978-0134083308 Chapter 11 Part 1

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Fundamentals of Investing, 13e (Smart)

Chapter 11 Bond Valuation

11.1 Learning Goal 1

1) The interest rate on the 10 year Treasury Bond has rarely fallen below the rate of inflation.

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2) The risk premium component of a bond’s market interest rate is related to the characteristics

of the particular bond and its issuer.

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3) The risk-free rate of return considers the expected rate of inflation.

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4) Actions by the Federal Reserve can keep the risk-free rate below the rate of inflation, at least

temporarily.

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5) Municipal bonds usually have higher yields than bonds issued by the U. S. Government.

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6) The higher a bond’s Moody’s or Standard & Poor’s rating, the higher its yield.

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7) Changes in the inflation rate have a direct and pronounced effect on market interest rates.

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8) The required return on a bond is equal to

A) the real rate of return plus a risk premium plus an expected inflation premium.

B) the real rate of return plus the coupon rate plus an inflation rate.

C) the risk-free rate plus a risk premium plus an expected inflation premium.

D) the real rate plus a risk premium.

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9) The risk-free rate of return is equal to the

A) real rate plus a risk premium.

B) required return minus the inflation premium.

C) real rate plus the inflation premium.

D) required return minus the real rate.

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10) Which of the following tend to raise interest rates?

I. an increase in the money supply

II. an increase in the expected rate of inflation

III. Federal Reserve actions taken to lower expected rates of inflation

IV. an increase in investing activities by businesses

A) I, II, III only

B) II, III, IV only

C) I, II and IV only

D) I, III, and IV only

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11) Interest rates in the U.S. and in major foreign economies

A) are uncorrelated or very weakly correlated.

B) tend to move in opposite directions.

C) tend to move in the same direction.

D) are the same when adjusted for inflation.

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12) Which of the following factors influence short-term interest rates on government securities?

I. Federal Reserve actions

II. interest rate risk

III. expected future inflation

IV. the real rate of return

A) I and III only

B) II and IV only

C) I, II and IV only

D) I, III and IV only

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13) Which of the following risks are included in the risk premium?

I. interest rate risk

II. liquidity risk

III. financial risk

IV. purchasing power risk

A) I and II only

B) II and III only

C) III and IV only

D) I and IV only

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14) Which one of the following will tend to cause domestic interest rates to rise?

A) an increase in the money supply

B) a decrease in the rate of inflation

C) a decrease in the federal budget deficit

D) an increase in interest rates overseas

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15) The single most important factor that influences the behavior of market interest rates is

A) inflation.

B) business profits.

C) the supply of new bonds.

D) the stock market.

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16) Which one of the following statements concerning interest rates is correct?

A) A decrease in the money supply will cause interest rates to decline.

B) A federal budget surplus will cause interest rates to decline.

C) Economic expansions will cause interest rates to decline.

D) Rising interest rates in foreign countries will cause U.S. interest rates to decline.

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11.2 Learning Goal 2

1) The relationship between the rate of return and the time to maturity of similar-risk securities

is known as the term structure of interest rates.

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2) A yield curve depicts the term structure of interest rates for similar-risk securities.

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3) Yield curves for corporate and government securities have similar shapes, but the corporate

rates track below the government rates.

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4) Treasury bond yields are commonly used as the basis for yield curves because they are low

risk and homogeneous in nature.

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5) A normal yield curve is flat or downward sloping.

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6) A downward sloping yield curve (short-term rates are higher than long-term rates) often

precedes a recession.

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7) The real rate of return is the same for all maturities.

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8) According to the expectations hypothesis, if investors anticipate higher rates of inflation in

the future, the yield curve will be downsloping.

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9) According to the liquidity preference theory, borrowers should pay a higher interest rate for

long-term borrowing than for short-term borrowing.

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10) Market segmentation theory would explain an upward sloping yield curve as a high demand

for short-term securities relative to the supply.

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11) A steep yield curve is generally considered a bullish sign for bonds.

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12) The yield curve depicts the relationship between a bond’s yield to maturity and its

A) duration.

B) term to call.

C) term to maturity.

D) volatility.

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13) An inverted yield curve

A) means that long-term bonds are yielding more than short-term bonds.

B) results when investor demand for longer maturities exceeds the demand for shorter

maturities.

C) rewards long-term investors for the additional risk they are assuming.

D) sometimes results from actions by the Federal Reserve to control inflation.

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14) The expectations hypothesis states that investors

A) require higher long-term interest rates today if they expect higher inflation rates in the

future.

B) expect higher long-term interest rates because of the lack of liquidity for long-term bonds.

C) require the real rate of return to rise in direct proportion to the length of time to maturity.

D) normally expect the yield curve to be downsloping.

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15) According to expectations theory if the 1 year interest is 3% this year and expected to be

5% next year, the 2 year interest rate should be approximately

A) 8%.

B) 5%.

C) 4%.

D) 3%.

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16) According to expectations theory if the 2 year interest rate is 4% and the 1 year rate is now

3%, the 1 year rate next year is expected to be

A) 8%.

B) 5%.

C) 4%.

D) 3%.

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17) Downward sloping or flat yield curves often indicate

A) a recession in the near future.

B) an economic expansion in the near future.

C) higher inflation in the near future.

D) a weaker dollar in the foreign exchange markets.

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18) Long-term bonds are ________ than short-term bonds.

A) less risky

B) more liquid

C) subject to more uncertainty

D) less sensitive to interest rate changes

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19) When compared to the yield curve for Treasury securities, the yield curve for corporate

securities should

A) slope in the opposite direction.

B) be similar in shape but higher.

C) be similar in shape but lower.

D) be nearly identical.

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20) The liquidity preference theory supports ________ yield curves.

A) upward sloping

B) flat

C) humped

D) downward sloping

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21) The market segmentation theory holds that

A) an increase in demand for long-term borrowings leads to an inverted yield curve.

B) expectations about the future level of interest rates is the major determinant of the shape of

the yield curve.

C) the yield curve reflects the maturity preferences of financial institutions and investors.

D) the shape of the yield curve is always downsloping.

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