CH3 MCQ PDF

Chapter 03 Valuing Bonds Answer Key Multiple Choice Questions 1. The following entities issue bonds to engage in long-term borrowing EXCEPT: A. the federal government B. state and local governments C. corporations D. individuals...

Chapter 03 Valuing Bonds Answer Key Multiple Choice Questions 1. The following entities issue bonds to engage in long-term borrowing EXCEPT: A. the federal government B. state and local governments C. corporations D. individuals Type: Easy 2. The type of bonds where the identities of bond owners are recorded and the coupon interest payments are sent automatically are called: A. bearer bonds B. government bonds C. registered bonds D. recorded bonds Type: Medium 3. A government bond issued in Germany has a coupon rate of 5%, a face value of 100 euros, and matures in five years. The bond pays annual interest payments. Calculate the price of the bond (in euros) if the yield to maturity is 3.5%. A. 100.00 B. 106.77 C. 106.33 D. 105.00 The annual interest payment = (100) × (0.05) = 5 euros; price = PV. Using a financial calculator: PMT = 5; I = 3.5; FV = 100; N = 5. Compute: PV = 106.77 euros. Alternatively, PV = (5/1.035) + (5/(1.0352)) + (5/(1.0353)) + (5/(1.0354)) + (105/(1.0355)) = 106.77. Type: Medium © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 4. Generally, a bond can be valued as a package of: (I) annuity, (II) perpetuity, (III) single payment A. I and II only B. II and III only C. I and III only D. I, II, and III Type: Easy 5. A government bond issued in Germany has a coupon rate of 5%, a face value of 100.00 euros, and matures in five years. The bond pays annual interest payments. Calculate the yield to maturity of the bond (in euros) if the price of the bond is 106.00 euros. A. 5.00% B. 3.80% C. 3.66% D. 6.00% The annual interest payment = (100) × (0.05) = 5 euros. Using a financial calculator: PMT = 5; FV = 100; & N = 5; and PV = -106. Compute: I = 3.66%. Type: Medium 6. Generally, bonds issued in the following countries pay interest semiannually. (I) USA, (II) UK, (III) Canada, (IV) Germany, and (V) Japan A. I, II, III, and IV B. III only C. II, III, and IV only D. I, II, III, and V Type: Medium © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 7. If a bond pays interest semiannually, then it pays interest: A. once per year B. every six months C. every three months D. every two years Type: Easy 8. A three-year bond with 10% coupon rate and $1,000 face value yields 8%. Assuming annual coupon payments, calculate the price of the bond. A. $857.96 B. $951.96 C. $1,000.00 D. $1,051.54 PV = (100/1.08) + (100/(1.08^2)) + (1100/(1.08^3)) = $1,051.54. Alternatively, using a financial calculator: PMT = 100; FV = 1000; N = 3; I = 8. Compute: PV = 1,051.54. Type: Medium 9. A five-year treasury bond with a coupon rate of 8% has a face value of $1,000. What is the semiannual interest payment? A. $80 B. $40 C. $100 D. $50 Annual interest payment = 1000(0.08) = $80. Semiannual payment = 80/2 = $40. Type: Easy © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 10. A three-year bond has an 8.0% coupon rate and a $1,000 face value. If the yield to maturity on the bond is 10.0%, calculate the price of the bond assuming that the bond makes semiannual coupon payments. A. $857.96 B. $949.24 C. $1,057.54 D. $1,000.00 PV = (40/1.05) + (40/(1.05^2)) +... + (1040/(1.05^6)) = $949.24. Alternatively, the semiannual payment = (1000) × (0.08/2) = $40. The semiannual yield = (10%)/2 = 5%. Using a financial calculator: PMT = 40; FV = 1000; N = (3 × 2); I = 5. Compute: PV = 949.24. Type: Difficult 11. A four-year bond has an 8% coupon rate and a face value of $1,000. If the current price of the bond is $878.31, calculate the yield to maturity of the bond (assuming annual interest payments). A. 8% B. 10% C. 12% D. 6% Use trial and error method: (80/1.12) + (80/(1.12^2)) + (80/(1.12^3)) + (1080/(1.12^4)) = $870.51. Therefore, yield to maturity is 12%. Or use a financial calculator: PV = -878.31; N = 4; PMT = 80; FV = 1,000. Compute: I = 12%. Type: Difficult © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 12. A five-year bond with a 10% coupon rate and $1,000 face value is selling for $1,123. Calculate the yield to maturity on the bond assuming annual interest payments. A. 10.0% B. 8.9% C. 7.0% D. 5.0% Use a financial calculator: PV = -1,123; FV = 1,000; PMT = 100, and N = 5. Compute I = 7.0%. Type: Medium 13. Which of the following statements about the relationship between interest rates and bond prices is true? I) There is an inverse relationship between bond prices and interest rates. II) There is a direct relationship between bond prices and interest rates. III) The price of short-term bonds fluctuates more than the price of long-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both). IV) The price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both). A. I and IV only B. I and III only C. II and III only D. II and IV only Type: Difficult © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 14. Consider a bond with a face value of $1,000, an annual coupon rate of 6.0%, a yield to maturity of 8.0%, and 10 years to maturity. This bond's duration is: A. 8.7 years B. 7.6 years C. 10.0 years D. 6.5 years Step 1: N = 10; PMT = 60; FV = 1,000; I = 8. Compute PV = 865.80. Step 2: Duration = [1(55.56) + 2(51.44) + 3(47.63) + 4(44.10) + 5(40.83) + 6(37.81) + 7(35) + 8(32.42) + 9(30.01) + 10(490.99)]/(865.80) = 7.6 years. Type: Difficult 15. A bond has a face value of $1,000, an annual coupon rate of 7%, yield to maturity of 10%, and 20 years to maturity. The bond's duration is: A. 10.0 years B. 7.4 years C. 20.0 years D. 12.6 years Step 1: N = 20; PMT = 70; FV = 1,000; I = 10. Compute PV = 744.59. Step 2: Duration = [((1)(70)/1.1) + ((2)(70)/1.1^2) +... + ((20)(1070)/1.1^20)]/744.59 = 10 years. Type: Difficult © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 16. A bond has a face value of $1,000, a coupon rate of 0%, yield to maturity of 9%, and 10 years to maturity. This bond's duration is: A. 6.7 years B. 7.5 years C. 9.6 years D. 10.0 years Duration is equal to maturity for zero-coupon bonds. Type: Difficult 17. A bond with duration of 10.0 years has a yield to maturity of 10.0%. This bond's volatility is: A. 9.09% B. 6.80% C. 14.6% D. 10.00% Volatility (%) = duration/(1 + yield) = 10/1.10 = 9.09%. Type: Difficult 18. A bond with duration of 5.7 years has a yield to maturity of 9.0%. The bond's volatility is: A. 1.9% B. 5.2% C. 5.7% D. 9.0% Volatility = 5.7/1.09 = 5.2. Type: Difficult © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 19. If a bond's volatility is 10.00% and the interest rate goes down by 0.75% (points), then the price of the bond: A. decreases by 10% B. decreases by 7.5% C. increases by 7.5% D. increases by 0.75% Percentage change in bond price = -(volatility) × (change in interest rates) = -10 × (-0.75) = +7.5% Type: Difficult 20. If a bond's volatility is 5% and its yield to maturity changes by 0.5% (points) then the price of the bond: A. changes by 5% B. changes by 2.5% C. changes by 7.5% D. will not change 5 × 0.5 = 2.5%. Type: Medium 21. The volatility of a bond is given by: I) Duration/(1 + yield) II) Slope of the curve relating the bond price to the interest rate III) Yield to maturity A. I only B. II only C. III only D. I and II only Type: Difficult © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 22. One can best describe the term structure of interest rates as the relationship between: A. spot interest rates and bond prices B. spot interest rates and stock prices C. spot interest rates and time D. yields of coupon bonds and their maturity Type: Difficult 23. The interest rate represented by "r2" is the: A. spot rate on a one-year investment B. spot rate on a two-year investment C. expected spot rate two years from today D. expected spot rate one year from today Type: Easy 24. If the nominal interest rate per year is 10% and the inflation rate is 4%, what is the real rate of interest? A. 10.0% B. 4.1% C. 5.8% D. 14.0% Using Irving Fisher's equation, 1 + rreal = (1 + rnominal)/(1 + rinflation) = 1.1/1.04 = 1.058; r real = 5.8%. Type: Easy © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 25. Mr. X invests $1,000 at a 10% nominal rate for one year. If the inflation rate is 4%, what is the real value of the investment at the end of one year? A. $1,100 B. $1,000 C. $1,058 D. $1,040 Real investment = (1000 × 1.10)/(1.04) = $1,058. Type: Medium 26. Which bond is more sensitive to an interest rate change of 0.75%? Bond A: YTM = 4.00%, maturity = 8 years, coupon = 6% or $60, par value = $1,000. Bond B: YTM = 3.50%, maturity = 5 years, coupon = 7% or $70, par value = $1,000. A. bond A B. bond B C. both are equally sensitive D. cannot be determined Volatility increases with duration. A relatively longer maturity or a relatively smaller coupon are both features that extend a bond's duration. The price of bond A decreases from 1,134 to 1,108. Bond B decreases in price from 1,158 to 1,121. Bond A drops by 4.67% while Bond B drops by 3.15%. Type: Difficult 27. As CFO of your corporation, you would prefer (all else equal) to see the price of your corporation's bonds: A. increase, indicating that bond investors view your firm as less risky B. decrease, indicating that bond investors view your firm as less risky C. increase, indicating that bond investors view your firm as more willing to take risks D. decrease, indicating that bond investors view your firm as more willing to take risks Lower perceived risk implies a lower spread and a higher bond price. For a given bond issue, the CFO can receive more funding. Type: Difficult © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 28. Which of the following bonds has the longest duration? A. five-year coupon bond B. five-year, zero-coupon bond C. ten-year coupon bond D. ten-year, zero-coupon bond Type: Easy 29. Which of the following bonds has the greatest volatility? A. five-year coupon bond B. five-year, zero-coupon bond C. ten-year coupon bond D. ten-year, zero-coupon bond Type: Medium True / False Questions 30. The yield to maturity on a bond is really its internal rate of return. TRUE Type: Easy 31. In the U.S., most bonds make coupon payments annually. FALSE Type: Easy 32. The duration of any bond is the same as its maturity. FALSE Type: Difficult 33. The duration of a zero-coupon bond is the same as its maturity. TRUE Type: Medium © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.