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Practice QA - Chapter 6 (1)

2020-06-19 来源：好走旅游网

Corporate Finance, 3e (Berk/DeMarzo) Chapter 6 Valuing Bonds

6.1 Bond Cash Flows, Prices, and Yields

1) Which of the following statements is FALSE?

A) Bonds are a securities sold by governments and corporations to raise money from investors today in exchange for promised future payments.

B) By convention the coupon rate is expressed as an effective annual rate. C) Bonds typically make two types of payments to their holders.

D) The time remaining until the repayment date is known as the term of the bond. Answer: B Diff: 1

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Definition

2) Which of the following statements is FALSE?

A) The principal or face value of a bond is the notional amount we use to compute the interest payments.

B) Payments are made on bonds until a final repayment date, called the term date of the bond. C) The coupon rate of a bond is set by the issuer and stated on the bond certificate. D) The promised interest payments of a bond are called coupons. Answer: B Diff: 1

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Definition

3) Which of the following statements is FALSE?

A) The bond certificate typically specifies that the coupons will be paid periodically until the maturity date of the bond.

B) The bond certificate indicates the amounts and dates of all payments to be made.

C) The only cash payments the investor will receive from a zero coupon bond are the interest payments that are paid up until the maturity date.

D) Usually the face value of a bond is repaid at maturity. Answer: C Diff: 1

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Definition

4) Which of the following statements is FALSE?

A) The amount of each coupon payment is determined by the coupon rate of the bond.

B) Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value. C) The simplest type of bond is a zero-coupon bond.

D) Treasury bills are U.S. government bonds with a maturity of up to one year. Answer: B Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Conceptual

5) Which of the following statements is FALSE?

A) Bond traders typically quote bond prices rather than bond yields . B) Treasury bills are zero-coupon bonds.

C) Zero-coupon bonds always trade at a discount.

D) The yield to maturity is typically stated as an annual rate by multiplying the calculated YTM by the number of coupon payment per year, thereby converting it to an APR. Answer: A Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Conceptual

6) Which of the following formulas is incorrect?

A) Yield to maturity for an n-period zero-coupon bond = B) Price of an n-period bond =

C) Price of an n-period bond = Coupon × D) Coupon =

+ ... +

Answer: A Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Conceptual

7) Which of the following statements is FALSE?

A) One advantage of quoting the yield to maturity rather than the price is that the yield is independent of the face value of the bond.

B) Unlike the case of bonds that pay coupons, for zero-coupon bonds, there is no simple formula to solve for the yield to maturity directly.

C) Because we can convert any bond price into a yield, and vice versa, bond prices and yields are often used interchangeably.

D) The IRR of an investment in a bond is given a special name, the yield to maturity (YTM). Answer: B Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Conceptual

8) Which of the following statements is FALSE?

A) The IRR of an investment in a zero-coupon bond is the rate of return that investors will earn on their money if they buy a default free bond at its current price and hold it to maturity.

B) The yield to maturity of a bond is the discount rate that sets the future value of the promised bond payments equal to the current market price of the bond.

C) Financial professionals also use the term spot interest rates to refer to the default-free zero-coupon yields.

D) When we calculate a bond's yield to maturity by solving the formula, Price of an n-period bond =

+ ... +

, the yield we compute will be a rate per

coupon interval. Answer: B Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Conceptual

9) Which of the following statements is FALSE?

A) Zero-coupon bonds are also called pure discount bonds.

B) The IRR of an investment opportunity is the discount rate at which the NPV of the investment opportunity is equal to zero.

C) The yield to maturity for a zero-coupon bond is the return you will earn as an investor from holding the bond to maturity and receiving the promised face value payment.

D) When prices are quoted in the bond market, they are conventionally quoted in increments of $1000. Answer: D Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Definition

Use the following information to answer the question(s) below.

Suppose the current zero-coupon yield curve for risk-free bonds is as follows:

Maturity (years) 1 2 3 4 5

YTM 3.25% 3.50% 3.90% 4.25% 4.40%

10) The price per $100 face value of a three-year, zero-coupon, risk-free bond is closest to: A) $93.80 B) $90.06 C) $89.16 D) $86.39 Answer: C

Explanation: C) $100/(1.039)3 = 89.1566 Diff: 1

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

11) The price per $100 face value of a four-year, zero-coupon, risk-free bond is closest to: A) $90.06 B) $89.16 C) $86.39 D) $84.66 Answer: D

Explanation: D) $100/(1.0425)4 = 84.6634 Diff: 1

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

12) Suppose a five- year bond with a 7% coupon rate and semiannual compounding is trading for a price of $951.58. Expressed as an APR with semiannual compounding, this bonds yield to maturity (YTM) is closest to: A) 7.0% B) 7.5% C) 7.8% D) 8.2% Answer: D

Explanation: D) PMT = 35, FV = 1000, PV = -951.58, N = 10, Compute I = 4.099949 × 2 = 8.199898% Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

13) Suppose a ten-year bond with semiannual coupons has a price of $1,071.06 and a yield to maturity of 7%. This bond's coupon rate is closest to: A) 3.5% B) 6.0% C) 7.0% D) 8.0% Answer: D

Explanation: D) I = 3.5, FV = 1000, PV = -1,071.06, N = 20, Compute PMT = 40 × 2 = 80/1000 = 8.0% Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

14) A three-month treasury bill sold for a price of $99.311998 per $100 face value. The yield to maturity of this bond expressed as an EAR is closest to: A) 2.5% B) 2.8% C) 3.2% D) 4.0% Answer: B

- 1 = 0.028 Explanation: B) EAR =

Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

15) Consider a zero coupon bond with 20 years to maturity. The price will this bond trade if the YTM is 6% is closest to: A) $215 B) $312 C) $335 D) $306 Answer: B

Explanation: B) FV = 1000 I = 6 PMT = 0 N =20

Compute PV = 311.80 or, PV =

= 311.80

Diff: 1

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

16) Consider a zero-coupon bond with a $1000 face value and 10 years left until maturity. If the YTM of this bond is 10.4%, then the price of this bond is closest to: A) $1000 B) $602 C) $1040 D) $372 Answer: D

Explanation: D) FV = 1000 I = 10.4 PMT = 0 N =10

Compute PV = 371.80 or, PV =

= 371.80

Diff: 1

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

17) Consider a zero-coupon bond with a $1000 face value and 10 years left until maturity. If the bond is currently trading for $459, then the yield to maturity on this bond is closest to: A) 7.5% B) 10.4% C) 9.7% D) 8.1% Answer: D

Explanation: D) FV = 1000 PV = -459 PMT = 0 N =10

Compute I = 8.09 8 or 8.1% Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

Use the information for the question(s) below.

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches

maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semiannually.

18) How much will each semiannual coupon payment be? A) $60 B) $40 C) $120 D) $80 Answer: B

Explanation: B) Coupon = (coupon rate × face value)/number of coupons per year = (.08 × 1000)/2 = $40 Diff: 1

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

19) Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then the price that this bond trades for will be closest to: A) $1,045 B) $691 C) $1,000 D) $957 Answer: A

Explanation: A) FV = 1000 I = 3.75 (7.5/2) PMT = 40 (80/2) N = 30 (15 × 2)

Compute PV = 1044.57 Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

20) Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then this bond will trade at A) par.

B) a discount. C) a premium.

D) None of the above Answer: C Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Conceptual

21) Assuming the appropriate YTM on the Sisyphean bond is 9.0%, then the price that this bond trades for will be closest to: A) $946 B) $919 C) $1,086 D) $1,000 Answer: B

Explanation: B) FV = 1000 I = 4.5 (9/2) PMT = 40 (80/2) N = 30 (15 × 2)

Compute PV = 918.56 Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

22) Assuming the appropriate YTM on the Sisyphean bond is 9%, then this bond will trade at A) a premium. B) a discount. C) par.

D) None of the above Answer: B Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

23) Assuming that this bond trades for $1,112, then the YTM for this bond is closest to: A) 8.0% B) 3.4% C) 6.8% D) 9.2% Answer: C

Explanation: C) FV = 1000 PMT = 40 (80/2) N = 30 (15 × 2) PV = -1112

Compute I = 3.3987 × 2 = 6.7975 or 6.8% Diff: 3

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

24) Assuming that this bond trades for $903, then the YTM for this bond is closest to: A) 8.0% B) 6.8% C) 9.9% D) 9.2% Answer: D

Explanation: D) FV = 1000 PMT = 40 (80/2) N = 30 (15 × 2) PV = -903

Compute I = 4.6027 × 2 = 9.2054 or 9.2% Diff: 3

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

Use the table for the question(s) below.

The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value):

Maturity (years) 1 2 3 4 5 Price (per $100 face value) 94.52 89.68 85.40 81.65 78.35

25) The yield to maturity for the two year zero-coupon bond is closest to: A) 6.0% B) 5.8% C) 5.6% D) 5.5% Answer: C

Explanation: C) yield = (100/price)(1/n) – 1 = (100/89.68).5 - 1 = .056 or 5.6% Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

26) The yield to maturity for the three year zero-coupon bond is closest to: A) 5.4% B) 5.8% C) 5.6% D) 6.0% Answer: A

Explanation: A) yield = (100/price)(1/n) - 1= (100/85.40)(1/3) - 1 = .054 or 5.4% Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

27) Based upon the information provided in the table above, you can conclude A) that the yield curve is flat.

B) nothing about the shape of the yield curve. C) that the yield curve is downward sloping. D) that the yield curve is upward sloping. Answer: C Diff: 3

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

28) What is the relationship between a bond's price and its yield to maturity?

Answer: There is an inverse relationship between a bond's yield to maturity and its price. As YTM increases, the value of the bond declines. Likewise, as the YTM falls, the value of the bond will increase. Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Conceptual

Use the information for the question(s) below.

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches

maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semiannually.

29) How much are each of the semiannual coupon payments? Assuming the appropriate YTM on the Sisyphean bond is 8.8%, then at what price should this bond trade for? Answer: Coupon = (coupon rate × face value)/number of coupons per year = (.08 × 1000)/2 = $40 FV = 1000 I = 4.4 (8.8/2) PMT = 40 (80/2) N = 30 (15 × 2)

Compute PV = 934.07 Diff: 2

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

30) Assuming that this bond trades for $1,035.44, then the YTM for this bond is equal to: Answer: FV = 1000 PMT = 40 (80/2) N = 30 (15 × 2) PV = -1035.44

Compute I = 3.8 × 2 = 7.6 or 7.6% Diff: 3

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

Use the table for the question(s) below.

The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value):

Maturity (years) 1 2 3 4 5 Price (per $100 face value) 94.52 89.68 85.40 81.65 78.35 31) Compute the yield to maturity for each of the five zero-coupon bonds. Answer:

Maturity (years) 1 2 3 4 5 Price (per $100 face value) 94.52 89.68 85.40 81.65 78.35 Yield to maturity 5.8% 5.6% 5.4% 5.2% 5.0% Each yield to maturity above is calculated using the formula: YTM = (100/price)(1/n) - 1 Diff: 3

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Analytical

32) Plot the zero-coupon yield curve (for the first five years). Answer:

Diff: 3

Section: 6.1 Bond Cash Flows, Prices, and Yields Skill: Graphing

6.2 Dynamic Behavior of Bond Prices

1) Which of the following statements is FALSE?

A) If the bond trades at a discount, and investor who buys the bond will earn a return both from receiving the coupons and from receiving a face value that exceeds the price paid for the bond. B) Most coupon bond issuers choose a coupon rate so that the bonds will initially trade at, or very near to, par.

C) Coupon bonds always trade for a discount.

D) At any point in time, changes in market interest rates affect a bond's yield to maturity and its price.

Answer: C Diff: 1

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

2) Which of the following statements is FALSE?

A) When a bond is trading at a discount, the price drop when a coupon is paid will be larger than the price increase between coupons, so the bond's discount will tend to decline as time passes. B) When a bond trades at a price equal to its face value, it is said to trade at par. C) As interest rates and bond yield rise, bond prices will fall.

D) Ultimately, the prices of all bonds approach the bond's face value when the bonds mature and their last coupon are paid. Answer: A Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

3) Which of the following statements is FALSE?

A) A bond trades at par when its coupon rate is equal to its yield to maturity. B) The clean price of a bond is adjusted for accrued interest.

C) The price of the bond will drop by the amount of the coupon immediately after the coupon is paid.

D) If a coupon bond's yield to maturity exceeds its coupon rate, the present value of its cash flows at the yield to maturity will be greater than its face value. Answer: D Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

4) Which of the following statements is FALSE?

A) Bond prices converge to the bond's face value due to the time effect, but simultaneously move up and down due to unpredictable changes in bond yields. B) As interest rates and bond yields fall, bond prices will rise.

C) Bonds with higher coupon rates are more sensitive to interest rate changes.

D) Shorter maturity zero coupon bonds are less sensitive to changes in interest rates than are longer-term zero coupon bonds. Answer: C Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

5) Which of the following statements is FALSE?

A) If a bond trades at a premium, its yield to maturity will exceed its coupon rate. B) A bond that trades at a premium is said to trade above par.

C) When a coupon-paying bond is trading at a premium, an investor's return from the coupons is diminished by receiving a face value less than the price paid for the bond.

D) Holding fixed the bond's yield to maturity, for a bond not trading at par, the present value of the bond's remaining cash flows changes as the time to maturity decreases. Answer: A Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

6) Which of the following formulas is INCORRECT? A) Invoice price = dirty price

B) Clean price = dirty price - accrued interest C) Accrued interest = coupon amount ×

D) Cash price = clean price + accrued interest Answer: C Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

7) Which of the following statements is FALSE?

A) Prices of bonds with lower durations are more sensitive to interest rate changes.

B) When a bond is trading at a discount, the price increase between coupons will exceed the drop when a coupon is paid, so the bond's price will rise and its discount will decline as time passes. C) Coupon bonds may trade at a discount, at a premium, or at par.

D) The sensitivity of a bond's price changes in interest rates is the bond's duration. Answer: A Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

8) If a bond is currently trading at its face (par) value, then it must be the case that: A) the bond's yield to maturity is less than its coupon rate. B) the bond's yield to maturity is equal to its coupon rate. C) the bond's yield to maturity is greater than its coupon rate. D) the bond is a zero-coupon bond. Answer: B Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

9) The discount rate that sets the present value of the promised bond payments equal to the current market price of the bond is called: A) the current yield. B) the yield to maturity. C) the zero coupon yield. D) the discount yield. Answer: B Diff: 1

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Definition

Use the following information to answer the question(s) below.

Consider the following four corporate bonds that have semiannual compounding:

Bond #1 #2 #3 #4 Price $1,000.00 $932.05 $1,067.95 $1,098.96

Coupon Rate 8% 7% 9% 9% Years to Maturity 5 10 10 20

10) Which of these bonds sells at a discount? A) #1 B) #2 C) #3 D) #4

Answer: B

Explanation: B) Only bond #2 sells for a price below $1000.00. Diff: 1

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

11) If the YTM of these bonds increased to 9%, which bond's price would be most sensitive to this change in YTM? A) #1 B) #2 C) #3 D) #4

Answer: D

Explanation: D) Bonds 2 - 4 have coupons within 1% of their current YTM of 8%. However, bond #4 has the longest maturity and therefore will have the highest change in price. Diff: 1

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

12) If the YTM of these bonds decreases to 7%, which bond's price would be most sensitive to this change in YTM? A) #1 B) #2 C) #3 D) #4

E) #3 and #4 Answer: D

Explanation: D) Bonds 2 - 4 have coupons within 1% of their current YTM of 8%. However, bond #4 has the longest maturity and therefore will have the highest change in price. Diff: 1

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

Use the following information to answer the question(s) below.

Suppose you purchase a 20-year treasury bond (Face Value is 1000) with a 6% annual coupon ten years ago at par. Today the bond's yield to maturity has risen to 8% (EAR).

13) If you hold this bond to maturity, the internal rate of return you will earn on your investment will be closest to: A) 5.0% B) 5.6% C) 6.0% D) 8.0% Answer: C

Explanation: C) N = 20, PMT = 60, PV = -1000, FV = 1000, Compute I = 6.00 Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

14) If you sell this bond now, the internal rate of return you will earn on your investment will be closest to: A) 5.0% B) 5.6% C) 6.0% D) 8.0% Answer: B

Explanation: B) Step #1 - Current Price N = 10, PMT = 60, FV = 1000, I = 8, compute PV = 865.80

N = 20, PMT = 60, PV = -1000, FV = 865.80, Compute I = 5.62 Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

15) Consider a zero coupon bond with 20 years to maturity. The amount that the price of the bond will change if its yield to maturity decreases from 7% to 5% is closest to: A) $120 B) -$53 C) $53 D) $673 Answer: A

Explanation: A) FV = 1000 I = 7 PMT = 0 N = 20

Compute PV = 258.42

FV = 1000 I = 5 PMT = 0 N = 20

Compute PV = 376.89

chg = (376.89 - 258.42) = 118.47 Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

16) Consider a zero coupon bond with 20 years to maturity. The percentage change in the price of the bond if its yield to maturity decreases from 7% to 5% is closest to: A) 46% B) 17% C) 22% D) 38% Answer: A

Explanation: A) FV = 1000 I = 7 PMT = 0 N = 20

Compute PV = 258.42

FV = 1000 I = 5 PMT = 0 N = 20

Compute PV = 376.89

%chg = (376.89 - 258.42)/258.42 = .4584 or 45.8% Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

17) Consider a bond that pays annually an 8% coupon with 20 years to maturity. The amount that the price of the bond will change if its yield to maturity increases from 5% to 7% is closest to:

A) -$270 B) -$225 C) -$310 D) -$250 Answer: A

Explanation: A) FV = 1000 I = 7

PMT = 80 N = 20

Compute PV = 1105.94

FV = 1000 I = 5

PMT = 80 N = 20

Compute PV = 1373.87

chg = (1105.94 - 1373.87 ) = -267.93 Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

18) Consider a bond that pays annually an 8% coupon with 20 years to maturity. The percentage change in the price of the bond if its yield to maturity increases from 5% to 7% is closest to: A) 20% B) 24% C) -20% D) -24% Answer: D

Explanation: D) FV = 1000 I = 7

PMT = 80 N = 20

Compute PV = 1105.94

FV = 1000 I = 5

PMT = 80 N = 20

Compute PV = 1373.87

chg = (1105.94 - 1373.87 ) = -267.93

%chg = -267.93/1373.87 = -0.195 or -19.5% Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

Use the table for the question(s) below.

Consider the following four bonds that pay annual coupons:

Bond Years to maturity Coupon YTM A 1 0% 5% B 5 6% 7% C 10 10% 9% D 20 0% 8% 19) The percentage change in the price of the bond \"A\" if its yield to maturity increases from 5% to 6% is closest to: A) -4% B) -6% C) -1% D) 4% Answer: C

Explanation: C)

Years to Price0 Price1 Bond maturity Coupon YTM % Chg $ Chg

A 1 0% 5% $952.38 $943.40 -0.94% ($8.98) B 5 6% 7% $959.00 $920.15 -4.05% ($38.85) C 10 10% 9% $1,064.18 $1,000.00 -6.03% ($64.18) D 20 0% 8% $214.55 $178.43 -16.83% ($36.12) Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

20) The percentage change in the price of the bond \"C\" if its yield to maturity increases from 9% to 10% is closest to: A) -17% B) -6% C) -4% D) 4% Answer: B

Explanation: B)

Years to Price0 Price1 Bond maturity Coupon YTM % Chg $ Chg

A 1 0% 5% $952.38 $943.40 -0.94% ($8.98) B 5 6% 7% $959.00 $920.15 -4.05% ($38.85) C 10 10% 9% $1,064.18 $1,000.00 -6.03% ($64.18) D 20 0% 8% $214.55 $178.43 -16.83% ($36.12)

Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

21) The amount that the price of bond \"B\" will change if its yield to maturity increases from 7% to 8% is closest to: A) -$36 B) $9 C) $36 D) -$39 Answer: D

Explanation: D)

Years to Price0 Price1 Bond maturity Coupon YTM $ Chg

1 0% 5% $952.38 $943.40 ($8.98) B 5 6% 7% $959.00 $920.15 ($38.85) C 10 10% 9% $1,064.18 $1,000.00 ($64.18) D 20 0% 8% $214.55 $178.43 ($36.12)

Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

22) The amount that the price of bond \"D\" will change if its yield to maturity increases from 8% to 9% is closest to: A) -$36 B) -$39 C) $36 D) $9

Answer: A

Explanation: A)

Years to Price0 Price1 Bond maturity Coupon YTM $ Chg

A 1 0% 5% $952.38 $943.40 ($8.98) B 5 6% 7% $959.00 $920.15 ($38.85) C 10 10% 9% $1,064.18 $1,000.00 ($64.18) D 20 0% 8% $214.55 $178.43 ($36.12)

Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

23) Which of the four bonds is the most sensitive to a one percent increase in the YTM? A) Bond A B) Bond B C) Bond C D) Bond D Answer: D

Explanation: D)

Years to Price0 Price1 Bond maturity Coupon YTM % Chg $ Chg

A 1 0% 5% $952.38 $943.40 -0.94% ($8.98) B 5 6% 7% $959.00 $920.15 -4.05% ($38.85) C 10 10% 9% $1,064.18 $1,000.00 -6.03% ($64.18) D 20 0% 8% $214.55 $178.43 -16.83% ($36.12)

Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

24) Which of the four bonds is the least sensitive to a one percent increase in the YTM? A) Bond A B) Bond B C) Bond C D) Bond D Answer: A

Explanation: A)

Years to Price0 Price1 Bond maturity Coupon YTM % Chg $ Chg

A 1 0% 5% $952.38 $943.40 -0.94% ($8.98) B 5 6% 7% $959.00 $920.15 -4.05% ($38.85) C 10 10% 9% $1,064.18 $1,000.00 -6.03% ($64.18) D 20 0% 8% $214.55 $178.43 -16.83% ($36.12)

Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

25) Consider a corporate bond with a $1000 face value, 8% coupon with semiannual coupon payments, 7 years until maturity, and a YTM of 9%. It has been 57 days since the last coupon payment was made and there are 182 days in the current coupon period. The dirty (cash) price for this bond is closest to: A) $949.70 B) $961.40 C) $936.40 D) $948.90 Answer: B

Explanation: B) Dirty price = Clean price + accrued interest

Clean Price: FV = 1000

PMT = 40 (80/2) I = 4.5 (9/2) N = 14 (7 × 2)

Compute PV = 948.89

Accrued Interest = coupon × (days since last payment/days in current coupon period) = 40 × (57/182) = 12.53

So, dirty price = 948.89 + 12.53 = 961.42 Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

26) Consider a corporate bond with a $1000 face value, 10% coupon with semiannual coupon payments, 5 years until maturity, and currently is selling for (has a cash price of) $1,113.80. The next coupon payment will be made in 63 days and there are 182 days in the current coupon period. The clean price for this bond is closest to: A) $1146.50 B) $1065.70 C) $1113.80 D) $1081.10 Answer: D

Explanation: D) Clean price = Dirty price - accrued interest

Accrued Interest = coupon × (days since last payment/days in current coupon period) = 50 × ((182 - 63)/182) = 32.69

So, clean price = $1,113.80 - 32.69 = 1081.11 Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

27) If its YTM does not change, how does a bond's cash price change between coupon payments?

Answer: Two part answer:

1. The bond's cash price (dirty price) will vary with the amount of accrued interest.

2. If the YTM is not equal to the coupon rate, then as time goes on the bond price will approach the face value. Diff: 2

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Conceptual

Use the table for the question(s) below.

Consider the following four bonds that pay annual coupons:

Years to

Bond maturity Coupon YTM A 1 0% 5% B 5 6% 7% C 10 10% 9% D 20 0% 8% 28) Assume that the YTM increases by 1% for each of the four bonds listed. Rank the bonds based upon the sensitivity of their prices from least to most sensitive. Answer:

Years to

Price1 Bond maturity Coupon YTM Price0 $ Chg % Chg Rank

A 1 0% 5% $952.38 $943.40 ($8.98) -0.94% 1 B 5 6% 7% $959.00 $920.15 ($38.85) -4.05% 2 C 10 10% 9% $1,064.18 $1,000.00 ($64.18) -6.03% 3 D 20 0% 8% $214.55 $178.43 ($36.12) -16.83% 4

Diff: 3

Section: 6.2 Dynamic Behavior of Bond Prices Skill: Analytical

6.3 The Yield Curve and Bond Arbitrage

1) Which of the following statements is FALSE?

A) Given the spot interest rates, we can determine the price and yield of any other default-free bond.

B) As the coupon increases, earlier cash flows become relatively less important than later cash flows in the calculation of the present value.

C) When the yield curve is flat, all zero-coupon and coupon-paying bonds will have the same yield, independent of their maturities and coupon rates.

D) When U.S. bond traders refer to \"the yield curve,\" they are often referring to the coupon-paying Treasury yield curve. Answer: B Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Conceptual

2) Which of the following statements is FALSE?

A) We can use the law of one price to compute the price of a coupon bond from the prices of zero-coupon bonds.

B) The plot of the yields of coupon bonds of different maturities is called the coupon-paying yield curve.

C) It is possible to replicate the cash flows of a coupon bond using zero-coupon bonds.

D) Because the coupon bond provides cash flows at different points in time, the yield to maturity of a coupon bond is the simple average of the yields of the zero-coupon bonds of equal and shorter maturities. Answer: D Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Conceptual

3) Which of the following statements is FALSE?

A) By convention, practitioners always plot the yield of the most senior issued bonds, termed the on-the-run-bonds.

B) We can determine the no-arbitrage price of a coupon bond by discounting its cash flows using the zero-coupon yields.

C) If the zero coupon yield curve is upward sloping, the resulting yield to maturity decreases with the coupon rate of the bond.

D) The yield to maturity of a coupon bond is a weighted average of the yields on the zero-coupon bonds. Answer: A Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Conceptual

4) Which of the following statements is FALSE?

A) The yield to maturity of a coupon bond is a weighted average of the yields on the zero-coupon bonds.

B) If the zero-coupon yield curve is downward sloping, the yield to maturity will decrease with the coupon rate.

C) The information in the zero-coupon yield curve is sufficient to price all other risk-free bonds. D) When the yield curve is flat, all zero-coupon and coupon-paying bonds will have the same yield, independent of their maturities and coupon rates. Answer: B Diff: 3

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Conceptual

Use the following information to answer the question(s) below.

Maturity (years) 1 2 3 4 5 Zero-Coupon

YTM 3.25% 3.50% 3.90% 4.25% 4.40%

5) The price today of a two-year default-free security with a face value of $1000 and an annual coupon rate of 5% is closest to: A) $1002.78 B) $1003.31 C) $1028.50 D) $1028.61 Answer: D

Explanation: D) Price =

= $1028.61

Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

6) The price today of a three-year default-free security with a face value of $1000 and an annual coupon rate of 4% is closest to: A) $1002.78 B) $1003.31 C) $1028.50 D) $1028.61 Answer: B

Explanation: B) Price =

= $1003.31

Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

7) A default-free security has an annual coupon rate of 3.25% and sells for par. This bond will mature in: A) 1 year B) 2 years C) 3 years D) 4 years Answer: A

Explanation: A) Since this bond is selling at Par the coupon rate must equal the YTM. The only possible term is the 1-year bond since the other maturity have higher yields. Diff: 1

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

8) Consider a five-year, default-free bond with an annual coupon rate of 5% and a face value of $1000. The YTM on this bond is closest to: A) 3.85% B) 4.20% C) 4.35% D) 4.40% Answer: C

Explanation: C) Step #1 Price =

= $1028.6283

Step #2

PMT = 50, FV = 1000, PV = -1028.6283, N = 5, Compute i = 4.35% Diff: 3

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

9) Consider a four-year, default-free bond with an annual coupon rate of 4.5% and a face value of $1000. The YTM on this bond is closest to: A) 3.85% B) 4.20% C) 4.35% D) 4.40% Answer: B

Explanation: B) Step #1 Price =

= $1010.4446

Step #2

PMT = 45, FV = 1000, PV = -1010.4446, N = 4, Compute i = 4.21% Diff: 3

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

Use the table for the question(s) below.

Consider the following zero-coupon yields on default free securities:

Maturity (years) 1 2 3 4 5 Zero-Coupon YTM 5.80% 5.50% 5.20% 5.00% 4.80%

10) The price today of a 3 year default free security with a face value of $1000 and an annual coupon rate of 6% is closest to: A) $1000 B) $1021 C) $1013 D) $1005 Answer: B

Explanation: B) P = 60/1.058 + 60/1.0552 + 1060/1.0523 = 1021.07 Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

11) A 3 year default free security with a face value of $1000 and an annual coupon rate of 6% will trade

A) at a discount. B) at a premium. C) at par.

D) There is insufficient information provided to answer this question. Answer: B

Explanation: B) P = 60/1.058 + 60/1.0552 + 1060/1.0523 = 1021.07 which is greater than

$1000, so it trades at a premium. The other way to answer this question is to simply note that the coupon rate is greater than any of the zero coupon yields during the first three years so its must trade at a premium. Diff: 1

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

12) The YTM of a 3 year default free security with a face value of $1000 and an annual coupon rate of 6% is closest to: A) 5.5% B) 5.8% C) 5.7% D) 5.2% Answer: D

Explanation: D) P = 60/1.058 + 60/1.0552 + 1060/1.0523 = 1021.07

PV = -1021.07 PMT = 60 FV = 1000 N = 3

Compute I = 5.223 or 5.2% Diff: 3

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

13) The price of a five-year, zero-coupon, default-free security with a face value of $1000 is closest to: A) $754 B) $772 C) $776 D) $791 Answer: D

Explanation: D) FV = 1000 PMT = 0 N = 5 I = 4.8

Compute PV = 791.03 Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

14) The price today of a 4 year default free security with a face value of $1000 and an annual coupon rate of 5.25% is closest to: A) $1000 B) $1003 C) $1008 D) $987 Answer: C

Explanation: C) P = 52.50/1.058 + 52.50/1.0552 + 52.50/1.0523 + 1052.50/1.0504 = 1007.78 Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

15) A 4 year default free security with a face value of $1000 and an annual coupon rate of 5.25% will trade

A) at a premium. B) at par.

C) at a discount.

D) There is insufficient information provided to answer this question. Answer: A

Explanation: A) P = 52.50/1.058 + 52.50/1.0552 + 52.50/1.0523 + 1052.50/1.0504 = 1007.78 which is greater than $1000, so it trades at a premium. Diff: 1

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

16) The YTM of a 4 year default free security with a face value of $1000 and an annual coupon rate of 5.25% is closest to: A) 5.2% B) 5.0% C) 4.9% D) 5.25% Answer: B

Explanation: B) P = 52.50/1.058 + 52.50/1.0552 + 52.50/1.0523 + 1052.50/1.0504 = 1007.78

PV = -1007.78 PMT = 52.50 FV = 1000 N = 4

Compute I = 5.030 or 5.0% Diff: 3

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

17) What is the price today of a two-year, default-free security with a face value of $1000 and an annual coupon rate of 5.75%? Does this bond trade at a discount, premium, or at par? Answer: $1004.46

P = 57.50/1.058 + 1057.50/1.0552 = 1004.46 and since this is > $1000, the bond sells at a premium. Diff: 2

Section: 6.3 The Yield Curve and Bond Arbitrage Skill: Analytical

6.4 Corporate Bonds

1) A corporate bond which receives a BBB rating from Standard and Poor's is considered A) a junk bond.

B) an investment grade bond. C) a defaulted bond. D) a high-yield bond. Answer: B Diff: 1

Section: 6.4 Corporate Bonds Skill: Definition

2) Which of the following statements is FALSE?

A) Investors pay less for bonds with credit risk than they would for an otherwise identical default-free bond.

B) The yield to maturity of a defaultable bond is equal to the expected return of investing in the bond.

C) The risk of default, which is known as the credit risk of the bond, means that the bond’s cash flows are not known with certainty.

D) For corporate bonds, the issuer may default—that is, it might not pay back the full amount promised in the bond certificate. Answer: B Diff: 2

Section: 6.4 Corporate Bonds Skill: Conceptual

3) Which of the following statements is FALSE?

A) Because the cash flows promised by the bond are the most that bondholders can hope to receive, the cash flows that a purchaser of a bond with credit risk expects to receive may be less than that amount.

B) By consulting bond ratings, investors can assess the credit-worthiness of a particular bond issue.

C) Because the yield to maturity for a bond is calculated using the promised cash flows, the yield of bond’s with credit risk will be lower than that of otherwise identical default-free bonds.

D) A higher yield to maturity does not necessarily imply that a bond's expected return is higher. Answer: C Diff: 2

Section: 6.4 Corporate Bonds Skill: Conceptual

4) Which of the following statements is FALSE?

A) The bond's expected return, which is equal to the firm's debt cost of capital, is less than the yield to maturity if there is a risk of default.

B) The two best-known bond-rating companies are Standard & Poor's and Dow Jones.

C) Bonds in the bottom five categories are often call speculative bonds, junk bonds, or high-yield bonds.

D) Bond ratings encourage widespread investor participation and relatively liquid markets. Answer: B Diff: 2

Section: 6.4 Corporate Bonds Skill: Conceptual

5) Which of the following statements is FALSE?

A) Bond ratings encourage widespread investor participation and relatively liquid markets. B) Bonds in the top four categories are often referred to as investment grade bonds.

C) A bond’s rating depends on the risk of bankruptcy as well as the bondholder's ability to lay claim to the firm’s assets in the event of a bankruptcy.

D) Debt issues with a low-priority claim in bankruptcy will have a better rating than issues from the same company that have a higher priority in bankruptcy. Answer: D Diff: 2

Section: 6.4 Corporate Bonds Skill: Conceptual

6) Which of the following statements is FALSE?

A) Investors pay less for bonds with credit risk than they would for an otherwise identical default-free bond.

B) Credit spreads fluctuate as perceptions regarding the probability of default change. C) Credit spreads are high for bonds with high ratings.

D) We refer to the difference between the yields of the corporate bonds and the Treasury yields as the default spread or credit spread. Answer: C Diff: 2

Section: 6.4 Corporate Bonds Skill: Conceptual

7) Taggart Transcontinental has issued at par a zero-coupon bond with a ten-year maturity. Investors believe there is a 10% chance that Taggart Transcontinental will default on these bonds. If they do default, investors expect to receive only 50 cents per dollar they are owned. If investors require an 8% return on their investment in these bonds, then the yield to maturity on these bonds will be closest to (assume annual compounding): A) 6.0% B) 6.5% C) 7.0% D) 8.0% Answer: B

Explanation: B) Step #1 Price = ( .90 × $1000 + .10 × $500)/(1.06)10 = $530.457 Step #2 FV = 1000, PMT = 0, N = 10, PV = -530.475, compute I = 6.455107 Diff: 2

Section: 6.4 Corporate Bonds Skill: Analytical

Use the following information to answer the question(s) below.

Term Yield

Security (years) (%)

Treasury 20 5.5% AAA Corporate 20 7.0% BBB Corporate 20 8.0% B Corporate 20 9.6%

8) The credit spread on AAA-rated corporate bonds is: A) 1.0% B) 1.5% C) 2.6% D) 4.1% Answer: B

Explanation: B) Spread = 7.0% - 5.5% = 1.5% Diff: 1

Section: 6.4 Corporate Bonds Skill: Analytical

9) The credit spread on B-rated corporate bonds is: A) 1.0% B) 1.5% C) 2.6% D) 4.1% Answer: D

Explanation: B) Spread = 9.6% - 5.5% = 4.1% Diff: 1

Section: 6.4 Corporate Bonds Skill: Analytical

10) Wyatt Oil is contemplating issuing a 20-year bond with semiannual coupons, a coupon rate of 7%, and a face value of $1000. Wyatt Oil believes it can get a BBB rating from Standard and Poor's for this bond issue. If Wyatt Oil is successful in getting a BBB rating, then the issue price for these bonds would be closest to: A) $800 B) $891 C) $901 D) $1,000 Answer: C

Explanation: C) FV = 1000, N = 40, I = 4, PMT = 35, Compute PV = 901.04 Diff: 2

Section: 6.4 Corporate Bonds Skill: Analytical

11) Wyatt oil is contemplating issuing a 20-year bond with semiannual coupons, a coupon rate of 8%, and a face value of $1000. Wyatt Oil believes it can get a AAA rating from Standard and Poor's for this bond issue. If Wyatt Oil is successful in getting a AAA rating, then the issue price for these bonds would be closest to: A) $891 B) $901 C) $1,000 D) $1,107 Answer: D

Explanation: D) FV = 1000, N = 40, I = 3.5, PMT = 40, Compute PV = 1106.78 Diff: 2

Section: 6.4 Corporate Bonds Skill: Analytical

Use the table for the question(s) below.

Consider the following yields to maturity on various one-year zero-coupon securities:

Security Yield (%) Treasury 4.6 AAA corporate 4.8 BBB corporate 5.6 B Corporate 6.2 12) The price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a BBB rating is closest to: A) 95.60 B) 94.16 C) 95.42 D) 94.70 Answer: D

Explanation: D) P = 100/(1.056) = 94.70 Diff: 1

Section: 6.4 Corporate Bonds Skill: Analytical

13) The price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a AAA rating is closest to: A) 94.70 B) 95.60 C) 94.16 D) 95.42 Answer: D

Explanation: D) P = 100/(1.048) = 95.42 Diff: 1

Section: 6.4 Corporate Bonds Skill: Analytical

14) The credit spread of the BBB corporate bond is closest to: A) 1.0% B) 5.6% C) 1.6% D) 0.8% Answer: A

Explanation: A) = 5.6% - 4.6% (BBB Yield - risk free yield) = 1.0% Diff: 1

Section: 6.4 Corporate Bonds Skill: Analytical

15) The credit spread of the B corporate bond is closest to: A) 1.6% B) 0.8% C) 1.0% D) 1.4% Answer: A

Explanation: A) = 6.2% - 4.6% (B Yield - risk free yield) = 1.6% Diff: 1

Section: 6.4 Corporate Bonds Skill: Analytical

Use the information for the question(s) below.

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1000 and a coupon rate of 7.0% (annual

payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings:

Rating AAA AA A BBB BB YTM 6.70% 6.80% 7.00% 7.40% 8.00% 16) Assuming that Luther's bonds receive a AAA rating, the price of the bonds will be closest to: A) $1021 B) $1014 C) $1000 D) $937 Answer: A

Explanation: A) FV = 1000 PMT = 70 N = 10 I = 6.7

Compute PV = 1021.37 Diff: 2

Section: 6.4 Corporate Bonds Skill: Analytical

17) Assuming that Luther's bonds receive a AAA rating, the number of bonds that Luther must issue to raise the needed $25 million is closest to: A) 24,655 B) 25,000 C) 24,477 D) 26,681 Answer: C

Explanation: C) FV = 1000 PMT = 70 N = 10 I = 6.7

Compute PV = 1021.37

Total number of bonds = $25,000,000/1021.37 = 24,476.93 Diff: 2

Section: 6.4 Corporate Bonds Skill: Analytical

18) What rating must Luther receive on these bonds if they want the bonds to be issued at par? A) A B) B C) BBB D) AA Answer: A

Explanation: A) FV = 1000 PMT = 70 N = 10

I = 7.0 (yield for A rating) Compute PV = 1000.00 Diff: 2

Section: 6.4 Corporate Bonds Skill: Analytical

19) Suppose that when these bonds were issued, Luther received a price of $972.42 for each bond. What is the likely rating that Luther's bonds received? A) AA B) BBB C) B D) A

Answer: B

Explanation: B) FV = 1000 PMT = 70 N = 10

PV = -972.42

Compute I = 7.4 which is the BBB rating yield Diff: 2

Section: 6.4 Corporate Bonds Skill: Analytical

20) Explain why the expected return of a corporate bind does not equal its yield to maturity? Answer: Because we calculate the yield to maturity using the promised cash flows rather than the expected cash flows. Since there is some non-zero probability of default, there is some chance that we will receive an amount less than the promised amount, thereby driving down the expected return below the YTM. Diff: 2

Section: 6.4 Corporate Bonds Skill: Conceptual

6.5 Sovereign Bonds

1) Sovereign debt is:

A) debt issued by national governments. B) debt denominated in sovereigns. C) always riskless.

D) debt issued by Greece. Answer: A Diff: 1

Section: 6.5 Sovereign Bonds Skill: Definition

2) According to Figure 6.5, the percent of countries in default or restructuring debt: A) hit an all-time high in 2000-2005. B) peaked during World War II. C) is high whenever Greece defaults. D) is never more than 1/3. Answer: B Diff: 1

Section: 6.5 Sovereign Bonds Skill: Definition

3) A key difference between sovereign default and corporate bonds is:

A) unlike a corporation, a country facing difficulty meeting its financial obligations is can not default.

B) unlike corporate debt, sovereign debt prices are not inverse to yields.

C) unlike a corporation, any country can turn to the EMU to pay off its debts.

D) unlike a corporation, a country facing difficulty meeting its financial obligations typically has the option to print more currency. Answer: D Diff: 1

Section: 6.5 Sovereign Bonds Skill: Definition

4) An exception to the key difference between sovereign default and corporate bonds is: A) member states of the U.S. B) member states of the EMU.

C) member states of the African Union. D) member states of the NAFTA. Answer: B Diff: 1

Section: 6.5 Sovereign Bonds Skill: Definition

6.6 Appendix: Forward Interest Rates

1) Forward interest rates:

A) accurately predict future spots rates because of the law of one price. B) tend not to be good predictors of future spot rates.

C) tend to be biased downward as predictors of future spot rates when the yield curve is upward sloping.

D) tend to be biased upward as predictors of future spot rates when the yield curve is downward sloping. Answer: B Diff: 2

Section: 6.6 Appendix: Forward Interest Rates Skill: Conceptual

2) Which of the following statements is FALSE?

A) The forward rate for year 1 is the rate on an investment that starts today and is repaid in one year; it is equivalent to an investment in a one-year zero-coupon bond.

B) The forward rate is only a good predictor of spot interest rates in the future when investors are risk adverse.

C) We can use the law of one price to calculate the forward rate from the zero-coupon yield curve.

D) An interest rate forward contract is a contract today that fixes the interest rate for a loan or investment in the future. Answer: B Diff: 2

Section: 6.6 Appendix: Forward Interest Rates Skill: Conceptual

3) Which of the following statements is FALSE?

A) In general, the expected future spot interest rate will reflect investor's preferences toward the risk of future interest rate fluctuations.

B) If investors did not care about risk, then they would be indifferent between investing in a two-year bond and investing in a one-year bond and rolling over the money in one-year.

C) When we refer to the one-year forward rate for year 5, we mean the rate available today on a one-year investment that begins four years from today and is repaid five years from today. D) In general, we can compute the forward rate for year n by comparing an investment in an n-year, zero-coupon bond to an investment in an (n + 1) year, zero-coupon bond, with the interest rate earned in the nth year being guaranteed through an interest rate forward contract. Answer: D Diff: 2

Section: 6.6 Appendix: Forward Interest Rates Skill: Conceptual

4) Which of the following statements is FALSE?

A) Forward rates tend not to be good predictors of future spot rates.

B) Given the risk associated with interest rate changes, corporate managers require tools to help manage this risk.

C) One of the most important tools to manage the risk of interest rate changes are interest rate forward contracts.

D) A spot rate is an interest rate that we can guarantee today for a loan or investment that will occur in the future. Answer: D Diff: 1

Section: 6.6 Appendix: Forward Interest Rates Skill: Conceptual

5) Which of the following equations is INCORRECT?

A) Expected future spot interest rate = forward interest rate + risk premium B) (1 + f1) × (1 + f2) × (1 + f3) × ... × (1 + fn) = (1 + YTMn)n C) fn =

- 1

D) (1 + YTMn)n = (1 + YTMn - 1)n - 1(1 + fn) Answer: C Diff: 3

Section: 6.6 Appendix: Forward Interest Rates Skill: Conceptual

Use the table for the question(s) below.

Consider the following zero-coupon yields on default free securities:

Maturity (years) 1 2 3 4 5 Zero-Coupon YTM 5.80% 5.50% 5.20% 5.00% 4.80%

6) The forward rate for year 2 (the forward rate quoted today for an investment that begins in one year and matures in two years) is closest to: A) 5.80% B) 5.50% C) 5.20% D) 5.65% Answer: C Explanation: C) f2 =

- 1 = (1.055)2/(1.058) = 1.052 - 1 = 5.2%

Diff: 1

Section: 6.6 Appendix: Forward Interest Rates Skill: Analytical

7) The forward rate for year 3 (the forward rate quoted today for an investment that begins in two years and matures in three years) is closest to: A) 4.5% B) 5.0% C) 5.2% D) 4.6% Answer: D Explanation: D) f3 =

- 1 = (1.0520)3/(1.055)2 = 1.046 - 1 = 4.6%

Diff: 1

Section: 6.6 Appendix: Forward Interest Rates Skill: Analytical

8) The forward rate for year 4 (the forward rate quoted today for an investment that begins in three years and matures in four years) is closest to: A) 4.5% B) 4.6% C) 4.4% D) 5.0% Answer: C Explanation: C) f4 =

- 1 = (1.050)4/(1.052)3 = 1.044 - 1 = 4.4%

Diff: 1

Section: 6.6 Appendix: Forward Interest Rates Skill: Analytical

9) The forward rate for year 5 (the forward rate quoted today for an investment that begins in four years and matures in five years) is closest to: A) 4.0% B) 3.8% C) 4.8% D) 4.2% Answer: A Explanation: A) f5 =

- 1 = (1.048)5/(1.050)4 = 1.040 - 1 = 4.0%

Diff: 1

Section: 6.6 Appendix: Forward Interest Rates Skill: Analytical

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