Answer Choices:
a. Long-term interest rates are more volatile than short-term rates.
b. Inflation is expected to decline in the future.
c. The economy is not in a recession.
d. Long-term bonds are a better buy than short-term bonds.
e. Maturity risk premiums could help to explain the yield curve’s upward slope.
Answer: e. Maturity risk premiums could help to explain the yield curve’s upward slope.
Question: The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Bonds A, B, and C all have a maturity of 10 years and a yield to maturity of 7%. Bond A’s price exceeds its par value, Bond B’s price equals its par value, and Bond C’s price is less than its par value. None of the bonds can be called. Which of the following statements is CORRECT?
Answer Choices:
a. If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its price.
b. Bond A has the most price risk.
c. If the yield to maturity on the three bonds remains constant, the prices of the three bonds will remain the same over the next year.
d. If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline.
e. Bond C sells at a premium over its par value.
Answer: d. True
Question: A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?
Answer Choices:
a. The prices of both bonds will decrease by the same amount.
b. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.
Answer: b. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. A zero coupon bond’s current yield is equal to its yield to maturity.
b. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par.
c. If all else equal, if a bond’s yield to maturity increases, its price will fall.
d. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.
e. All else equal, if a bond’s yield to maturity increases, its current yield will fall.
Answer: c. True
Question: If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?
Answer Choices:
a. An upward-sloping yield curve would imply that interest rates are expected to be lower in the future.
b. If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now.
c. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond.
d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
e. Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds.
Answer: d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
Question: Diversification will normally reduce the riskiness of a portfolio of stocks.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
b. Liquidity premiums are generally higher on Treasury than corporate bonds.
c. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
d. Default risk premiums are generally lower on corporate than on Treasury bonds.
e. Reinvestment risk is lower, other things held constant, on long-term than on short-term bonds.
Answer: e. True
Question: A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?
Answer Choices:
a. If the yield to maturity remains constant, the bond’s price one year from now will be higher than its current price.
b. The bond is selling below its par value.
c. The bond is selling at a discount.
d. If the yield to maturity remains constant, the bond’s price one year from now will be lower than its current price.
e. The bond’s current yield is greater than 9%.
Answer: d. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
b. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
c. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.
d. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond.
Answer: a. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
Question: An individual stock’s diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. You hold two bonds, a 10-year, zero coupon, issue and a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from its current level, the zero coupon bond will experience the larger percentage decline.
b. The time to maturity does not affect the change in the value of a bond in response to a given change in rates.
c. You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline.
d. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates, other things held constant.
e. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates.
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The yield to maturity for a coupon bond that sells at a premium consists entirely of a positive capital gains yield; it has a zero current interest yield.
b. The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm has filed for bankruptcy.
c. Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices.
d. The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.
e. The expected capital gains yield on a bond will always be zero or positive because no investor would purchase a bond with an expected capital loss.
Answer: d. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
b. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.
c. The pure expectations theory of the term structure states that borrowers generally prefer to borrow on a long-term basis while savers generally prefer to lend on a short-term basis, and as a result, the yield curve is normally upward sloping.
d. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
e. Liquidity premiums are generally higher on Treasury than on corporate bonds.
Answer: d. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
Question: Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT?
Answer Choices:
a. If the yield curve for Treasury securities is flat, Short’s bond must under all conditions have the same yield as Long’s bonds.
b. If the yield curve for Treasury securities is upward sloping, Long’s bonds must under all conditions have a higher yield than Short’s bonds.
c. If Long’s and Short’s bonds have the same default risk, their yields must under all conditions be equal.
d. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short’s bonds must under all conditions have a lower yield than Long’s bonds.
e. If the Treasury yield curve is downward sloping, Long’s bonds must under all conditions have the lower yield.
Answer: d. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short’s bonds must under all conditions have a lower yield than Long’s bonds.
Question: Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.
Answer Choices:
a. 3.80%
b. 3.99%
c. 4.19%
d. 4.40%
e. 4.62%
Answer: b. 3.99%
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.
b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.
c. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.
d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.
e. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.
Answer: d. True