy &iddy bonds bonds.. : #he yield yield on &imbaug &imbaugh h bonds bonds is highe higherr than than the the yield yield on &iddy &iddy bon bonds. ds. : #he &imbau &imbaugh gh bond bondss pay pay coup coupons ons more more often often than than twice twice a year year.. Ans$ B

&evel$ Intermediate



70. All else eual" the mar*et value of a corporate bond bond is always inversely inversely related to its I. time to maturity II. coupon rate III. yield!to!maturity A: I only B: II only C: III only : I and III only : I" II" and III Ans$ C

&evel$ Basic




4age 10


72. Khich bond would most li*ely possess the highest degree of interest rate rate ris*L A: 86 coup coupon on rat rate" e" 15 15 yea years rs to matu maturi rity ty B: 86 coup coupon on rate rate"" )5 )5 yea years rs to matu maturi rity ty C: 156 156 cou coupo pon n rat rate" e" 15 15 yea years rs to matu maturi rity ty : 156 156 cou coupo pon n rat rate" e" )5 )5 yea years rs to matu maturi rity ty : 1)6 1)6 cou coupo pon n rat rate" e" )5 year yearss to to mat matur urit ity y Ans$ B

&evel$ Basic

'ub(ect$ Interest Rate Ris*


73. All else the same" same" interest interest rate ris* is highest highest for bonds bonds with$ I. &ow coupon rates. II. Variable Variable rate coupons. coupons. III. &ong maturities. A: I only B: I and II only C: I and III only : II and III only : I" II" and II Ans$ C

&evel$ Basic


77. As a corporate corporate treasurer" treasurer" you manage a 155 million bond portfolio. conomists suggest 9and you believe: that mar*et interest rates are headed up over the neHt several months. #o reduce interest rate ris* you should attempt to$ I. Reduce the average maturity of the portfolio portfolio by selling long!term long!term bonds and buying buying short!term bonds. II. &engthen the average maturity of the portfolio by buying long!term bonds bonds and selling selling short!term short!term bonds. III. Reduce the average coupon coupon rate by selling high!coupon bonds bonds and buying low!coupon bonds. IV. Increase the average coupon rate by buying high!coupon high!coupon bonds and selling low!coupon bonds. A: I only B: I and II only C: II and III only : I and IV only : I" II" III" an and IV Ans$ 

&evel$ Intermediate



78. A bond indenture indenture is li*ely to include include which of the followin followingL gL I. ,aturity date II. 'in*ing fund provision III. 4rotective covenants IV. 'ecurit y or collateral collat eral A: I and II only B: I" II" and III onl y C: I" II" and IV only : II" II III" an and IV IV onl y : I" II" III" an and IV Ans$ 

&evel$ Intermediate




4age 12


7;. Khich of the following provisions would =# be listed in the bond indentureL A: Amount of of bo bonds is issued B: Repa Repay ymen ment arr arrang angeme ements nts C: #he #he tot total al amou amount nt of bond bondss iss issue ued d : 4rotective ive co covenants : Inte Intere rest st rate rate on simi simila larr ris ris* * bon bonds ds Ans$ 

&evel$ Basic



85. Khich of the following items isEare included in the bond bond indentureL I. Call provisions 9if any: II. 'in*ing fund provisions 9if any: III. =egative covenants 9if any: IV. A description of the property used as security 9if any: A: I and II only B: I and III only C: I" II" and IV only : II" II III" an and IV IV onl y : I" II" III" an and IV Ans$ 

&evel$ Basic

'ub(ect$ Indenture


81. Khich of the following is =# a duty of a trust company appointed appointed when bonds are issuedL issuedL A: ,a*e ,a*e sur suree term termss of the the inde indent ntur uree are are obey obeyed ed.. B: ,anag anagee the the sin*i in*ing ng fund fund.. C: eci ecide de when when the the bon bonds ds shou should ld be calle called. d. : ,onitor ,on itor the protec protective tive covena covenants nts for the bon bondho dholde lders. rs. : Repr Repres esen entt the the bond bondho hold lder erss in def defau ault lt.. Ans$ C

&evel$ Basic

'ub(ect$ Bond #rustees


8). All else the same" the eHistence of a  will increase the reuired reuired return on a bond. bond. A: call provision B: conversion ion feature C: sin*ing fund : trust deed : protec tectiv tive covenant Ans$ A

&evel$ Basic



8-. A firm intends to ta*e on a significant amount of new debt in order to fund the purchase of a close close competitor. @owever" before it can complete the transaction" the firm must call one of its outstanding bond issues. It is plausible that the called bonds$ A: Are Are bac* bac*ed ed by by the the corp corpor orat ation ion/s /s fiHe fiHed d asse assets ts.. B: @ave @ave a high higher er int inter eres estt rate rate than than the the new new bon bonds ds will will.. C: @ave @ave an an infe inferi rior or taH taH sta statu tuss than than the the new new bon bonds ds will will.. : Can Can be calle called d at at a pric pricee that that is is very very nea nearr par par. : @ave @ave cov coven enan ants ts whic which h rest restri rict ct such such incr increa ease se in deb debt. t. Ans$ 

&evel$ Basic

'ub(ect$ Restrictive Covenants



4age 13


80. Khich of the following would be classified classified as a positive positive protective covenantL A: #he firm firm must must furn furnish ish audited audited annual annual financ financial ial statem statement ents. s. B: #he #he firm firm can canno nott pled pledge ge any any ass asset etss to oth other er len lende ders rs.. C: #he #he firm firm mus mustt not not issu issuee addi additio tiona nall long long!te !term rm deb debt. t. : #he #he fir firm m can canno nott mer merge ge with with anoth another er firm firm.. : #he firm firm must must limit limit the the amoun amountt of divid dividend endss it pays pays acco accordi rding ng to some some form formula ula.. Ans$ A

&evel$ Basic

'ub(ect$ 4ositive Bond Covenants


82. Khich of the following following is =# a typical negative negative bond covenantL covenantL A: #he #he firm firm must must limit limit divi divide dend nd paym paymen ents ts.. B: #he #he fir firm m can canno nott mer merge ge with with anoth another er firm firm.. C: #he #he firm firm can canno nott issu issuee addi additio tiona nall long! long!te term rm deb debt. t. : #he firm firm canno cannott allow allow its its bond bond rati rating ng to fall fall below below its its initia initiall level. level. : #he #he firm firm can canno nott pled pledge ge any any ass asset etss to oth other er len lende ders rs.. Ans$ 

&evel$ Basic

'ub(ect$ =egative Covenants


83. Khich of the following statements statements about bond bond ratings isEare isEare accurateL I. Bond ratings are typically paid for by a company/s bondholders. II. Bond ratings are based based solely on information acuired from from sources other than the firm firm itself. III. Bond ratings represent an independent assessment of the creditworthiness of bonds. A: II only B: I and II only C: III only : I and III only : II and III only Ans$ C

&evel$ Basic



87. Khich of the following ris*s do debt ratings specifically specifically attempt to assessL I. Interest rate ris* II. efault ris* III. #he ris* of a call being made A: I only B: II only C: I and II only : II and III only : I" II" and III Ans$ B

&evel$ Basic



88.  is the rating rating given to income bonds on which no interest is being paid. A: % B:  C: C : Ca : B Ans$ B

&evel$ Basic




4age 17


8;.  is the highest highest rating given by BR' that is =# considered investment grade. grade. A: A B: BBB C: BB : B : C Ans$ C

&evel$ Basic



;5. Khich of the following is correctL A ero coupon bond . A: typical typically ly pay payss coup coupons ons only during during the first first five five years years B: sells sells for for a pric pricee that that is is grea greate terr than than the the fac facee value value C: has no inte interes restt payment paymentss and and is thus not taHabl taHablee until until maturi maturity ty : is also also *no *nown wn as a dee deep p dis disco coun untt bond bond : prov provid ides es no cash cash flow flow to the the holde holderr at at matu maturi rity ty Ans$ 

&evel$ Basic

'ub(ect$ Dero Coupon Bonds


;1. Assume the reuired reuired return on a ero!coupon bond will remain constant over the remainder of its life. #he mar*et value of the bond will$ A: Increa Increase se each each year year by an an amount amount eua euall to the imput imputed ed coupo coupon n rate rate for the the perio period. d. B: Increa Increase se each each year year by by an amou amount nt eual eual to to the impu imputed ted inte intere rest st for for the period period.. C: Increa Increase se each each year year by an amou amount nt eua euall to the the bond/s bond/s curr current ent yield. yield. : ecrea ecrease se each each year year by by an amoun amountt eual eual to the the bond/ bond/ss yield yield to matur maturity ity.. : Remain unchanged. Ans$ B

&evel$ Basic

'ub(ect$ Dero Coupon Bond 4rices


;). AEan    bond is often putable and and has a NcollarN. A: floating rate B: act of god C: ero!coupon : (un* : convertible Ans$ A

&evel$ Basic



;-. +our +our neighbour is bragging that that the coupon payment on the bonds he bought five years ago ago has increased in each of the last three years. +ou +ou *now he must own . A: a ero coupon bond B: an income bond C: a convertible bond : a put bond : a floating rate bond Ans$ 

&evel$ Basic




4age 18


;0. If a firm is allowed to miss a payment on a bond in a year year in which it reports an operating operating loss" the bond is li*ely aEan  bond. A: putable B: ero coupon C: income : floating rate : callable Ans$ C

&evel$ Basic

'ub(ect$ Income Bonds


;2. Ignoring default" which of the following is =# accurate$ 4rior to maturity" maturity" . A: an unpr unprotec otected ted callab callable le bond bond can be termin terminated ated 9calle 9called: d: by the the issu issuer er B: an income income bon bond d can be termina terminated ted 9repai 9repaid: d: by the issuer issuer C: a conv convert ertible ible bon bond d can can be termina terminated ted 9conve 9converte rted: d: by the invest investor or : a put put bond bond can can be be term termina inate ted d 9put: 9put: by the the inv inves estor tor : a bond bond with with a sin*i sin*ing ng fund fund can be termin terminate ated d 9repa 9repaid: id: by the the bond bond truste trusteee Ans$ B

&evel$ Intermediate

'ub(ect$ Income Bonds


;3. Khich of the following following items does =# general generally ly appear in The National Post corporate corporate bond uoteL A: current yield B: price C: yi el eld!to!maturit y : coupon rate : maturity da date Ans$ A

&evel$ Basic

'ub(ect$ Bond 4rice Reporting


;7. 'uppos 'upposee you you open open The National Post and and see that -5!year Canada Bonds are yielding yielding 8.26. #his is an eHample of . A: a real return B: a nominal return C: an inflati latio on premiu mium : a de default ris* is* pr premiu mium : a ta taHability pr premium Ans$ B

&evel$ Basic

'ub(ect$ =ominal Returns


;8.  returns measure the percentage change in one/s purchasing power" power" i.e." the change in your standard of living. A: Real B: =ominal C: Ad(usted : @olding period : Capital gain Ans$ A

&evel$ Basic

'ub(ect$ Real Returns



4age 1;


;;. #he component9s: of nominal returns =# described in the %isher effect effect is 9are: $ I. #he real return on investment. II. #he default default ris* premium. III. #he taHability premium. premium. IV. #he inflation premium. A: II only B: I and III only C: I" III" and IV onl y : II and III only : I" II" III" an and IV Ans$ 

&evel$ Basic



155. #he  component of the term structure does not influence influence the shape of the term term structure" rather it affects the overall level of i nterest rates. A: inflation pr premium B: inte intere rest st rate ris* is* pre premi mium um C: real ra rate of int intere erest : default ri ris* premiu mium : liuidity premium Ans$ C

&evel$ Intermediate

'ub(ect$ #erm #erm 'tructure eterminants


151. Khich of the following is a basic basic component that affects the term structure of interest ratesL ratesL I. #he eHpected rate of inflation II. #he interest rate ris* premium III. #he real rate of interest A: I only B: II only C: I and II only : I and III only : I" II" and III Ans$ 

&evel$ Intermediate Intermediate

'ub(ect$ Components Components f #he #erm #erm 'tructure

#ype$ #ype$ Concepts Concepts

15). #he term structure structure of interest rates may be downward sloping if$ A: #he inte interes restt rate ris* ris* premi premium um is the the same same for both both shor shortt and long! long!ter term m bonds. bonds. B: #he #he infl inflat atio ion n prem premiu ium m decr decrea ease sess with with mat matur urity ity.. C: #he real real rate rate of interes interestt is lowe lowerr this this year year than than it was was last last year year.. : efault efault ris* ris* premiu premiums ms are are higher higher for longer longer term term bonds bonds than for shorter shorter term term bonds. bonds. : #her #heree are are bond bondss that that hav havee an unf unfav avou oura rable ble taH taH sta statu tus. s. Ans$ B

&evel$ Intermediate

'ub(ect$ Inflation 4remium



4age )5


15-.  will cause the slope of the term structure of interest rates to increase. I. An eHpected increase increase in the rate of inflation II. An increase in the interest rate ris* premium III. An increase in the real rate of interest A: I only B: II only C: I and II only : I and III only : I" II" and III Ans$ C

&evel$ Intermediate

'ub(ect$ #erm #erm 'tructure 'lope


150. Khich of the following is a basic basic component that affects the slope of the term structure of interest ratesL A: inflation pr premium B: liuidity premium C: real ra rate of int intere erest : default ri ris* premiu mium : taHabilit y premium Ans$ A

&evel$ Intermediate

'ub(ect$ 'lope of the #erm #erm 'tructure


152. Khich of the following following stateme statements nts is falseL falseL A: If the the rate rate of inflation inflation is eHpected eHpected to decline decline by a small small amount" amount" there there could still be be an upward! upward! sloping term structure. B: A bond/s bond/s yield yield is typically typically calcula calculated ted assuming assuming that all all of the promise promised d coupon coupon and princip principal al payments will be made. C: Investors Investors demand demand eHtra eHtra yield yield for for nontaHable nontaHable bonds as compens compensation ation for the the unfavour unfavourable able taH taH treatment. : #he compen compensation sation investors investors demand demand for for bearing bearing intere interest st rate rate ris* adds an an upward upward slope slope to the the term term structure of interest rates. : #he compen compensation sation investors investors demand demand for buying bonds that don/t don/t trade trade very often is called called a liuidity liuidity premium. Ans$ C

&evel$ Basic

'ub(ect$ #erm #erm 'tructure ffects


153. If investors are uncertain uncertain that they will be able to sell a corporate corporate bond uic*ly" the investors will demand a higher yield in the form of a9n: . A: inflation pr premium B: inte intere rest st rate ris* is* pre premi mium um C: default ris* premiu mium : liu liuid idit ity y ris* is* pre premium mium : incr increa ease sed d real real rate rate of inte intere rest st Ans$ 

&evel$ Basic

'ub(ect$ &iuidity 4remium



4age )1


157. If investors are uncertain uncertain that a corporate bond issuer issuer will ma*e all of the bond payments payments as promised" the investors will demand a higher yield in the form of A: an incr increa ease sed d inf infla lati tion on prem premiu ium m B: an incr increa ease sed d int inter eres estt rate rate ris* ris* prem premiu ium m C: an incr increa ease sed d def defau ault lt ris* ris* prem premiu ium m : an inc incre reas ased ed li liui uidi dity ty ris ris* * prem premiu ium m : an incr increa ease sed d rea reall rat ratee of of int inter eres estt Ans$ C

&evel$ Basic

'ub(ect$ efault 4remium


158. uration is a useful useful measure of interest rate ris* because it incorporates incorporates I. a bond/s maturity II. a bond/s default ris* III. a bond/s coupon rate A: I only B: II only C: I and II only : I and III only : I" II" and III Ans$ 

&evel$ Basic

'ub(ect$ AppendiH$ uration


15;. #he call provision found found on most publicly publicly issued bonds are advantageous to the  because . A: issuerG issuerG it allows issuing issuing firms firms to purchase purchase bac* the bonds bonds if interes interestt rates rates mov movee favoura favourably. bly. B: buyerG buy erG it allow allowss buyer buyerss to sell sell bac* bac* their their bonds bonds to the the issuer issuer if if intere interest st rates rates move move up. up. C: govern gov ernmen mentG tG issuin issuing g compani companies es and and buyers buyers have have to pay high higher er taHes taHes on these these bond bonds. s. : buyerG buy erG these these bon bonds ds typica typically lly have have lower lower coupon coupon rates rates.. : issuerG issuerG they they can can issue issue these these bonds bonds with relative relatively ly lower lower coupon coupon rates than bonds without a call call provision. Ans$ A

&evel$ Basic

'ub(ect$ Callable Bonds


115. Khich of the following statements are correct concerning interest rate ris*L I. #he shorter the term" the greater the interest rate ris*. II. #he longer the term" the greater the interest rate ris*. III. #he lower the coupon coupon rate" the greater the interest rate rate ris*. IV. #he higher higher the coupon rate" rate" the higher the interest rate ris*. A: I and III only B: I and IV only C: II and III only : II and IV only Ans$ C

&evel$ Intermediate




4age ))


111.. Alberto wants to profit should an uneHpected 111 uneHpected decrease in mar*et mar*et interest rates occur. Alberto should purchase$ A: #hree!year 36 36 bo bonds. B: #hree!year 86 bonds. C: #en!year 26 26 bo bonds. : #en!year ;6 bonds. : #en!y n!year ear e ero coupo oupon n bond bonds. s. Ans$ 

&evel$ Intermediate



11). ,argaret wants to compute compute the present value of a siH siH year semi!annual 86 coupon coupon bond that has a ;6 yield!to!maturity. Khich one of the following is correctL A: #he #he numb number er of inte intere rest st pay payme ments nts is twelve twelve.. B: #he #he pre prese sent nt valu valuee is is ass assum umed ed to be 1"5 1"555 55.. C: #he #he amo amoun untt of of eac each h inter interes estt pay paymen mentt is is 85 85.. : #he #he bon bond d is is sel selli ling ng at a pre premi mium um.. : #he curren currentt price price of the the bond bond will be grea greater ter than than the the par par value value.. Ans$ A

&evel$ Intermediate

'ub(ect$ 'emiannual Coupons


11-. Khen using a financial calculator to compute the yield!to!maturity of a semi!annual coupon coupon bond" the$ A: Coup Coupon on rate rate is the the dis disco coun untt rat rate. e. B: %ace %ace valu valuee is the the futu future re valu value. e. C: =umber =umber of paymen payments ts is is the the numb number er of years years to matu maturity rity.. : Call Call prem premiu ium m is is the the pres presen entt val value ue.. : ,ar* ,ar*et et pric pricee is is the the futu future re valu value. e. Ans$ B

&evel$ Intermediate

'ub(ect$ %inancial Calculator And %ace Value Value


110. Khich one of the following is the correct bond pricing pricing euationL t A: Bond Bond valu valuee  OCPO OCPOQ1 Q1  1 E 91S 91Sr: r:TT E r P S %  1 E 91Sr:tT E r B: Bond Bond value alue  OCP OCPOQ OQ1 1 S 1 E 91Sr: 1Sr:tT E rP S %E91Sr:t C: Bond Bond value alue  OCP OCPOQ OQ1 1  1 E 91Sr 1Sr:tT E rP S %E91Sr: t : Bond Bond valu valuee  OCPO OCPOQ1 Q1 S 1 E 91S 91Sr: r:TT E r tP S %E91Sr: : Bond Bond value alue  OCP OCPOQ OQ1 1 S 1 E 91Sr: 1Sr:tT E rP S Q%  91Sr t:ErT Ans$ C

&evel$ Intermediate

'ub(ect$ Bond 4ricing uation


112. Khich of the following is 9are: correct concerning concerning the yield!to!maturity 9+#,:L 9+#,:L I. #he +#, is is greater greater than the coupon coupon rate rate for a discount discount bond. II. #he +#, +#, is less than the coupon rate when the coupon rate is 76 and the mar*et rate is 36. III. #he +#, +#, is eual to the coupon rate when a bond sells at par value. value. IV. #he +#, +#, is greater than the coupon rate rate for a bond selling at a premium. A: I and III only B: II and IV only C: II and III only : I" II" and III onl y : II" III" and IV onl y Ans$ 

&evel$ Intermediate

'ub(ect$ +ield!#o!,aturity +ield!#o!,aturity



4age )-


113. Khich one of the following is correct correct concerning bonds and bondholdersL bondholdersL A: A bond bondhol holder der has the righ rightt to vote vote on *ey *ey corp corpora orate te decis decisions ions.. B: #he inte interes restt paid on a bond bond is is no nott taH dedu deductib ctible le as a busine business ss eHpe eHpense nse.. C: A bon bondho dholder lder can never never forc forcee a compan company y into into ban* ban*rup ruptcy tcy.. : A bon bondh dhol olde derr is a part partia iall owner owner of of a cor corpo pora ratio tion. n. : A bon bond d can can be sold sold priva privately tely and never never off offere ered d to the pub public. lic. Ans$ 

&evel$ Intermediate

'ub(ect$ Bond %eatures


117. Khich of the following are common features of most most callable bondsL I. A call premium premium is paid if the bond bond is redeemed early. II. #he bond is generally redeemed on the original date date of maturity. III. #he right right to call the bond is deferred for a period of of time. IV. #he call premium increases increases as the time to maturity decreases. A: I and III only B: I and IV only C: II and III only : I" III" and IV onl y : II" III" and IV onl y Ans$ A

&evel$ Intermediate

'ub(ect$ Callable Bond


118. Khich one of the following is designed designed to benefit the corporation rather rather than the bondholderL A: 4ositive co covenant B: 'in*ing fund C: Call pr provision : =egative co covenant : Call premium Ans$ C

&evel$ Intermediate

'ub(ect$ Covenants


11;.. #he purpose 11; purpose of a sin*ing sin*ing fund fund is to$ A: istri istribut butee the proc proceed eedss recei received ved from from a bond bond issu issuee over over a perio period d of time time.. B: ?ather ?ather funds funds so that that suffic sufficient ient money money is available available when when the bond bond issue issue matures matures to pay off the debt. debt. C: istri istribut butee the intere interest st payme payments nts to to the the indivi individua duall bondh bondhold olders ers.. : Retire Retire part part or all of a bond bond issue issue prior prior to maturity maturity.. : Reta Retain in the the inter interes estt that that accru accrues es on on ero ero cou coupo pon n bond bonds. s. Ans$ 

&evel$ Intermediate



1)5. ,i*e purchased an ABC Co. bond that gives gives him the right to sell the bond to ABC Co. at a set price. price. ,i*e bought a  bond. A: Callable B: iscount C: Dero coupon : 4ut : %loating!rate Ans$ 

&evel$ Intermediate

'ub(ect$ 4ut Bond



4age )0


1)1. Khen investors believe that inflation is going going to decline in the future the term term structure of interest rates will$ A: Be humped. B: Rise Rise at at an incre increas asin ing g rate rate ove overr a per period iod of time. time. C: Rise Rise in a line linear ar mann manner er over over a per perio iod d of of time time.. : Be hig highe herr in the long long term term tha than n in the the shor shortt term term.. : ecr ecrea ease se as the the time time to matu maturi rity ty get getss long longer er.. Ans$ 

&evel$ Intermediate Intermediate



1)). #he =ational 4ost lists a bond with the following information$#he bond has a closing price of ;3.;3" a coupon of 3.255" maturity date of ,ay 5;E52 and +ld6 of 3.216. Khich one of the following statements about this bond is correctL A: #he clos closing ing pric pricee of the the bond bond on the prio priorr tradi trading ng day day was was 1"5;3 1"5;3.;3 .;3.. B: #he #he bond ond matu maturres in )55; )55;.. C: #he #he yiel yield d to matu maturi rity ty is 3.21 3.216. 6. : #he #he bon bond d is is a pre premiu mium bon bond d. : ach ach coup coupon on pay payment ment is 32. 32.55 55.. Ans$ C

&evel$ Intermediate

'ub(ect$ Bond &isting


1)-. All of the following following are bond rating rating services services UC4#$ UC4#$ A: omi omini nion on Bond Bond Rati Rating ng 'erv 'ervic ice. e. B: Cana Canadi dian an Bond Bond Rati Rating ng 'erv 'ervic ice. e. C: nta ntari rio o 'ecu 'ecuri riti ties es Comm Commis issi sion on.. : ,oody/s. : 'tan tandard and 4oor/s. Ans$ C

&evel$ Basic

'ub(ect$ Bond Rating 'ervices


1)0. #he term structu structure re of interest interest rates$ rates$ I Compares the components of the %isher formula. II Reveals the pure time value of money for various various periods periods of time. III Compares short!term versus long!term real rates of return. IV oes not include any default ris*. A: I and III only. B: I and II only. C: II and IV only. : II and III only. : II" II III" an and IV IV on onl y. y. Ans$ C

&evel$ Intermediate



1)2. Khich one of the following statements is true concerning bond ratingsL A: Bond Bond rating ratingss are base based d on both both the ris* ris* of of defaul defaultt and the the intere interest st rate rate ris*. ris*. B: A bon bond d rate rated d BBB BBB or low lower er is is cons consid ider ered ed a (un (un* * bond bond.. C: All else else eua eual" l" a bond bond rated rated BB BB should should pay pay a high higher er retur return n than than a bond bond rated rated B. B. : Bond Bond rat rating ingss are are base based d only only on on the the ris* ris* of of defa default ult.. : By mutua mutuall agreem agreement ent"" BR' and and 'tanda 'tandard rd M 4oor/s 4oor/s issu issuee compar comparabl ablee ratings ratings on on all bonds bonds.. Ans$ 

&evel$ Intermediate




4age )2


1)3. Khich one of the following is correct correct concerning bond pricesL A: All else else eual" eual" a 1)6 bon bond d will will sell sell at a higher higher price price than than a 156 156 bond. bond. B: #he price price of of a short!t short!term erm bond bond is more more sensiti sensitive ve to interes interestt rate changes changes than the price price of a long!term long!term bond. C: #he price price of of a ero!c ero!coupon oupon bond is is less sensitive sensitive to interest interest rate rate changes changes than than the price of a coupon coupon bond. : Bond Bond price pricess tend tend to to fluc fluctua tuate te more more the less less time time to to matur maturity ity.. : ,oveme ,ov ements nts in bond bond prices prices are are direct directly ly relate related d to movemen movements ts in the mar*e mar*ett rate of inter interest est.. Ans$ A

&evel$ Intermediate

'ub(ect$ Bond 4rices


1)7. In addition to interest interest rate ris* and and the real rate" rate" bond yields include the effects of$ I. #aHability. II. efault ris*. III. Hpected future inflation. IV. #he lac* of liuidity. liui dity. A: I and II only. B: II and III only. C: II" III" an and IV only. ly. : I" II" and III only. ly. : I" II" III" an and IV. Ans$ 

&evel$ Intermediate



1)8. All else eual" which bond bond will tend to have have the most stable mar*et value if interest rates fluctuateL A: Dero Dero coup coupon on"" shor short! t!te term rm bond bond B: %loa %loati ting ng!r !rat ate" e" shor short! t!te term rm bond bond C: &ong ong!ter !term" m" low low cou coupo pon n bo bond : AAA AAA rat rated ed"" inte interm rmed edia iate te ter term m bon bond d : Cana Canadi dian an ?ove ?overrnm nmen entt bond bond Ans$ B

&evel$ Intermediate

'ub(ect$ %loating Rate Bond


1);. If the coupon rate and yield!to!maturity yield!to!maturity are both 26" 26" then the bond must be$ A: A ero coupon bond. B: 'ellin ling at a discount. C: 'elling at par. : ,atur aturin ing g wit withi hin n one one year ear. : 'el 'elling ling above bove face ace valu value. e. Ans$ C

&evel$ Intermediate

'ub(ect$ 4ar Value Value



4age )3


1-5. Khich of the following is 9are: true concerning bond pricesL I. A discount bond will be priced priced closer and closer to face value as the time to maturity decreases" all else eual. II. A bond price is the present value value of an annuity annuity stream of payments. payments. III. A bond/s price reflects reflects the bond/s rating and time to maturity. IV. A bond/s price will decrease as interest rates rates increase. increase. A: I and IV only B: II and III only C: II and IV only : I" III" and IV onl y : I" II" III" an and IV Ans$ 

&evel$ Intermediate



1-1. M? nterprises issues bonds with a 1"555 1"555 face value that ma*e coupon coupon payments of -5 every three months. Khat is the coupon rateL A: 5.-56 B: -.556 C: ;.556 : 1).556 : -5.556 Ans$ 

&evel$ Basic


#ype$ #ype$ 4roblems

1-). n
&evel$ Basic



1--. 'uppose you read that a bond bond with a face value of 1"555 1"555 and a coupon of 85 85 per year has a yield to maturity of eHactly 86. @ow many years remain remain until maturityL I. ?reater than )5 years II. ?reater than 15 years but less than )5 III. &ess than 15 years A: I only B: II only C: III only : I" II II" or or III III may may be be co corre rrect : Cann Cannot ot be comp compute uted d sinc sincee pri price ce is not not give given n Ans$ 

&evel$ Basic

'ub(ect$ Bond ,aturity



4age )7


1-0. 'uppose you purchase a ero coupon bond with face value 1"555" maturing in )5 years" for for )10.22. Khat is the implicit interest" in dollars" in the first year of the bond/s lifeL A: 10.83 B: 13.80 C: 17.13 : -;.)7 : 85.55 Ans$ C

&evel$ Intermediate



1-2. 'uppose you purchase purchase a ero ero coupon bond with face value 1"555" maturing in )5 years" for )10.22. If the yield to maturity on the bond remains unchanged" what will the price of the bond be five years from nowL A: -12.)0 B: -87.2) C: 015.;1 : 385.28 : 1"555.55 Ans$ A

&evel$ Intermediate



1-3. Khat is the yield to maturity on a 12!year" 12!year" ero coupon coupon bond selling for -7.26 of par valueL A: 0.056 B: 2.356 C: 2.;76 : 3.736 : -7.256 Ans$ 

&evel$ Basic



1-7.
&evel$ Basic



1-8.
&evel$ Basic




4age )8


1-;. Khat is the mar*et value of a bond that will pay a total of 05 semiannual semiannual coupons of 25 each over the remainder of its lifeL Assume the bond has a 1"555 face value and an 86 yield to maturity. A: 3-0.83 B: 30).)3 C: 1"1-2.;5 : 1"1;7.;: 1")12.3) Ans$ 

&evel$ Basic

'ub(ect$ Bond 4rice


105.
&evel$ Basic

'ub(ect$ Bond 4rice


101.
&evel$ Basic



10).
&evel$ Basic



10-.
&evel$ Basic




4age );


100. Khat would you pay for a bond that pays an annual coupon coupon of -2" has a face face value of 1"555" matures in seven years" and has a yield to maturity of 86L A: 732.71 B: 872.-0 C: ;55.18 : ;15.10 : ;73.-8 Ans$ A

&evel$ Basic

'ub(ect$ Bond 4rice


102. ing =oodles/ bonds have have a 7.26 coupon rate. Interest is paid uarterly and the bonds have a maturity of eight years. If the appropriate discount rate rate is 86 on similar bonds" what is the price of ing =oodles/ bondsL A: ;75.33 B: ;75.87 C: ;71.)7 : ;8;.3: ;;-.)7 Ans$ A

&evel$ Basic



103. #he bonds of ,icrohard" ,icrohard" Inc. carry a 156 annual coupon" have a 1"555 face face value" and mature in four years. Bonds of euivalent euivalent ris* yield 76. Khat is the mar*et value of ,icrohard/s bondsL bondsL A: 1"511.)5 B: 1"587.)2 C: 1"5;2.33 : 1"151.3) : 1"135.)2 Ans$ 

&evel$ Basic



107. #he bonds of ,icrohard" ,icrohard" Inc. carry a 156 annual coupon" have a 1"555 face face value" and mature in four years. Bonds of euivalent euivalent ris* yield 126. ,icrohard is having having cash flow problems and has as*ed its bondholders to accept the following deal$ #he firm would li*e to ma*e the neHt three coupon payments at half the scheduled amount" and ma*e the final coupon payment be )25. If this plan is implemented" the mar*et price of the bond will 9riseEfall: 9riseEfall: to . 9Continue to assume a 126 reuired reuired return.: A: 858.8; B: 8)8.82 C: 821.)2 : 832.02 : 8;).21 Ans$ B

&evel$ Intermediate



108. If the following bonds bonds are identical eHcept for coupon" coupon" what is the price price of bond BL Bond A Bond B %ace value 1"555 1"555 'emiannual Coupon 02 -2 +ears to maturity )5 )5 4rice 1"5;8.;3 L


4age -5


A: B: C: : :

;51.50 ;)2.-1 ;35.00 1"5-7.83 1"57;.3-

Ans$ A

&evel$ Intermediate



10;. U+D Co. ero!coupon bonds have a face value of 1"555 and mature in 18 years. #hey currently sell for 17;.83 today. By what percentage will the mar*et price rise if the mar*et/s reuired return falls by halfL A: ;;6 B: 1-16 C: 1-76 : 1726 : )-16 Ans$ B

&evel$ Intermediate



125. &iddy 4roducts" Inc. (ust issued 15!year" 86 coupon bonds at par. utstanding bonds of &imbaugh Corp. " &iddy/s closest competitor" have a maturity of 15 years and are viewed by investors as being of about the same ris* as the &iddy bonds" but carry a 26 coupon. Assume mar*et interest rates rise by five percentage points. #he value of the  bonds will fall by  more than the bonds of their competitor. 9Assume all bonds pay interest annually.: A: &iddyG 10.03 B: &iddyG -8.2) C: &iddyG 1 15-.37 : &imbaughG -8.2) : &imbaughG -8.2) Ans$ B

&evel$ Intermediate



121. iy Corp. bonds bearing a coupon rate of 126" pay coupons coupons semiannually" have two years remaining to maturity" and are currently currently priced at ;85 per bond. Khat is the yield to maturityL A: 12.556 B: 12.;;6 C: 13.)16 : 13.)26 : 13.276 Ans$ C

&evel$ Basic



12). #he mar*et price of a bond bond is 1")-3.;0" it has 10 years to maturity" a 1"555 face value" and pays an an annual coupon of 155. Khat is the yield to maturityL A: -.186 B: 0.)36 C: 2.-76 : 3.116 : 7.)26 Ans$ 

&evel$ Basic




4age -1


12-. Cornerstone Industries has a bond bond outstanding that has a 76 coupon rate and a mar*et price of 887.73. If the bond matures in five years and interest is paid semiannually" what is the +#,L A: 0.;6 B: 2.26 C: 7.26 : ;.;6 : 10.;6 Ans$ 

&evel$ Basic



120. ?eorge bought an an investment one year ago and (ust calculated his return return on investment. @e found that his purchasing power has increased by 126 as a result of his investment. If inflation over the period was 06" his . A: real real retu return rn on inve investm stmen entt is more more than than 126 126 B: nomi nomina nall retu return rn on inve investm stmen entt is more more than than 126 126 C: nomi nomina nall retu return rn on inve investm stmen entt is less less than than 116 116 : real real retu return rn on inve investm stmen entt is is eu eual al to 06 : ability ability to purc purchas hasee good goodss has has decl decline ined d over over the past past year year Ans$ B

&evel$ Basic

'ub(ect$ Real vs. =ominal Returns


122. +ou +ou presently own stoc* that you you purchased one year ago. ago. +our +our return on the stoc* for for the past year was )26. +ou +ou calculate your real return on investment was 1-.3-6. #he rate of inflation must have been . A: 1.16 B: -.36 C: 15.56 : )2.56 : 0).56 Ans$ C

&evel$ Basic

'ub(ect$ Real vs. =ominal Returns


123. +ou +ou purchased a bond one year ago for 8-;.37 and (ust received the annual annual coupon of 85. +ou +ou sell the bond today for 8);.--. Khat is your real return if inflation was 26L A: -.106 B: 3.5)6 C: 3.076 : ;.856 : 15.)36 Ans$ A

&evel$ Basic

'ub(ect$ Real Returns


127. If investors reuire a 76 nominal return and the eHpected eHpected inflation rate is -6" what is the eHpected real returnL A: 1.506 B: -.556 C: -.886 : 0.556 : 15.)16 Ans$ C

&evel$ Basic




4age -)


128. +ou +ou earn a 26 real return. return. If the inflation rate rate is 06" what is your nominal returnL A: 5.;36 B: 1.5;6 C: ;.556 : ;.)56 : 15.;)6 Ans$ 

&evel$ Basic



12;. Khat is the duration of a ero ero coupon bond with five years years to maturity that is currently priced at at ;85 and has an interest rate of 86L A: 0.83 years B: ).2 years C: 15 years : 2 years : cann cannot ot be det deter ermin mined ed with with the the inf infor ormat mation ion pro provid vided ed.. Ans$ 

&evel$ Challenge



135. Calculate the duration of an 86 coupon bond that ma*es annual coupon coupon payments that is currently priced priced at ;25 and has three years left to maturity. A: -.) years B: -.5 years C: ).8 years : ).3 years : ).0 years Ans$ C

&evel$ Challenge



Fse the following to answer uestions 131!130$ Co Corporate Imperial il

Coupon ;.872

,at. ate ec12E52

Bid  153.1)

+ld6 2.2-

131. n this trading trading day" day" the Imperial Imperial il bond bond is A: sellin lling g at a discount B: selling at a premium C: sell sellin ing g at its its face ace valu valuee : li*ely li*ely to increa increase se in value value as it approa approache chess m matu aturity rity : none of the above Ans$ B

&evel$ Basic

'ub(ect$ Bond Wuote


13). Assume this bond/s bond/s face value is 1"555. #hen the current mar*et mar*et price of this bond is . A: ;87.25 B: 1531.)5 C: 1555.55 : 1"522.-5 : 15"31).55 Ans$ B

&evel$ Basic

'ub(ect$ Bond Wuote



4age --


13-.. %or this 13this coupon coupon bond bond A: the the yiel yield d to matu maturi rity ty is ;.87 ;.8726 26 B: the the coup coupon on yield ield is 3.1)6 .1)6 C: the the yie yield ld to matu maturrity ity is is 2 2.2 .2-6 -6 : the the yie yield ld to matu maturrity ity is is 5 56 6 : the co coupon yie yield ld is 2.2 2.2-6 Ans$ C

&evel$ Basic

'ub(ect$ Bond Wuote


130. n ecember ecember 12" )552 the price price of this bond bond should be A: 1555.55 B: 1"522.-5 C: 1"531.)5 : 1"5;8.72 : 1"525.55 Ans$ A

&evel$ Basic

'ub(ect$ Bond Wuote


132. #he &angley Company has 36 annual coupon bonds that are currently selling for ;8;.2- and have eleven years left to maturity. Khat is the yield!to!maturityL A: 2.876 B: 2.;06 c. 3.1-6 C: 3.-76 : 3.256 Ans$ C

&evel$ Intermediate



133. #he 2.)26 semi!annual coupon bonds for ,artha/s Cupboards" Cupboards" Inc. are currently uoted uoted in the newspaper at a price of 151.)2. #he bonds mature in seven years. Khat is the yield to maturity on these bondsL A: 2.506 B: 2.1;6 C: 2.)26 : 2.--6 : 2.0;6 Ans$ A

&evel$ Intermediate



137. #he current real rate is 1.)26 1.)26 and the inflation rate is 1.056. 1.056. Khat rate would you eHpect eHpect to see on a #reasury billL A: 1.726 B: ).326 C: ).376 : ).716 : ).7-6 Ans$ C

&evel$ Intermediate

'ub(ect$ Real Rate f Return



4age -0


138. #his morning" ,arty bought a 06 coupon bond at par value. value. #he bond pays semi!annual semi!annual interest and has twenty years to maturit y. By what percentage will the price of ,arty/s bond change if mar*et interest rates rise by 1.26 tonightL A: 18.536 B: 8.1;6 C: 0.156 : !8.1;6 : !18.536 Ans$ 

&evel$ Intermediate



13;. #his morning" Alicia bought bought a ten!year 76 coupon coupon bond that pays interest annually. annually. 'he paid ;;0 for a 1"555 bond. If the mar*et interest rate on this type of bond declines to 3.26 tonight" how much will Alicia receive for her first interest paymentL A: -).-1 B: -2.55 C: 32.55 : 3;.28 : 75.55 Ans$ 

&evel$ Intermediate



175. 'ara wants to buy a ero coupon bond that will pay her 1"555 ten years from today. today. @ow much should 'ara pay today to buy this bond if she wants to earn 7.26 on her investmentL A: 082.1; B: 2)-.1C: 725.55 : ;)2.55 : 1"555.55 Ans$ A

&evel$ Intermediate

'ub(ect$ Bond 4rice


171. ?erry Industries has some some 86 coupon bonds on the mar*et that are selling at ;8;" pay interest semi! annually" and mature in fifteen years. #he company would li*e to issue 1 million in new fifteen!year bonds. Khat coupon rate should be applied to the new bonds if ?erry Industries wants to sell them at parL A: 7.876 B: 8.556 C: 8.1-6 : 8.)36 : 8.--6 Ans$ C

&evel$ Intermediate



17). ,ayflower" Inc. Inc. has some 76 semi!annual coupon coupon bonds on the mar*et selling selling at 1"51). #he bonds have ; years left to maturity. Khat is the effective annual yield on t hese bondsL A: 3.8)6 B: 3.;16 C: 3.;06 : 7.506 : 7.1)6 Ans$ C

&evel$ Challenge




4age -2


17-. Curtis bought an 8.26 annual coupon coupon bond at par. ne year later" he sold the bond at a uoted uoted price of ;8. uring the year" mar*et interest rates rose and inflation was -6. Khat real rate of return did Curti s earn on this investmentL A: -.056 B: -.256 C: 3.056 : 3.256 : 3.756 Ans$ A

&evel$ Challenge

'ub(ect$ Real Rate


170. #hree years ago" the %rench %rench Co. issued twenty!year bonds with a ;6 coupon rate and semi!annual interest payments. #oday #oday these bonds are uoted at a price of 152.72. Khat is the yield!to!maturityL A: 8.526 B: 8.-36 C: 8.056 : 8.0-6 : 8.216 Ans$ B

&evel$ Intermediate



172. #he Hley Company bonds are currently selling for 1"501.-5. #hese #hese bonds mature in seven seven years" pay semi!annual interest and have a yield!to!maturity of 3.726. Khat is the coupon rateL A: 3.256 B: 3.726 C: 7.556 : 7.)26 : 7.256 Ans$ 

&evel$ Intermediate



173. #he Kind(ammer Co. bonds are currently currently selling for 1"55-.17. #hese bonds mature in three years" pay interest annually" and have a yield!to!maturity of 3.3-6. Khat is t he coupon rateL A: 3.256 B: 3.356 C: 3.3-6 : 3.726 : 3.;56 Ans$ 

&evel$ Intermediate



177. #oday atrina purchased a bond at a uoted price of ;8.7. #he bond matures in five years" pays semi! annual interest" and has a 3.26 coupon rate. If atrina holds the bond to maturity" what real rate of return will she earn if inflation remains constant at )6L A: 0.7)6 B: 0.816 C: 3.2)6 : 3.7)6 : 3.816 Ans$ A

&evel$ Challenge




4age -3


178. Canadian #reasury #reasury bills are yielding ).3-6. Inflation Inflation is ).026. Khat is the real real rate of return on the #reasury billL A: !5.186 B: 5.186 C: 5.-36 : 5.376 : 1.856 Ans$ B

&evel$ Intermediate



17;. ,artha owns a 76 coupon coupon bond that has 1- years years to maturity. #he bond pays interest interest annually and is currently selling for 1"5-0.25. Khat is the yield to maturity on this bondL A: 3.256 B: 3.356 C: 3.336 : 3.776 : 3.886 Ans$ B

&evel$ Intermediate



185. #his morning #im purchased purchased a 12!year" 12!year" 1"555 face value ero ero coupon bond for -;0.-0. -;0.-0. Assume the yield! to!maturity remains constant over the li fe of the bond. Khat price should #im receive for his bond i f he wants to sell it 0 years from todayL A: 252.05 B: 212.35 C: 200.00 : 222.82 : 231.-Ans$ A

&evel$ Intermediate

'ub(ect$ Implicit Interest


181. ,icalah/s Crafts needs ))2"555 today to purchase some new new euipment. #hey are planning on issuing 15! year bonds with a 36 coupon rate and semi!annual interest payments. #he current mar*et rate of i nterest is 3.26. @ow many bonds must ,icalah/s Crafts sell to raise the money they needL A: )13 B: ))2 C: ))3 : )-1 : )- 0 Ans$ 

&evel$ Intermediate

'ub(ect$ =umber f Bonds


18). lise/s Crafts needs ))2"555 today to purchase purchase some new new euipment. #hey are are planning on issuing 15! year ero coupon bonds. #he current mar*et rate of interest is 3.26. @ow many bonds must lise/s Crafts sell to raise the money they needL A: ))2 B: -;1 C: 0): 025 : 03 7 Ans$ C

&evel$ Intermediate

'ub(ect$ =umber f Bonds



4age -7


18-. #he discussion of asset pricing pricing in the teHt suggests that an investor investor will be indifferent between two bonds bonds which have eual yields to maturity as long as they are of euivalent euivalent default ris*. Can you thin* of any real!world factors which might ma*e a given investor prefer one of these bonds over the ot herL Ans$ =ote that that the uestion uestion only implies implies the bonds bonds have have the same yields yields and bond bond ratings. ratings. #here #here are the additional issues of taHability" liuidity" and and interest rate ris*. #o give a complete answer to this uestion" the A!student will be able to repeat the discussion of determinants of bond yields in 'ection 7. 7. &evel$ Intermediate


#ype$ #ype$ ssays

180. efine what is meant by interest rate ris*. Assume you are the manager manager of a 155 155 million portfolio of corporate bonds and you you believe interest rates will fall. Khat ad(ustments should you ma*e to your portfolio based on your beliefsL Ans$ Interest rate ris* is the ris* that arises for bond owners from fluctuating interest rates. All else the same" if interest rates are eHpected to fall you should purchase long!term bonds andEor low coupon bonds" and sell shorter!term" higher!coupon higher!coupon bonds. &evel$ Intermediate



182. Khy do corporations issue 155!year bonds" *nowing that interest interest rate ris* is highest for very very long!term bondsL @ow does the interest rate ris* affect the issuerL Ans$ ssentially" the issuer ta*es the opposite side of the interest rate rate ris* position. By issuing long!term bonds" the corporation is essentially betting that rates won/t fall significantly. If they do" the corporation will incur a loss due to borrowing at rates higher than than the going mar*et rates. n the other hand" if rates rise" the corporation benefits by having loc*ed in it s borrowing rate for up to 155 years. &evel$ Intermediate

'ub(ect$ Interest Rate Ris* M #he Issuer


183. ne of the bond rating agencies agencies ran into controversy when it began rating bonds of some companies without their approval. ,any of the companies whose bonds were rated in this manner were upset by this. Khy do you thin* a company would be unhappy to receive a NfreeN bond ratingL Ans$ Khen ratings agencies rate bonds" they do so by relying on information provided by the company. company. Absent this information" the rating agency must rely on publicly available information" and may not have as clear a picture of the firm as it would i f it received information directly from t he company. Also" some firms argued that the rating agency was harsher with its ratings when the company was not compensating them for providing this service. As a result" some of the firms argued that they were essentially being blac*mailed into buying a rating service in order to prevent poor ratings for their bonds. Also" for whatever reason" some firms may not wish to be rated by more than one agency and may purchase only one rating. If another rating agency steps in without being reuested to do so" you could end up with crossover bonds. &evel$ Intermediate



187. Hplain Hplain how it is that the bond prices prices reported reported in The National Post are are generated. Ans$ Bond prices prices are are the result result of the buying buying and selling selling of bonds bonds by investors investors.. As these these parties parties interact" interact" the bond price moves so that the seller can find a buyer buyer and vice versA: Khat is needed to answer this uestion is a general understanding of t he operation of financial mar*ets. &evel$ Basic

'ub(ect$ Bond 4rice Wuotes



4age -8


188. In the early 1;85s" the #reasury #reasury yield curve curve had a severe downward downward slope with short!term yields near )56 )56 and long!term yields below 126. Hplain how such a pattern might occur. occur. Ans$ #he downward downward slope slope occurs occurs because because the eHpected eHpected inflation inflation premium premium is declining. declining. #he decline decline in the inflation premium is significant enough to overcome the interest rate ris* premium. &evel$ Intermediate

'ub(ect$ +ield Curve


18;. Assume the real real rate of interest on 1!year" 1!year" 15!year" 15!year" and -5!year bonds is -6. Also assume assume the rate rate of inflation is eHpected to be -6 for the coming year. year. Considering only an inflation premium" construct an eHample showing how an eHpected increase in the rate of inflation leads to an upward sloping term structure via the %isher effect. effect. #hen" eHplain how the addition of interest rate rate ris* will affect your results. Ans$ #he student student is eHpected to generate generate three three nominal rates" rates" each based on an increasing increasing level level of inflation" beginning with a one!year nominal rate rate of 3.5;6. #he result will be an upward sloping term structure of interest rates. rates. Adding interest rate ris* ris* to the miH will increase the yields on the 15 and -5!year bonds" increasing the slope of the term structure. &evel$ Challenge

'ub(ect$ +ield Curve


1;5. Hplain Hplain liuidity" liuidity" default ris*" ris*" and taHability premiums. premiums. Ans$ &iuidity &iuidity problems problems eHist in thinly traded traded bonds" default default ris* is the li*elihood li*elihood the corporation corporation will default on its bond obligations" and the taHability premium reflects the fact that some bonds are taHed disadvantageously compared to others. others. If any of these eHist" eHist" investors will demand to be compensated for the ris* by demanding a yield premium to own the bonds. &evel$ Intermediate

'ub(ect$ Bond +ield 4remiums


1;1. Fsing a teeter!totter as the basis for your analysis" analysis" eHplain the relationship between the mar*et price of a bond and the mar*et rate of interest. Include time to maturity in your eHplanation. Ans$ #he mar*et price of a bond is one side of the teeter!totter teeter!totter and the mar*et mar*et rate of interest is the other side of the teeter!totter. As one side rises" the other side falls. #his depicts the i nverse relationship between the price and the rate. A short!term bond would be depicted as a point close to the fulcrum point of the teeter!totter. An intermediate!term bond would be depicted as a point part way between the fulcrum point and the end of one side. A long!term bond would be depicted as a point on the very end of one side of the teeter!totter. #he #he further away from the fulcrum a point is" the greater the degree of upward and downward movement. #his illustrates t hat long!term bonds fluctuate more in price than short!term bonds. &evel$ Intermediate



1;). Investors who purchased purchased bonds several years ago en(oyed double digit yields. #hese #hese same investors today are complaining loudly about the current low single digit returns. Are investors that much worse off todayL Hplain what investors should be considering and how to determine whether they are better off or worse off today than they were several years ago. Ans$ Investors are are comparing the nominal rates rates of return. #he important thing to consider is the real rate of return" which considers the effects of inflation. If the real rate of return has held constant" then investors are neither better nor worse off than they were previously. If the real rate of return has increased" then investors are actually better off even though the nominal rate of return decreased significantly. nly if the real rate of return has decreased would investors be worse off. #he %isher formula should be mentioned as the method m ethod of determining the real rate of return. &evel$ Intermediate

'ub(ect$ Real Rate Versus Versus =ominal Rate



4age -;

Chapter 07

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