Download File ch17 Chapter 17 Bond Yields Type: Multiple Choice 1. How is

File ch17.rtf Chapter 17 Bond Yields
Type: Multiple Choice
1. How is the value of a bond determined?
a) The price is set by the government or corporate issuer.
b) The present value of the bond’s future cash flows is discounted by an appropriate rate.
c) The present value of the company’s future cash flows is discounted by an appropriate rate.
d) The constant growth dividend model is often used to value bonds.
Ans: B
EASY
Response: Section: Bond Prices.
2. Which of the following statements is most correct?
a) The real risk-free rate of interest is the rate that is shown in the Wall Street Journal for the
shortest term federal securities.
b) The real risk-free rate of interest is the rate that is shown in the Wall Street Journal for the
longest term federal securities.
c) The real risk-free rate of interest is the rate that is shown in the Wall Street Journal for the
shortest term federal securities, plus a forecast of the rate of inflation for the period of the
securities.
d) The real risk-free rate of interest is the rate that is shown in the Wall Street Journal for the
longest term federal securities, plus a forecast of the rate of inflation for the period of the
securities.
Ans: C
EASY
Response: Long-term treasury bonds typically yield more per year than short-term treasury bills.
Section: Bond Yields and Interest Rates.
3. What is meant by the real risk-free rate of interest?
a) The rate actually used in the market, not in textbooks.
b) The rate quoted on short-term Treasury bills.
c) The opportunity cost of foregoing consumption.
d) The nominal risk-free interest rate, less the expected inflation.
Ans: C
MEDIUM
Response: Section: Bond Yields and Interest Rates
4.
a)
b)
c)
d)
Which of the following bond yields is the most important for bond investors?
Coupon rate.
Current yield
Yield to Maturity
Yield to Call
Ans: D
EASY
Response: Especially for bonds trading at a premium, it is probable that the bonds will be called
as soon as calling is profitable for the issuer. The investor will thus receive the maturity amount
well before the original maturity date. Section: Bond Yields and Interest Rates.
5. What is meant by “Yield to Maturity”?
a) The coupon interest rate paid each year, divided by the face value of the bond.
b) The coupon interest rate paid each, divided by the current price of the bond.
c) The periodic interest rate that equates the current price with the expected future flows.
d) The periodic interest rate that equates the current price with the expected future flows, up to
the time of the first call..
Ans: C
MEDIUM
Response: Section: Bond Yields and Interest Rates.
6. An investor has three sources of dollar returns from a bond investment. Which of the
following is NOT included among the three sources?
a) The semi-annual coupon payments
b) The interest earned on reinvesting the coupon payments.
c) The principal paid at maturity.
d) The interest earned on reinvesting the principal.
Ans: D
HARD
Response: The total dollar return is calculated by adding the funds at the time of maturity, so the
principal repayment cannot be reinvested. Section: Bond Yields and Interest Rates.
7. Which of the following is a situation in which an investor will NOT receive the promised yield
to maturity?
a) The investor holds the bond until maturity, and reinvests coupon payment at the original yield
to maturity.
b) Interest rates do not change during the life of the bond.
c) The issuer calls the bond prior to original maturity.
d) The realized compound yield is equal to the promised yield to maturity.
Ans: C
HARD
Response: A call means the issuer is paying back the amount borrowed, plus a call premium,
earlier than the original maturity date. The issuer will choose to do so only if interest rates have
fallen, so the investor will not be able to reinvest at the original Yield to Maturity. Section:
Measuring Bond Yields.
8. Which of the following is the best definition of “realized compound yield”?
a) The yield an investor realizes on the bond coupons.
b) The total amount of the coupon and principal payments.
c) The ending wealth divided by the starting wealth.
d) The total amount of the coupon and principal payments, and the reinvestment of these flows.
Ans: D
MEDIUM
Response: Section: Measuring Bond Yields.
9. What is the difference between the Yield-to-Maturity and the Realized Compound Yield?
a) They are actually the same concept.
b) The yield to maturity is the actual return, calculated at the end of the investment; the realized
compound yield is the expected return at the beginning of the investment.
c) The realized compound yield is the actual return, calculated at the end of the investment; the
yield to maturity is the expected return at the beginning of the investment.
d) The yield to maturity continues as far as the first call, the realized compound yield continues
until final payment is made.
Ans: C
MEDIUM
Response: Section: Measuring Bond Yields.
10. Which of the following typically contributes the greatest portion to the Total Dollar Return?
a) The semi-annual coupon payments
b) The interest earned on reinvesting the coupon payments.
c) The principal paid at maturity.
d) The interest earned on reinvesting the principal.
Ans: B
EASY
Response: As shown in Figure 17-1, the interest-on-interest is greater than either the principal or
coupons. Section: Investments Intuition.
11. Assume an investor buys a newly issued 8 percent, semi-annual 10 year bond at par. He
sells it two years later, when market interest rates have decreased to 6 percent. How much is the
investor’s capital gain or loss?
a) $1,000 gain
b) $1,125.44 gain
c) $125.44 gain
d) $377.00 loss
Ans: C
HARD
Response: We use Table A-2 to look up the value of the $1000 principal to be paid 8 years or 16
semi-annual periods. Looking at the 3% row (rate per semi-annual period), we find the factor of
.623. Multiplying by $1000, the investor is selling the value of the principal for $623.00. Using
Table A-4, we also look up R=3% and N=16 to find the factor 12.561. Multiplying 12.561 times
the $40 semi-annual coupon, we find our investor is selling the remaining stream of 16 coupon
payments for $502.44. Thus the price of the bond is $623.00 + $502.44 = $1,125.44. But the
bond originally cost our investor $1,000, so the capital gain is 125.44 (using financial calculator,
the answer is $125.61). Section: Measuring Bond Yields.
12. Now let’s look from the view of the investor who buys an 8 percent semiannual bond with 8
years remaining to maturity, when market rates are 6%. If this investor pays $1,125.44 for the
bond, what is his current yield?
a) 3.55 percent
b) 7.11 percent
c) 8.00 percent
d) 10.00 percent
Ans: B
HARD
Response: Divide the $40 semi-annual coupon by the $1,125.44 to get 3.55%. Multiply by 2 to
get the annual rate of 7.11% Section: Measuring Bond Yields.
13. What happens to the price of bonds, if interest rates go up?
a) The price of bonds goes up.
b) The price of bonds stays the same.
c) The price of bonds goes down.
d) The relationship between interest rates and bond prices cannot be determined.
Ans: C
EASY
Response: Section: Bond Price Changes.
14. Which of the following bonds will be most sensitive to changes in market interest rates?
a) 8 percent semiannual coupon with 8 years to maturity.
b) 6 percent semiannual coupon with 8 years to maturity.
c) 8 percent semiannual coupon with 6 years to maturity.
d) 6 percent semiannual coupon with 6 years to maturity.
Ans: B
MEDIUM
Response: Changes in bond prices are directly related to time to maturity (8 years is more than 6
years), but changes in bond prices are inversely related to coupon rates (6 percent coupon means
more of the bond’s value comes at maturity). Section: Bond Price Changes.
15. Examine Example 17-11. The basic data is repeated here, in financial calculator format: FV
= 1000, N=30, PMT=50
I/Y
At 10%
At 8%
At 12%
Price=PV
$1,000.00
$1,172.93
$ 862.35
% change
+17.29 %
-13.77 %
Why are the % changes different?
a) They are actually the same: the table includes an error.
b) The prices shown are rounded to the nearest penny, slightly moving the % changes.
c) The relationship between interest rates and price is not linear.
d) Other factors, including duration and coupon rate, will also affect the relationship between
interest rates and prices.
Ans: C
HARD
Response: Section: Measuring Bond Yields.
16. Which of the following is NOT one of the factors used in calculating duration?
a) The final maturity of the bond.
b) The coupon payment
c) The yield to maturity
d) The current price
Ans: D
EASY
Response: Section: Bond Price Changes
17. Why is duration important for investing in bonds?
a) Investors need to know the relationship between interest rates and prices
b) Investors need to know the “average” maturity of the bonds they are considering.
c) Investors need to know the coupon rates of the bonds they are considering.
d) Investors need to know the yield to maturity.
Ans: A
MEDIUM
Response: Section: Bond Price Changes.
18. Which of the following is NOT a true statement?
a) Duration measures the time until the principal is repaid.
b) Duration is the weighted average of the timing of the bond’s payments.
c) The weights in the calculation of duration are the present value of each payment, divided by
the value of the bond.
d) Modified duration measures the sensitivity of the bond’s price to interest rate changes.
Ans: A
EASY
Response: The time until the principal is repaid is time to maturity. Section: Bond Price
Changes.
19. Consider Example 17-13 and Table 17-3. What happens to the duration if the coupon rate
was 6%, rather than the 5% shown?
a) No change – duration is based time to maturity
b) The duration increases to 4.57, as the YTM increases
c) The duration decreases to 4.38, as more payments come earlier
d) The YTM is set by the market, so it will not change.
Ans: B
EASY
Response: Recalculate Table 17-3, using a $30 semi-annual payment. Section: Bond Price
Changes.
20. Consider Example 17-13 and Table 17-3. Let’s say the price is $950.00 rather $974.17 (so
the YTM goes to 6.1% from 5.6%). What happens to duration?
a) It increases substantially.
b) It increases only a little amount.
c) It decreases substantially.
d) It decreases only a little amount
Ans: D
MEDIUM
Response: A recalculation of Table 17-3 show that duration decreases to 4.469 from 4.477.
Section: Bond Price Changes.
Type: True False
1. Both stocks and bonds are valued by summing the discounted future flows of interest (or
dividends), and the repayment of principal (or sale of the stock).
Ans: True
Response: Section: Bond Yields and Interest Rates.
2. Bond traders use the term “basis point” to mean one percentage point in interest rate.
Ans: False.
Response: A basis point is one hundredth of one percent. Section: Bond Yields and Interest
Rates.
3. The vast majority of corporate bonds pay floating rate interest on a quarterly basis.
Ans: False
Response: Most, but not all, bonds pay a fixed rate of interest semiannually. Section: Measuring
Bond Yields.
4. Reinvestment risk represents the possibility that future payments cannot be reinvested at the
assumed rate.
Ans: True
Response: Section: Investments Intuition.
5. A financial crisis or an accounting scandal can just as easily cause yield spreads to widen as
weak earnings at a company.
Ans: True
Response: Litigation problems and excessive debt levels are also common reasons for a
company’s bond spreads to widen. Section: Bond Price Changes.
6. As interest rates increase, long bonds will decrease in price more slowly than shorter bonds.
Ans: False
Response: An examination of Table 17-2 shows that a change of interest from 8% to 10%
results in a larger change to the longer maturity bonds. Section: Bond Price Changes.
7. For a zero coupon bond, duration is the same as time to maturity.
Ans: True
Response: A zero coupon bond has only one cash flow, the face value at maturity. Thus,
Formula 17-9 reduces to (PV(Face value) / market price) x t. The fraction reduces to 1, so the
Macaulay duration = t, the time to maturity. Section: Bond Price Changes.
8. Holding maturity constant, a decrease in rates will raise bond prices on a percentage basis
more than a corresponding increase in rates will lower bond prices.
Ans: True
Response: This is the basis for the concept of convexity. Section: Bond Price Changes.
9. Convexity is used to correct the approximate percentage change in bond value, calculated
using modified duration.
Ans: True
Response: Section: Bond Price Changes.
10. An investor desiring a bond investment that changes as little as possible as interest rates
change should seek a bond with short duration.
Ans: True
Response: Section: Bond Price Changes.