Answer Options:
a. True
b. False
Answer: b
Question: A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?
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
Question: If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value?
a. A 1-year zero coupon bond.
b. A 1-year bond with an 8% coupon.
c. A 10-year bond with an 8% coupon.
d. A 10-year bond with a 12% coupon.
e. A 10-year zero coupon bond.
Answer: e
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.
a. True
b. False
Answer: b
Question: Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?
a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
b. If the pure expectations theory holds, the corporate yield curve must be downward sloping.
c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.
d. If inflation is expected to decline, there can be no maturity risk premium.
e. The expectations theory cannot hold if inflation is decreasing.
Answer: a
Question: Which of the following statements is CORRECT?
Answer Options:
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: c
Question: You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.
Answer Options:
a. True
b. False
Answer: a
Question: Which of the following statements is CORRECT?
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
Question: Which of the following statements is CORRECT?
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. 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
Question: Which of the following events would make it more likely that a company would call its outstanding callable bonds?
a. The company’s bonds are downgraded.
b. Market interest rates rise sharply.
Answer: b
Question: Over the past 88 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?
Answer Options:
a. Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.
b. Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds.
c. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.
d. U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks.
e. Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.
Answer: c
Question: Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that
a. Inflation is expected to decline in the future.
b. The economy is not in a recession.
c. Long-term bonds are a better buy than short-term bonds.
d. Maturity risk premiums could help to explain the yield curve’s upward slope.
e. Long-term interest rates are more volatile than short-term rates.
Answer: d
Question: Which of the following statements is CORRECT?
Answer Options:
a. Downward-sloping yield curves are inconsistent with the expectations theory.
b. The actual shape of the yield curve depends only on expectations about future inflation.
c. If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.
d. If the yield curve is upward sloping, the maturity risk premium must be positive and the inflation rate must be zero.
e. Yield curves must be either upward or downward sloping—they cannot first rise and then decline.
Answer: c
Question: Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
a. Bond 8’s current yield will increase each year.
b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
c. Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
d. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year.
e. Over the next year, Bond 8’s price is expected to decrease, Bond 10’s price is expected to stay the same, and Bond 12’s price is expected to increase.
Answer: d
Question: Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?
Answer Options:
a. The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities.
b. The yield on any corporate bond must exceed the yields on all Treasury bonds.
c. The yield on 7-year corporate bonds must exceed the yield on 10-year Treasury bonds.
d. The stated conditions cannot all be true—they are internally inconsistent.
e. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.
Answer: a
Question: Which of the following statements is CORRECT?
a. Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued.
b. Most sinking funds require the issuer to provide funds to a trustee, who holds the money so that it will be available to pay off bondholders when the bonds mature.
c. A sinking fund provision makes a bond more risky to investors at the time of issuance.
d. Sinking fund provisions never require companies to retire their debt; they only establish “targets” for the company to reduce its debt over time.
e. If interest rates increase after a company has issued bonds with a sinking fund, the company will be less likely to buy bonds on the open market to meet its sinking fund obligation and more likely to call them in at the sinking fund call price.
Answer: a
Question: Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?
Answer Options:
a. The yield curve should be downward sloping, with the rate on a 1-year bond at 6%.
b. The interest rate today on a 2-year bond should be approximately 6%.
c. The interest rate today on a 2-year bond should be approximately 7%.
d. The interest rate today on a 3-year bond should be approximately 7%.
e. The interest rate today on a 3-year bond should be approximately 8%.
Answer: c
Question: Which of the following statements is CORRECT?
a. Senior debt is debt that has been more recently issued, and in bankruptcy it is paid off after junior debt because the junior debt was issued first.
b. A company’s subordinated debt has less default risk than its senior debt.
c. Convertible bonds generally have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.
d. Junk bonds typically provide a lower yield to maturity than investment-grade bonds.
e. A debenture is a secured bond that is backed by some or all of the firm’s fixed assets.
Answer: c
Question: If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?
a. The yield on a 10-year bond would be less than that on a 1-year bill.
b. The yield on a 10-year bond would have to be higher than that on a 1-year bill because of the maturity risk premium.
c. It is impossible to tell without knowing the coupon rates of the bonds.
d. The yields on the two securities would be equal.
e. It is impossible to tell without knowing the relative risks of the two securities.
Answer: a
Question: Which of the following statements is CORRECT?
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
Question: A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT?
a. The bond’s current yield is less than 9%.
b. If the yield to maturity remains at 8%, then the bond’s price will decline over the next year.
Answer: b
Question: Suppose the U.S. Treasury issued $50 billion of short-term securities and sold them to the public. Other things held constant, what would be the most likely effect on short-term securities’ prices and interest rates?
a. Prices and interest rates would both rise.
b. Prices would rise and interest rates would decline.
c. Prices and interest rates would both decline.
d. Prices would decline and interest rates would rise.
e. There is no reason to expect a change in either prices or interest rates.
Answer: d
Question: A bond trader observes the following information:
The Treasury yield curve is downward sloping.
Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds.
Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields.
On the basis of this information, which of the following statements is most CORRECT?
a. A 10-year corporate bond must have a higher yield than a 5-year Treasury bond.
b. A 10-year Treasury bond must have a higher yield than a 10-year corporate bond.
c. A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.
d. The corporate yield curve must be flat.
e. Since the Treasury yield curve is downward sloping, the corporate yield curve must also be downward sloping.
Answer: c
Question: A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?
a. The bond’s coupon rate exceeds its current yield.
b. The bond’s current yield exceeds its yield to maturity.
c. The bond’s yield to maturity is greater than its coupon rate.
d. The bond’s current yield is equal to its coupon rate.
e. If the yield to maturity stays constant until the bond matures, the bond’s price will remain at $850.
Answer: c