FIN2601 EXAM PREPARATION.

(Difficulty: E = Easy, M = Medium, and T = Tough) Multiple Choice: Conceptual Easy: Interest rates Answer: e Diff: E 1. One of the basic relationships in interest rate theory is that, other things held constant, for a given change in the required rate of return, the the time to maturity, the the change in price. a. longer; smaller. b. shorter; larger. c. longer; greater. d. shorter; smaller. e. Statements c and d are correct. Interest rates and bond prices Answer: c Diff: E 2. Assume that a 10-year Treasury bond has a 12 percent annual coupon, while a 15-year Treasury bond has an 8 percent annual coupon. The yield curve is flat; all Treasury securities have a 10 percent yield to maturity. Which of the following statements is most correct? a. The 10-year bond is selling at a discount, while the 15-year bond is selling at a premium. b. The 10-year bond is selling at a premium, while the 15-year bond is selling at par. c. If interest rates decline, the price of both bonds will increase, but the 15-year bond will have a larger percentage increase in price. d. If the yield to maturity on both bonds remains at 10 percent over the next year, the price of the 10-year bond will increase, but the price of the 15-year bond will fall. e. Statements c and d are correct. Interest rates and bond prices Answer: c Diff: E 3. A 12-year bond has an annual coupon rate of 9 percent. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7 percent. Which of the following statements is most correct? a. The bond is currently selling at a price below its par value. b. If market interest rates decline today, the price of the bond will also decline today. c. If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today. d. All of the statements above are correct. e. None of the statements above is correct. Interest rates and bond prices Answer: d Diff: E 4. A 10-year Treasury bond has an 8 percent coupon. An 8-year Treasury bond has a 10 percent coupon. Both bonds have the same yield to maturity. If the yields to maturity of both bonds increase by the same amount, which of the following statements is most correct? a. The prices of both bonds will increase by the same amount. b. The prices of both bonds will decrease by the same amount. CHAPTER 7 BONDS AND THEIR VALUATION FIN2601 EXAM PREPARATION. c. The prices of the two bonds will remain the same. d. Both bonds will decline in price, but the 10-year bond will have a greater percentage decline in price than the 8-year bond. e. Both bonds will decline in price, but the 8-year bond will have a greater percentage decline in price than the 10-year bond. Interest vs. reinvestment rate risk Answer: e Diff: E 5. Which of the following statements is most correct? a. All else equal, long-term bonds have more interest rate risk than short-term bonds. b. All else equal, high-coupon bonds have more reinvestment rate risk than low-coupon bonds. c. All else equal, short-term bonds have more reinvestment rate risk than do long-term bonds. d. Statements a and c are correct. e. All of the statements above are correct. Interest vs. reinvestment rate risk Answer: c Diff: E 6. Which of the following statements is most correct? a. Relative to short-term bonds, long-term bonds have less interest rate risk but more reinvestment rate risk. b. Relative to short-term bonds, long-term bonds have more interest rate risk and more reinvestment risk. c. Relative to coupon-bearing bonds, zero coupon bonds have more interest rate risk but less reinvestment rate risk. d. If interest rates increase, all bond prices will increase, but the increase will be greatest for bonds that have less interest rate risk. e. One advantage of zero coupon bonds is that you don’t have to pay any taxes until you sell the bond or it matures. Price risk Answer: a Diff: E 7. Which of the following bonds will have the greatest percentage increase in value if all interest rates decrease by 1 percent? a. 20-year, zero coupon bond. b. 10-year, zero coupon bond. c. 20-year, 10 percent coupon bond. d. 20-year, 5 percent coupon bond. e. 1-year, 10 percent coupon bond. Callable bond Answer: a Diff: E 8. Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds? a. A reduction in market interest rates. b. The company’s bonds are downgraded. c. An increase in the call premium. d. Statements a and b are correct. e. Statements a, b, and c are correct. Call provision Answer: b Diff: E 9. Other things held constant, if a bond indenture contains a call provision, the yield to maturity that would exist without such a call provision will generally be the YTM with a call provision. a. Higher than. b. Lower than. c. The same as. d. Either higher or lower (depending on the level of the call premium) than. e. Unrelated to. Bond coupon rate Answer: c Diff: E 10. All of the following may serve to reduce the coupon rate that would otherwise be required on a bond issued at par, except a a. Sinking fund. b. Restrictive covenant. c. Call provision. d. Change in rating from Aa to Aaa. e. None of the statements above. (All may reduce the required coupon rate.) Bond concepts Answer: a Diff: E 11. Which of the following statements is most correct? a. All else equal, if a bond’s yield to maturity increases, its price will fall. b. All else equal, if a bond’s yield to maturity increases, its current yield will fall. c. If a bond’s yield to maturity exceeds the coupon rate, the bond will sell at a premium over par. d. All of the statements above are correct. e. None of the statements above is correct.