TUTORIAL 3 CHAPTER 5

MULTIPLE CHOICE QUESTIONS

1. Which of the following statements is true? a. Bond prices and interest rates move together. b. Coupon rates are fixed at the time of issue. c. Short-term securities have large price swings relative to long-term securities. d. The higher the coupon, the lower the price of a bond. Which of the following statements is true about bonds? a. The higher the coupon rate, the shorter the duration. b. The yield on a bond is usually fixed. c. A bond's coupon rate is equal to its face value. d. Most bonds pay interest annually. $5,000 invested at 6%, compounded quarterly, will be worth how much after 5 years? a. $6,691 b. $16,036 c. $6,734 d. $5,386 Tom deposits $10,000 in a savings deposit paying 4%, compounded monthly. What amount would he have at the end of seven years? a. $13,225 b. $13,159 c. $13,179 d. $13,325 Judy would like to accumulate $70,000 by the time her son starts college in ten years. What amount would she need to deposit now in a deposit account earning 6%, compounded yearly, to accumulate her savings goal? a. $4,200 b. $39,513 c. $39,088 d. $125,359 If a $1000 par value bond has an 8% coupon (annual payments) rate, a 4-year maturity, and similar bonds are yielding 11%, what is the price of the bond? a. $1,000.00 b. $880.22 c. $906.93 d. $910.35 A corporate bond, paying $65 interest at the end of each year for 6 years, has a face value of $1,000. If market rates on newly issued similarly rated corporate bonds are now 7.5%, what is the current market price of this bond? a. $953.06 b. $1,000.00 c. $1,048.41 d. $936.42 A $1000 bond with an 8.2% coupon rate, interest paid semiannually, and maturing in six years is currently yielding 7.6% in the market. What is the current price of the bond? a. $1,027.08 b. $1,131.19 c. $1,028.48 d. $972.00 A $1000 bond with a coupon rate of 7% matures in eight years. The bond is now selling for $950, what is the expected yield to maturity on the bond? a. 6.5% b. 7.9% c. 9.0% d. 8.3% A $1000 bond with a coupon rate of 10%, interest paid semiannually, matures in eight years and sells for $1120. What is the yield to maturity? a. 10.8% b. 11.0% c. 7.9% d. 7.6%

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When a bond's coupon rate is equal to the market rate of interest, the bond will sell for
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b. a premium.

c. par.

d. a variable rate.

A bond currently selling at a premium price above face value a. has a yield equal to its coupon rate. b. has a yield below its coupon rate. c. has a yield above its coupon rate. d. has no risk. If market interest rates fall after a bond is issued, the a. face value of the bond increases. b. investor will sell the bond. c. market value of the bond is increasing. d. market value of the bond is decreasing. Duration is a measure of a. a bond's price. b. a bond's contractual maturity. c. the length of time it takes to get back the original investment. d. bond price volatility. Bond A has a duration of 5.6 while bond B has a duration of 6.0. Bond B a. will have greater price variability, given a change in interest rates, relative to bond A. b. will have a longer maturity than bond A. c. will have a higher coupon rate than bond A. d. will have less price variability, given a change in interest rates, relative to bond A. A 3-year zero coupon bond selling at $900 and yielding 12.18 percent has a duration of a. 3 years. b. 2.78 years. c. 2.50 years. d. 2 years. A $1000 2-year 10% coupon bond is priced at $1000 in the market. The duration is a. less than two years. b. more than two years. c. 10%. years. d. 2

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The duration of a $1000, 2-year, 7% coupon bond (interest paid annually) is _____ when market rates are 8%? a. 2.036 b. 1.934 c. 1.902 d. 1.856 As bond maturity _________, so does the _________ and ________. a. decreases; coupon rate; market price. b. decreases; duration; face value. c. increases; duration; price variability. d. increases; risk; coupon rate. A $1,000 par, 8% Treasury bond maturing in three years is priced to yield 7%. price (assuming semiannual compounding) is a. $974.21 b. $813.50 c. $927.50 d. $1,026.64 Which of the following risks will not affect zero coupon bonds? a. price risk b. reinvestment risk c. credit risk d. default risk A bond yield measure should capture all of the following except a. coupon payments.
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Its market

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reinvestment income. changing coupon rate levels. capital gains or losses.

The yield to maturity measure assumes that coupon interest is reinvested at a. the yield to maturity. b. the changing market rates. c. the coupon rate. d. the treasury bond rate. Calculate the realized return on a $1,000 face value, 9 percent coupon bond (annual) purchased for $800 and sold one year later for $850. a. 9% b. 11.25% c. 14.5% d. 17.5% Calculate the volatility of $1,000 face value 8% coupon bond whose price has varied from $1,020 to $1,050. a. $30.00 b. 5% c. 3% d. $50.00 Interest rate risk is a. duration. b. the extent that coupon rates vary with time. c. the potential variability in the realized rate of return caused by changes in market rates. d. the potential variability in the bond maturity caused by changing discount rates. Price risk and reinvestment risk a. offset one another to a certain extent as interest rates change. b. are two bond risks related to credit risk. c. work together to magnify the price impact of a change in interest rate. d. both have an effect on bond price. 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. 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. 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.

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

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ESSAY QUESTIONS 1. Name and discuss the variables that determine the price or value of a fixed-rate coupon bond.

2. Name and discuss the factors that must be considered when calculating the realized rate of return on a bond. 3. What are the relationships between bond price volatility and (a) bond maturity; (b) coupon rate?

4. Define and discuss interest rate risk. What are the two risk components of interest rate risk and how do these interact with each other? 5. What is bond duration and what are the implications of holding a bond to its duration versus holding the bond to maturity?