Q&A Hero

Q: When comparing stock indexes around the world we: A. find that a given percentage change across all indexes has the same value.B. observe that they always move together.C. can see that the numeric change in indices allows investors to make easy comparisons of value.D. can examine their respective movements if we look at them as percentage changes.

Q: When studying world stock indexes, we observe that: A. the S&P 500 is largest in terms of index value.B. most of the world's indexes are price-weighted.C. the indexes are very comparable.D. the indexes are comparable but only in percentage terms.

Q: The most broadly based stock index in use is the: A. Nasdaq Composite Index.B. Wilshire 5000.C. Dow Jones Industrial Average.D. Standard and Poor's 500 Index.

Q: The Nasdaq Composite Index is: A. made up of over 50,000 firms traded on the Over-the-Counter market.B. a price-weighted index.C. made up of mainly newer firms, and heavily influenced by technology and internet companies.D. the most broadly based index in use.

Q: The Nasdaq Composite Index is: A. a value-weighted index.B. a price-weighted index.C. made up of over 5000 companies traded on the NYSE.D. made of mainly older firms and is heavily weighted by manufacturing.

Q: Which of the following statements is not true? A. A value-weighted index is a better index to use to reflect changes in the economy's overall wealth.B. A price-weighted index is a better index to use to reflect the average change in the price of a typical share of stock.C. The Dow Jones Industrial Average is a price-weighted index.D. The S&P 500 is a price-weighted index.

Q: The Standard & Poor's 500 Index: A. gives more weight to large companies than small companies.B. actually includes more than 500 of the largest corporations in the U.S.C. is a price-weighted index.D. assigns equal weight to all the prices of all the stocks in the index.

Q: Considering the S&P 500 Index, if each company's stock price increased by 10%: A. the weights in the index would remain the same.B. the companies with the most shares outstanding would have even greater weight after the increase.C. the companies with fewer shares would gain more weight at the expense of the companies with greater shares.D. the weights in the index would change to reflect the percentage changes in the prices of the various stocks.

Q: Suppose that the Federal Reserve is concerned about rising inflation, so they increase short-term interest rates. How will this affect long-term rates and the yield curve? What does the slope of the yield curve reveal about the effectiveness of the Fed's policy? Explain in the context of the Liquidity Premium Theory.

Q: The paper-bill spread refers to the interest rate spread between commercial paper and Treasury bills with the same maturity. Is this a risk spread or a term spread? How do you expect the paper-bill spread is related to GDP growth? What is the intuition for this result? What does this imply about the yield curve?

Q: We have heard the predictions regarding the large number of people that will be retiring over the next 25-50 years and the strain this is going to place on the federal budget. Assuming that federal borrowing will have to increase, what is the likely impact going to be on the risk and term structure (if any) of interest rates and why?

Q: Under the Expectations Hypothesis of the term structure of interest rates, explain the impact of a U.S. Treasury decision to phase out the 30-year bond and to only focus on 3-month, 1-year, 5-year and 10-year bonds.

Q: In 2002 and 2003, the financial markets were hit by many corporate accounting scandals. Discuss these scandals and the impact they would have not only in terms of a flight to quality, but also in terms of the faith that people place in bond rating agencies.

Q: Please use the graphs to show what happens to the risk (yield) differential in each situation and why? Assume the corporate and Treasury bonds have the same maturity.a) If the corporate bonds are default-risk free, what could you tell about the price and yields of each?b) If the corporate bonds are now viewed as having the possibility of default, what happens in each market?c) If the corporate bonds are granted tax-exempt status, what happens in each market?d) If the corporate bonds have a longer maturity than the Treasury bonds what would happen?

Q: At the beginning of 2006 the yield curve was usually flat, and sometimes downward sloping (inverted). This raised concerns that a recession might be on the way. But the slope of the yield curve is only part of the story. What else is important?

Q: Explain why most retired individuals are not likely to be heavily invested in municipal bonds.

Q: Does the Expectations Hypothesis allow for people to have a preference for longer-term investments? Explain.

Q: Why might we expect to see a high correlation between increases in the risk structure of interest rates and the yield curve becoming inverted?

Q: Explain why an inverted yield curve is a valuable forecasting tool.

Q: Why do yield curves usually slope upward?

Q: Describe the concept of flight to quality in terms of the Russian government default of August 1998.

Q: When we compare the graphs of GDP growth over time to the corresponding risk spread on Baa bonds compared to 10-year U.S. Treasury bonds, what relationship can be inferred?

Q: During economic slowdowns why would you expect the risk premium to increase the most between U.S. Treasury bonds and junk bonds?

Q: What impact should an economic slowdown have on the risk structure of interest rates?

Q: Why can't the Expectations Hypothesis stand alone as an adequate theory to explain yield curves?

Q: The usually upward sloping yield curve indicates that long-term bonds have higher yields than short-term bonds. Why is this?

Q: Any theory of the yield curve must be able to explain what three general conditions?

Q: Assuming the Expectations Hypothesis is correct, and given the following information:The current four-year interest rate is 5.0%The current one-year interest rate is 4.0%The expected one-year rate for one year from now is 5.0%The expected one-year rate for two years from now is 5.5%What is the expected one-year rate for three years from now? Explain.

Q: What is the equivalent tax-exempt bond yield for a taxable bond with an 8% yield and a bondholder in a 35% marginal tax rate? Explain.

Q: Using the information provided and the Expectations Hypothesis, compute the yields for a two-year, three-year, and four-year bonds. Now, suppose there is a risk premium attached to each bond. These risk premiums are given in the table below: Using the information above and the Liquidity Premium Theory, compute the yields for a two-year, three-year, and four-year bonds. How does this yield curve compare to the one you computed using the Expectations Hypothesis?

Q: Consider the following four investors. Rank each according to who has the most to gain from investing in 30-year tax-exempt municipal bonds. Each investor has $1000 in a savings account that he/she plans to use to buy bonds. Explain briefly why you ranked the investors this way.(a) A 20-year old college student who earns low income through working over summers and breaks. The student plans to graduate next year.(b) The CEO of a large company who is currently in the highest tax bracket.(c) A middle-income household saving up to move into a larger home.(d) A 60-year old nurse who plans to retire at age 62. He uses a tax-exempt pension fund for all of his savings.

Q: What is the effective after-tax yield to an investor from a bond paying $70 per $1,000 annually, if the investor is in a 25% marginal tax bracket? Explain.

Q: Explain why many mayors of cities facing the need to borrow for infrastructure improvements, may not look favorably on a large federal income tax rate reduction.

Q: If the yield curve is flat, using liquidity premium theory, what do you know about the expected future short-term interest rate?

Q: Why do economists pay particular attention to inverted yield curves?

Q: An investor sees the current twelve-month rate at 4% and expects the following future twelve-month rate for each of the subsequent years; 4.5%, 5.5% and 6.0%. If this investor views a four-year maturity at 5.65% as equal to four consecutive one-year securities, what is his/her risk premium?

Q: How did asset backed commercial paper (ABCP) rollover risk contribute to the financial crisis of 2007-2009?

Q: If an investor wants to compare commercial paper to a corresponding default-free investment, which security would he/she use and why?

Q: What is meant by a subprime mortgage?

Q: Briefly describe the two different types of junk bonds (high-yield bonds).

Q: The bond rating of a security reflects the: A. size of the coupon payment relative to the face value.B. likelihood the lender/borrower will be repaid by the borrower/issuer.C. return a holder is likely to receive.D. size of the coupon rate relative to other interest rates.

Q: If the purchase price of a bond exceeds the face value, the yield to maturity: A. is greater than the coupon rate because the capital gain is positive.B. will equal the current yield.C. will be less than the coupon rate because the capital gain will be negative.D. will be greater than the current yield.

Q: When the price of a bond equals the face value the: A. yield to maturity will be above the coupon rate.B. yield to maturity will be below the coupon rate.C. current yield is equal to the coupon rate.D. yield to maturity is greater than the current yield.

Q: When the price of a bond is below the face value, the yield to maturity: A. is below the coupon rate.B. will be above the coupon rate.C. will equal the current yield.D. will equal the coupon rate.

Q: When the price of a bond is above face value the yield to maturity: A. is below the coupon rate.B. will be above the coupon rate.C. will equal the current yield.D. will equal the coupon rate.

Q: Which of the following statements is most accurate? A. Yield to maturity is equal to the coupon rate if the bond is held to maturity.B. Yield to maturity is the same as the coupon rate.C. Yield to maturity will exceed the coupon rate if the bond is purchased for face value.D. Yield to maturity is the same as the coupon rate if the bond is purchased for face value and held to maturity.

Q: If a consol is offering an annual coupon of $50 and the annual interest rate is 6%, the price of the consol is: A. $47.17B. $813.00C. $833.33D. $8333.33

Q: The price (P) of a consol offering an annual coupon payment (C) is best expressed by: A. F/CB. C(1 + i)C. C/(1 + i)D. C/i

Q: The difference in the prices of a zero-coupon bond and a coupon bond with the same face value and maturity date is simply: A. zero, since they are the same.B. the present value of the final payment.C. the present value of the coupon payments.D. the future value of the coupon payments.

Q: The price of a coupon bond can best be described as the: A. present value of the face value.B. future value of the coupon payments.C. future value of the coupon payments and the face value.D. present value of the face value plus the present value of the coupon payments.

Q: Most home mortgages are good examples of: A. consols.B. zero-coupon bonds.C. coupon bonds.D. fixed-payment loans.

Q: U.S. government bonds that provide for bondholders to receive a fixed rate of interest plus the change in the consumer price index were designed to remove: A. default risk.B. liquidity risk.C. inflation risk.D. interest-rate risk.

Q: Which of the following is true of interest-rate risk? A. It is the risk that the coupon rate for a bond will change, affecting current bondholders' coupon payments.B. It refers to the probability that a borrower will default on debt obligations.C. It is the risk that the face value of a bond will change before maturity.D. Individuals owning long-term bonds are exposed to greater interest-rate risk.

Q: A student receives a five-year loan to pay for a $2,000 used car. The lender and the student agree to an 8% interest rate on a fixed-rate loan. Expected inflation was estimated to equal 2.5%, but unexpectedly decreases to 2%. Which of the following is true? A. The real interest rate decreased.B. The student is made worse off because her real cost of borrowing is higher.C. The lender is made worst off because his real return on the car loan is lower.D. Both the student and the lender benefit.

Q: Consider a one-year corporate bond that has a 20% probability of default. The payoff on the bond is $2,000 if the corporation does not default. The interest rate is 10%. If buyers of this bond are risk-neutral, this bond will sell for: A. $400B. $909.09C. $1,454.54D. $1,600

Q: Consider a zero-coupon bond with a $1,100 payment in one year. Suppose the interest rate decreases from 10% to 8%. The price of this bond: A. increases from $1,000 to $1,018.B. increases from $1,000 to $1,375.C. decreases from $110 to $88.D. decreases from $1,210 to $1,188.

Q: Consider the bonds below. Which is subject to the greatest interest-rate risk? A. A 30-year fixed-rate mortgage (fixed payment loan)B. A consolC. A Treasury billD. A 20-year corporate bond

Q: Default risk is the risk associated with: A. the bond issuer not being able to make the promised payments.B. the illiquidity associated with small issues.C. the effect on bond prices caused by changes in market rates of interest.D. changes in the expected inflation rate.

Q: Fly-By-Night Inc. issues $100 face value, zero-coupon, one-year bonds. The current return on one-year, zero-coupon U.S. government bonds is 3.5%. If the Fly-By-Night bonds are selling for $92.00, what is the risk premium for these bonds? A. 8.7%B. 1.5%C. 5.2%D. 8.0%

Q: The market for bonds is initially described by the supply of bonds - S0, and the demand for bonds - D0, with the equilibrium price and quantity being P0 and Q0. If the U.S. government's borrowing needs decrease, all other factors constant: A. Bond supply curve to shift to S1B. Bond demand curve to shift to D1C. Bond supply curve to shift to S2D. Bond demand curve to shift to D2

Q: The market for bonds is initially described by the supply of bonds - S0, and the demand for bonds - D0, with the equilibrium price and quantity being P0 and Q0. If the federal government were to offer larger tax breaks on the purchase of new equipment for businesses, all other factors constant, we would expect to see: A. Bond supply curve to shift to S1B. Bond demand curve to shift to D1C. Bond supply curve to shift to S2D. Bond demand curve to shift to D2

Q: The market for bonds is initially described by the supply of bonds - S0, and the demand for bonds - D0, with the equilibrium price and quantity being P0 and Q0. Suppose that the expected return on bonds falls relative to other assets. In the bond market this will result in: A. Bond supply curve to shift to S1B. Bond demand curve to shift to D1C. Bond supply curve to shift to S2D. Bond demand curve to shift to D2

Q: If the quantity of bonds demanded exceeds the quantity of bonds supplied, bond prices: A. would rise and yields would fall.B. would fall and yields would increase.C. will rise and yields will remain constant.D. will rise and yields would increase.

Q: If the quantity of bonds supplied exceeds the quantity of bonds demanded, bond prices would: A. rise and yields would fall.B. fall and yields would rise.C. rise but yields will remain constant.D. fall and yields would fall.

Q: The bond demand curve slopes downward because: A. at lower prices the reward for holding the bond increases.B. as bond prices fall so do yields.C. as bond prices fall bonds are less attractive.D. as bond prices rise yields increase.

Q: The bond supply curve slopes upward because: A. as bond prices rise people holding bonds are more tempted to hold them.B. as bond prices rise yields increase.C. for companies seeking financing, the higher the price of bonds the more attractive it is to sell bonds.D. as bond prices rise yields decrease.

Q: As bond prices increase: A. the quantity of bonds supplied increases.B. the quantity of bonds supplied decreases.C. the quantity of bonds demanded increases.D. yields increases.

Q: Bond prices and yields: A. move together in the same direction.B. do not change if the coupon is fixed.C. move together inversely.D. are independent of each other.

Q: If a one-year zero-coupon bond has a face value of $100, is purchased for $94, and is held to maturity the: A. holding period return will exceed the yield to maturity.B. yield to maturity will exceed the holding period return.C. yield to maturity will be 6.38%.D. holding period return is 6.0%.

Q: Suppose there is a decrease in the price at which a bondholder sells her bond. In this case, the holding period return will: A. increase, since yields and prices are inversely related.B. decrease, since this lowers the capital gain.C. be negative.D. equal the coupon rate.

Q: The holding period return has relevance because: A. most bonds are held by the original purchaser until maturity.B. most bonds are held by the original purchaser until they mature.C. bonds are frequently traded.D. current yields are not that important to bondholders.

Q: In considering the holding period return, the longer the term of the bond the: A. less important is the capital gain and the more important in the current yield.B. less important is the coupon rate and the more important is the current yield.C. less important is the capital gain.D. more important is the capital gain.

Q: Which of the following best expresses the equation for holding period return? A. Current yield + coupon rateB. Yield to maturity - current yieldC. Current yield + capital gainD. Coupon rate + capital gain

Q: One characteristic that distinguishes holding period return from the coupon rate, the current yield, and the yield to maturity is: A. all of the other returns can be calculated at the time the bond is purchased, but holding period return cannot.B. holding period return will always be the highest return.C. holding period return will usually be less than the other returns.D. only the holding period return includes the capital gain/loss.

Q: The holding period return on a bond: A. can never be more than the yield to maturity.B. will equal the yield to maturity if the bond is purchased for face value and sold at a lower price.C. will be less than the yield to maturity if the bond is sold for more than face value.D. will be less than the yield to maturity if the bond is sold for less than face value.

Q: The larger the bond dealer's spread the: A. less liquid is the market for that bond.B. greater is the coupon rate for that bond.C. more liquid is the market for that bond.D. less risk there is for the dealer to hold that bond.

Q: The size of the bond dealer's spread is mainly a function of the: A. purchase price of the bond.B. current yield.C. liquidity of the bond market.D. face value of the bond.

Q: The bond dealer's spread is: A. the asking price less the bid price.B. the difference between the current yield and the yield to maturity.C. the bid price less the asking price.D. usually negative; the dealer makes a profit holding the bonds.

Q: In reading bond quotes: A. the bid price is usually above the asked price.B. the asked price is fixed over the life of the bond.C. the asked price is usually above the bid price.D. bid and asked prices must be equal as set forth by SEC regulations.

Q: The bid price for a bond quote is: A. the price at which the bond dealer is willing to sell the bond.B. the price at which the bond dealer is willing to purchase the bond.C. fixed over the life of a bond.D. determined solely by the time left to maturity.