Q&A Hero

Q: What shapes of the yield curve can be explained by each of the theories of the term structure of interest rates?

Q: How do bond options such as a call, put, and convertibility influence the yields on securities relative to bonds without such options?

Q: Define the term default risk premium. Why does the "premium" represent the "expected default loss rate"? Explain how and why default risk premiums vary over the business cycle.

Q: Explain how the term structure of interest rates can be used to help forecast future interest rates.

Q: All of the following are examples of restrictive debt covenants EXCEPTa. prohibition on selling accounts receivable.b. constraint on subsequent borrowing.c. supplying the creditor with audited financial statements.d. prohibition on entering certain types of lease arrangements.

Q: To analyze the economic condition, you collect the following yields: U.S. T-bill = 9%, 5- year U.S. T-note = 8%, IBM common stock = 15%, IBM Corporate Bond (Moody's rating Aaa) = 14%, and 10-year U.S. T-bond = 6.5%. Based on the above information, the shape of the yield curve is a. upward sloping. b. downward sloping. c. flat. d. normal.

Q: The slope of the yield curve is affected by a. inflationary expectations. b. liquidity preferences. c. the comparative equilibrium of supply and demand in the short-term and long-term market segments. d. all of the above.

Q: According to the expectation theory a. markets are segmented and buyers stay in their own segment b. the long term spot rate is an average of the current and expected future short term interest rates c the term structure will most often be upward sloping d liquidity premiums are negative and time varying

Q: The relationship between maturity and yield to maturity is called the ________________. a. term structure b. loan covenant c. bond indenture d. Fisher effect

Q: According to the expectations theory, if the market believes that interest rates are likely to decrease in the near future, a. borrowers would immediately increase their supply of short-term securities. b. investors would immediately increase their demand for long-term securities. c. borrowers would immediately increase their supply of long-term securities. d. neither borrowers nor investors would do anything until the interest rates actually increase. e. both a and b

Q: According to the expectations theory, if the market believes that interest rates are likely to increase in the near future, it would lead to a. an increase in the demand for short-term securities. b. an increase in the demand for long-term securities. c. a decrease in the supply of short-term securities. d. an increase in the supply of long-term securities.

Q: According to expectations theory, an investor who believes that interest rates are likely to decrease in the near future would a. invest in short-term securities immediately. b. invest in long-term securities immediately. c. sell long-term securities from her portfolio. d. sell corporate securities and invest in Treasury securities.

Q: Consider a yield curve that has taken into consideration both the expectations theory and the liquidity premium theory. Assume the yield curve is initially downward sloping. If liquidity premium theory is no longer important, the yield curve you would expect to see would be: a. more steeply downward sloping b. more upward sloping c. less steeply downward sloping d. flat e. Either c or d can happen.

Q: Contingent Convertible bonds (CoCos) are NOTsimilar to ordinary convertible bonds because: a. CoCos are convertible to the firm's preferred stock while the ordinary convertible bonds are convertible to the firm's common stock. b. CoCos offer a higher coupon than ordinary convertible bonds. c. Cocos are convertible into stock only if the firm's stock price hits a certain level. d. Ordinary convertible bonds are converted to the firm's stock if the firm's stock falls below a certain level.

Q: Which of the following statements is true? a. Convertible bonds offer higher yields than similar nonconvertible bonds. b. Putable bonds offer higher yields than similar nonputable bonds. c. Bonds with call options must offer higher interest rates than similar noncallable bonds. d. All Treasury securities offer lower rates than any securities issued by business firms. e. All of the above statements are true.

Q: A conversion option gives a valuable right to a bond's _______; a put option gives a valuable right to a bond's _______. a. issuer; issuer b. issuer; holder c. holder; issuer d. holder; holder

Q: An issuer of a bond is more likely to exercise a call option on the bond after an increase in interest rates. a. a decrease in interest rates. b. a decrease in the bond's price. c. a downgrade of the bond's rating by Moody's.

Q: Which of the following is not considered when assigning a bond rating? a. the variability of earnings b. the expected cash flow c. the rating on the prior issue of securities sold d. the amount of the fixed contractual cash payments

Q: Bonds are called speculative grade or junk bonds if their Standard & Poor's rating is a. above BBB. b. below BBB. c. B and below. d. A and below

Q: Historically, high default premiums have been associated with a. economic recessions. b. economic boom periods. c. generally rising interest rates. d. the number of bonds rated by Moody's and Standard & Poor's.

Q: Commercial banks, savings and loan associations, and finance companies traditionally have better profits when a. the level of interest rates were expected to fall sharply. b. the yield curve had a downward slope. c. the yield curve had an upward slope. d. loan losses were increasing.

Q: Which of the following theories of the term structure of interest rates best explains discontinuities in the yield curve? a. the market segmentation theory b. the liquidity premium theory c. the expectations theory d. the loanable funds theory

Q: Which of the following statements explains the liquidity premium theory of the term structure of interest rates? a. Investors will pay higher prices for longer-term securities. b. Investors demand a lower yield for securities that cannot be sold quickly at high prices. c. Investors demand a higher return on longer-term securities with greater price risk and less marketability. d. Investors will pay higher prices for securities with greater price risk and less marketability.

Q: The yield differentials between an AAA-rated corporate bond and an otherwise similar BBB-rated corporate bond may be explained by a. marketability. b. tax treatment. c. default risk. d. term to maturity.

Q: A bondholder in the 30 percent tax bracket owns a $1000 Treasury bond with an 8 percent coupon rate. What is the after-tax return on the bond? a. 8 percent b. 2.4 percent c. 5.6 percent d. 5 percent

Q: What actions by bond investors, given their expectations of increasing interest rates, result in an upward sloping yield curve? a. selling long-term securities and buying short-term securities. b. buying long-term securities and selling short-term securities. c. selling short-term securities and holding cash. d. selling long-term securities and holding cash.

Q: The liquidity premium theory of the term structure of interest rates is best supported by what type of yield curve? a. a decreasing curve over time. b. a flat yield curve. c. an increasing yield curve over time. d. a twisted yield curve e. none of the above.

Q: Applying the expectations theory, a bank depositor chooses between purchasing a one- year CD paying 5 percent and a two-year CD paying 5.5 percent. If indifferent between the two, the depositor must expect one-year CDs one year from now to have a rate of a. 6.5% b. 4.5% c. 6.0% d. 5.0%

Q: With reference to the data above, what is the expected after-tax real rate of return on the one-year Treasury Bill for an investor in the 33 percent marginal tax bracket? a. 1.11% b. 3.13% c. 0.13% d. -1.11%

Q: With reference to the above data, what is the approximate expected pre-tax real rate of return on the one-year Treasury bill? a. 3.00% b. 1.62% c. 4.67% d. 0.13%

Q: With reference to the above data, at what marginal tax rate would an investor be indifferent between owning the corporate bond and the municipal bond? a. 18% b. 20% c. 22% d. 28%

Q: With reference to the data above, the implied one-year forward rate (expected one-year rate one year from now) on Treasuries is a. 4.67% b. 5.83% c. 5.58% d. 4.09%

Q: Use the following interest rate data to answer the next five questions:Treasury Bills, 90 days 4.20%Commercial Paper, 90 days 4.84%Treasury Bill, 1 year 4.67%Treasury Note, 2 year 5.25%Corporate Bond AA, 20 year 8.23%Municipal Bond AA, 20 year 6.42%Expected Annual Inflation Rate 3.00%With reference to the data above, the default risk premium on the 90-day commercial paper above isa. 3.39%b. 0.17%c. 0.64%d. 1.84%

Q: Yield difference in Treasury securities of varied maturities may be explained bya. marketability.b. default risk.c. expectations of future inflation.d. all of the abovee. none of the above

Q: Federal Agency securities have higher yields than similar Treasury securities because theya. have greater default risk.b. have shorter maturities.c. are less marketable.d. both a and c

Q: Bond A is not putable; bond B is putable. Investors will require a lower yield on bond __ and will pay ____ for the bond. a. A; less b. A; more c. B; less d. B; more

Q: Bond A is not callable; bond B is callable. Investors will require a higher yield on bond __ and will pay ____ for the bond. a. A; less b. A; more c. B; less d. B; more

Q: Which of the following statements about callable bonds is nottrue? a. Callable bonds have higher yields than comparable noncallable bonds. b. The call price is usually above the bond's par value. c. The shorter the term to maturity, the greater the call interest premium. d. Investors are notified when bonds are called.

Q: With reference to the data above, the yield curve slopes _______, indicating the market expectation of ______ future short-term rates. a. downward; falling b. downward; rising c. upward; falling d. upward; rising e. flat; stable

Q: With reference to the data above, what is the default risk premium on 3-year AA-rated corporate bonds? a. 0.85% b. 0.95% c. 3.03% d. 6.60% e. There is no default risk on these bonds.

Q: With reference to the data above, at what tax rate would an investor be indifferent between holding the 3-year municipal or 3-year corporate bond? a. 15% b. 20% c. 25% d. 30% e. 33%

Q: With reference to the data above, what is the one-year forward rate on Treasury securities two years from now according to the expectations theory? a. 8.80% b. 9.10% c. 9.18% d. 9.40% e. 9.55%

Q: With reference to the data above, what is the default risk premium on commercial paper? a. 5.65% b. 0.95% c. 0.79% d. 0.55% e. 0%

Q: With reference to the data above, what is the expected real rate of return on the 2-year Treasury security? a. 12.6% b. 9.1% c. 5.4% d. 4.2% e. 3.5%

Q: Use the following interest rate data to answer the next seven questions.90-day Treasury bills 8.36 percent180-day Treasury bills 8.48 percent2-year Treasury notes 9.10 percent3-year Treasury notes 9.25 percent90-day Commercial paper 9.15 percent3-year Corporate bonds (AA) 10.10 percent3-year Municipal (AA) 7.07 percentExpected 2-year inflation rate 3.50 percentWith reference to the data above, which security below did the market view as having the greatest default risk?a. 90-day Treasury securitiesb. 180-day Treasury securitiesc. 2-year Treasury securitiesd. 90-day Commercial paper

Q: a. Which of the following statements is true?b. The more marketable a security, the higher its yield.c. The longer the security's term to maturity, the greater its yield.d. Putable bonds offer higher yields than similar non-putable bondse. Taxable bonds have to offer higher before-tax yields than comparable tax-exempt bonds.

Q: Which of the following statements about interest rates is true? a. Interest rates generally tend to move together. b. The expected rate of inflation influences the level of interest rates. c. At the bottom of the business cycle, the yield curve is typically upward sloping. d. All the above are true.

Q: Default risk premiums vary _______ with the ________ of the security. a. directly; default risk b. inversely; default risk c. inversely; maturity d. directly; marketability

Q: The major determinant of the bond ratings assigned by Moody's, Standard and Poor, or Fitch is a. marketability. b. tax treatment. c. term to maturity. d. default risk. e. frequency of interest payments.

Q: Formosan Independence Co. issues a 9-year semiannual payment bond with a par value of $1,000 a 10% coupon annual rate. The bond's credit rating is AA. Currently, this bond is a par bond in market. a. What is the duration of this par bond? b. If Standard and Poors unexpectedly downgrades the U.S. government bond rating. The market interest rates increase. This bond's annual YTM increases by 2%. What is the impact on bond's interest rate risk? Please use duration to explain.

Q: What is bond duration and what are the implications of holding a bond to its duration versus holding the bond to maturity?

Q: Define and discuss interest rate risk. What are the two risk components of interest rate risk and how do these interact with each other?

Q: What are the relationships between bond price volatility and ANS: (a) bond maturity; ANS: (b) coupon rate?

Q: Name and discuss the factors that must be considered when calculating the realized rate of return on a bond.

Q: Name and discuss the variables that determine the price or value of a fixed-rate coupon bond.

Q: A semiannual payment bond with a $1,000 par has a 7% coupon rate, a 6% YTM, and 5 years to maturity. What is the bond's duration? a. 4.85 years b. 4.57 years c. 4.46 years d. 4.32 years

Q: A semiannual payment bond with a $1,000 par has a 5% coupon rate, a 6% YTM, and 5 years to maturity. What is the bond's duration? a. 5.00 years b. 4.85 years c. 4.76 years d. 4.47 years

Q: According to the above, when increases of market interest rates cause an increase in YTM, ceteris paribus, the interest rate risk of this bond should a. Increase b. Decrease c. Unchange

Q: If the Federal Reserve announces a QE and, therefore, pushes interest rates unexpectedly fall. This bond's YTM drops by 1%. What is the new duration? a. 10.00 years b. 9.592 years c. 7.461 years d. 6.352 years

Q: A 10-year semiannual payment bond with a par value of $1,000 has a 7% coupon annual rate. Currently this bond is a par bond in market. Use the above information to answer the following three questions.What is the duration of this par bond?a. 10.00 yearsb. 8.392 yearsc. 8.452 yearsd. 7.355 years

Q: An 16 year corporate bond pays has a 3.5% coupon rate. What should be the bond's price if the required return is 3% and the bond pays interest annually?a. $1060.44b. $1062.81c. $1065.45d. $1072.99

Q: The duration of any financial instrument a. cannot exceed the instrument's term to maturity b. is a proxy for the instrument's default risk c. must exceed the instrument's term to maturity d. must be calculated before yield to maturity can be accurately determined

Q: All of the following are contractually fixed except a. par value b. yield c. maturity d. coupon

Q: In a fixed rate bond, the variable which changes to provide the current market rate of return to investors is a. face value b. coupon rate c. maturity d. price

Q: An increase in the demand for securities a. will be associated with an increase in interest rates. b. will be associated with a decrease in interest rates. c. will have no affect on interest rates. d. will be matched with an increase in the supply of securities.

Q: An increase in the supply of bonds in the bond market will a. be associated with a decrease in interest rates. b. always be matched by an increased demand for securities. c. be associated with an increase in bond interest rates. d. not affect interest rates, only security prices.

Q: The sum of time weighted discounted cash flows divided by the price of the security is the a. volatility of the security. d. present value of the security cash flows. c. duration of the security. d. always greater than the maturity of the security.

Q: Two factors that affect interest rate risk are a. default risk and reinvestment risk. b. liquidity risk and reinvestment risk. c. price risk and political risk. d. price risk and reinvestment risk.

Q: If a bond investor receives all the coupon payments on time and the face value on the contract maturity date, investor's return could still vary because of a. default risk b. price risk c. liquidity risk d. reinvestment risk.

Q: The _______ the interest rate and the ________ the number of compounding periods in a year, the _________ the rate of return on a present sum. a. lower, greater, lower b. higher, fewer, higher c. higher, greater, higher d. lower, lower, higher

Q: Bonds with _______ coupon rates have a ________ duration than bonds with ________ coupons of the same maturity. a. higher; shorter; smaller b. lower; longer; smaller c. higher; longer; larger d. higher; shorter; larger

Q: There is generally a _______ relationship between term to maturity and duration. a. positive b. favorable c. inverse d. large

Q: Reinvestment risk is the variability of return associated with a. the variability of bond maturities. b. the variability of bond coupon payments. c. the variability of rates of return on reinvested coupons. d. the variability of the market price on the bond.

Q: An investor who selects coupon bond maturities matching his/her holding period a. has eliminated price risk, but not reinvestment risk. b. has eliminated just one part of interest rate risk. c. cannot precisely predict the rate of return on the bond. d. All of the above.

Q: An investor worried about interest rate risk should a. not purchase coupon bonds. b. select bonds whose maturity matches the investor's investment holding period. c. select bonds whose duration matches the investor's investment holding period. d. invest only in U.S. Treasury bonds.

Q: The bond yield to maturity calculation is a. the guaranteed rate of return to an investor. b. the same as the coupon rate. c. the expected rate of return on the bond. d. the realized rate of return on the bond.

Q: Tom purchased a bond last year for $1240, received $60 in interest return, and sold the bond for $1300 one year later. What is Tom's realized annual rate of return? a. 4.8% b. 9.7% c. 9.2% d. More than 10%.

Q: What is the price of the bond in the above question, if the market rate rises to 12% and the bond matures in 5 years? (Assume semiannual compounding). a. $829.60 b. $1,000.00 c. $926.40 d. $1,040.80

Q: What is the price of a $1,000 face value bond with a 10% coupon if the market rate is 10%? a. more than $1,000 b. $1,000 c. less than $1,000 d. cannot ascertain

Q: Which of the following statements about duration is true? a. Duration is the length of time necessary to pay back the investor's original investment. b. The duration of a bond is some time longer than the maturity of the bond. c. Duration is the investment period necessary to offset price risk and reinvestment risk. d. A bond sold at the duration point will always be priced at $1,000.