a. The coupon rate should be exactly equal to 6%.
b. The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%.
c. The rate should be slightly greater than 6%.
d. The rate should be over 7%.
e. The rate should be over 8%.
Answer: b
Question: Which of the following statements is CORRECT?
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
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
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
Question: Suppose the federal deficit increased sharply from one year to the next, and the Federal Reserve kept the money supply constant. Other things held constant, we would expect to see interest rates decline.
True
False
Answer: False
Question: There is an inverse relationship between bonds’ quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower.
Answer Options:
a. True
b. False
Answer: a
Question: If the required rate of return on a bond (rd) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)
Answer Options:
a. True
b. False
Answer: a
Question: Bond X has an 8% annual coupon, Bond Y has a 10% annual coupon, and Bond Z has a 12% annual coupon. Each of the bonds is noncallable, has a maturity of 10 years, and has a yield to maturity of 10%. Which of the following statements is CORRECT?
a. If the bonds’ market interest rate remains at 10%, Bond Z’s price will be lower one year from now than it is today.
b. Bond X has the greatest reinvestment risk.
c. If market interest rates decline, the prices of all three bonds will increase, but Z’s price will have the largest percentage increase.
d. If market interest rates remain at 10%, Bond Z’s price will be 10% higher one year from today.
e. If market interest rates increase, Bond X’s price will increase, Bond Z’s price will decline, and Bond Y’s price will remain the same.
Answer: a
Question: A bond that had a 20-year original maturity with 1 year left to maturity has more price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates, and they cannot be called.)
Answer Options:
a. True
b. False
Answer: b
Question: During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining.
True
False
Answer: True
Question: If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward-sloping yield curve.
True
False
Answer: True
Question: Which of the following statements is CORRECT?
a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
b. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include the same shares of each one.
c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.
d. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.
e. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.
Answer: c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.
Question: Which of the following statements is CORRECT?
a. The total return on a bond during a given year is based only on the coupon interest payments received.
b. All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required return for bonds of similar risk is 8%.
c. The price of a discount bond will increase over time, assuming that the bond’s yield to maturity remains constant.
Answer: c