Answer Options:
a. True
b. False
c. True
d. False
e. False
Answer: b. True
Question: A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation.
Answer Options:
a. True
b. False
Answer: b. False
Question: Assuming the pure expectations theory is correct, which of the following statements is CORRECT?
Answer Options:
a. If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.
b. If both 2-year and 3-year Treasury rates are 7%, then 5-year rates must also be 7%.
c. If 1-year rates are 6% and 2-year rates are 7%, then the market expects 1-year rates to be 6.5% in one year.
d. Reinvestment rate risk is higher on long-term bonds, and interest rate (price) risk is higher on short-term bonds.
e. Interest rate (price) risk and reinvestment rate risk are relevant to investors in corporate bonds, but these concepts do not apply to Treasury bonds.
Answer: a
Question: Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts price risk to companies, it offers no advantages to corporate issuers.
Answer Options:
a. True
b. False
Answer: b. False
Question: A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond.
Answer Options:
a. True
b. False
Answer: b. False
Question: Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond’s face value.
Answer Options:
a. True
b. False
Answer: a. True
Question: A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%.
Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following bonds has the greatest price risk? a. A 10-year $100 annuity. b. A 10-year, $1,000 face value, zero coupon bond. c. A 10-year, $1,000 face value, 10% coupon bond with annual interest payments. d. All 10-year bonds have the same price risk since they have the same maturity. e. A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.
Answer: b. A 10-year, $1,000 face value, zero coupon bond.
Question: Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?
Answer Options:
a. In equilibrium, long-term rates must be equal to short-term rates.
b. An upward-sloping yield curve implies that future short-term rates are expected to decline.
c. The maturity risk premium is assumed to be zero.
d. Inflation is expected to be zero.
e. Consumer prices as measured by an index of inflation are expected to rise at a constant rate.
Answer: c
Question: Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return? a. Because of the call premium, the required rate of return would decline. b. There is no reason to expect a change in the required rate of return. c. The required rate of return would decline because the bond would then be less risky to a bondholder. d. The required rate of return would increase because the bond would then be more risky to a bondholder. e. It is impossible to say without more information.
Answer: d. The required rate of return would increase because the bond would then be more risky to a bondholder.
Question: An investor is considering buying one of two 10-year, $1,000 face value, noncallable bonds: Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, and the YTM is expected to remain constant for the next 10 years. Which of the following statements is CORRECT?
Answer Options:
a. Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price.
b. One year from now, Bond A’s price will be higher than it is today.
c. Bond A’s current yield is greater than 8%.
d. Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price.
e. Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.
Answer: b
Question: The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond’s remaining maturity.
Answer Options:
a. True
b. False
Answer: a. True
Question: A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?
Answer Options:
a. The bond sells at a price below par.
b. The bond has a current yield greater than 8%.
c. The bond sells at a discount.
d. The bond’s required rate of return is less than 7.5%.
e. If the yield to maturity remains constant, the price of the bond will decline over time.
Answer: e
Question: Which of the following statements is CORRECT?
Answer Options:
a. Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve.
b. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
c. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
d. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve cannot become inverted.
e. The most likely explanation for an inverted yield curve is that investors expect inflation to increase in the future.
Answer: a