a. If a coupon bond is selling at par, its current yield equals its yield to maturity.
b. If rates fall after its issue, a zero coupon bond could trade at a price above its maturity (or par) value.
c. If rates fall rapidly, a zero coupon bond’s expected appreciation could become negative.
d. If a firm moves from a position of strength toward financial distress, its bonds’ yield to maturity would probably decline.
e. If a bond is selling at a premium, this implies that its yield to maturity exceeds its coupon rate.
Answer: a
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?
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: Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows:
T-bond = 7.72%
AAA = 8.72%
BBB = 10.18%
The differences in rates among these issues were most probably caused primarily by:
a. Real risk-free rate differences.
b. Tax effects.
c. Default and liquidity risk differences.
d. Maturity risk differences.
e. Inflation differences.
Answer: c
Question: The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond is called “reinvestment rate risk.”
True
False
Answer: True
Question: Which of the following statements is CORRECT?
a. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond.
b. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
c. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
d. The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5-year AAA-rated corporate bond.
e. The following represents a “possibly reasonable” formula for the maturity risk premium on bonds: MRP = –0.1%(t), where t is the years to maturity.
Answer: b
Question: Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?
a. An 8-year bond with a 9% coupon.
b. A 1-year bond with a 15% coupon.
c. A 3-year bond with a 10% coupon.
d. A 10-year zero coupon bond.
e. A 10-year bond with a 10% coupon.
Answer: d
Question: Because the maturity risk premium is normally positive, the yield curve is normally upward sloping.
True
False
Answer: True
Question: Which of the following statements is CORRECT?
a. If a bond is selling at a discount, the yield to call is a better measure of return than is the yield to maturity.
b. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.
c. On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest.
Answer: a
Question: Which of the following statements is CORRECT?
a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.
b. If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.
c. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.
d. If the maturity risk premium (MRP) equals zero, the yield curve must be flat.
e. The yield curve can never be downward sloping.
Answer: a
Question: If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase.
True
False
Answer: True
Question: Which of the following statements is CORRECT?
a. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value.
b. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.
c. Other things held constant, including the coupon rate, a corporation would rather issue noncallable bonds than callable bonds.
d. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond because it would have a shorter expected life.
e. Bonds are exposed to both reinvestment risk and price risk. Longer-term low-coupon bonds, relative to shorter-term high-coupon bonds, are generally more exposed to reinvestment risk than price risk.
Answer: b
Question: The “yield curve” shows the relationship between bonds’ maturities and their yields.
True
False
Answer: True
Question: Which of the following statements is CORRECT?
Answer Options:
a. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
b. The most likely explanation for an inverted yield curve is that investors expect inflation to increase.
c. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.
d. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
e. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.
Answer: c
Question: The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant.
a. True
b. False
Answer: a
Question: The real risk-free rate of interest is expected to remain constant at 3% for the foreseeable future. However, inflation is expected to increase steadily over the next 30 years, so the Treasury yield curve has an upward slope. Assume that the pure expectations theory holds. You are also considering two corporate bonds, one with a 5-year maturity and one with a 10-year maturity. Both have the same default and liquidity risks. Given these assumptions, which of these statements is CORRECT?
Answer Options:
a. Since the pure expectations theory holds, the 10-year corporate bond must have the same yield as the 5-year corporate bond.
b. Since the pure expectations theory holds, all 5-year Treasury bonds must have higher yields than all 10-year Treasury bonds.
c. Since the pure expectations theory holds, all 10-year corporate bonds must have the same yield as 10-year Treasury bonds.
d. The 10-year Treasury bond must have a higher yield than the 5-year corporate bond.
e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.
Answer: e
Question: Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that
Answer Options:
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