Fundamentals of Investing, 11e (Gitman/Joehnk/Smart)
Chapter 11 Bond Valuation
1) The real rate of interest is the risk free rate minus the inflation premium.
2) The risk premium component of a bond’s market interest rate is related to the characteristics of
the particular bond and its issuer.
3) The risk-free rate of return considers the expected rate of inflation.
4) As the Federal Government’s budget deficit rises, interest rates tend to fall.
5) Municipal bonds usually have higher yields than bonds issued by the U. S. Government.
6) The higher a bond’s Moody’s or Standard & Poors rating, the higher its yield.
7) Changes in the inflation rate have a direct and pronounced effect on market interest rates.
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.
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.
10) Rank the following taxable bonds from lowest yielding to highest yielding.
I. U.S. Treasury bonds
II. Corporate bonds
III. Agency bonds
A) I, II, III
B) II, I, III
C) III, II, I
D) I, III, II
11) Which of the following factors will tend to cause the risk free rate to rise?
I. An increase in the money supply.
II. An increase in the federal budget deficit.
III. An increase in the level of economic activity.
IV. Falling rates in foreign markets.
A) I, II, III only
B) II, III only
C) I and IV
D) I, II, III, and IV
12) Which of the following statements concerning bonds are correct?
I. Municipal bond interest is federally tax-free.
II. Bond yields are related to bond ratings.
III. General obligation bonds yield more than revenue bonds.
IV. At the time of issue, callable bonds have higher yields than noncallable bonds.
A) I and III only
B) II and IV only
C) I, II and IV only
D) I, II and III only
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
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
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.
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.
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.
2) A yield curve depicts the term structure of interest rates for similar-risk securities.
3) Predicting the direction of interest rate movements is relatively easy.
4) Treasury bond yields are commonly used as the basis for yield curves because they are low
risk and homogeneous in nature.
5) A normal yield curve is flat or downward sloping.
6) The real rate of return is the same for all maturities.
7) A flat or downward sloping yield curve indicates that the economy may be heading toward a
recession.
8) According to the expectations hypothesis, if investors anticipate higher rates of inflation in the
future, the yield curve will be downsloping.
9) According to the liquidity preference theory, borrowers should pay a higher interest rate for
long-term borrowing than for short-term borrowing.
10) A down-sloping yield curve indicates that interest rates are about to rise.
11) A steep yield curve is generally considered a bullish sign for bonds.
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.
13) An inverted yield curve
A) means that long-term bonds are yielding more than short-term bonds.
B) exists when intermediate-term bonds have higher yields than either short-term or long-term
bonds.
C) rewards long-term investors for the additional risk they are assuming.
D) generally results from actions by the Federal Reserve to control inflation.
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.
15) According to the expectations hypothesis, investors’ expectations of decreasing inflation will
result in
A) a downward-sloping yield curve.
B) an upward-sloping yield curve.
C) a flat yield curve.
D) a humped yield curve.
16) 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.
17) 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
18) The liquidity preference theory supports ________ yield curves.
A) upsloping
B) flat
C) humped
D) downsloping
19) 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.
20) Market segmentation theory explains the typical upward sloping shape of yield curves as a
function of
A) normally greater demand for long-term bonds than for short-term notes.
B) normally greater demand for short term notes than for long-term bonds.
C) expectations that inflation will be higher in the future than it is now.
D) the greater liquidity of short-term notes as compared to long-term bonds.
21) At any given time, the yield curve is affected by
I. lender preferences.
II. inflationary expectations.
III. liquidity preferences.
IV. short- and long-term supply and demand conditions.
A) I and IV only
B) II, III, and IV only
C) I, II and III only
D) I, II, III and IV
22) If the yield curve begins to rise sharply, it is usually an indication that
A) stocks are offering low returns as the economy enters a recession.
B) inflation rates have peaked and are about to decline.
C) bond prices are expected to increase.
D) inflation is starting to increase, or is expected to do so in the near future.
23) Evidence indicates that the theory of interest rates with the most predictive power is
A) market segmentation theory.
B) expectations theory.
C) liquidity preference theory.
D) a combination of expectations, market expectations and liquidity preference.
24) If inflation is expected to increase significantly, cautious bondholders should
A) expect interest rates to rise.
B) expect a flat yield curve for the intermediate-term.
C) buy long-term bonds today.
D) move to the short-end of the yield curve.
25) Explain how a yield curve is constructed and what its shape reveals about interest rates.
1) If a bond’s yield to maturity is lower than its coupon rate, the bond will sell at a discount.
2) A bond’s discount or premium will tend to increase as the bond approaches its maturity date.
3) The price of a bond is equal to the present value of the bond’s future cash flows.
4) Bonds with the same level of risk, the same maturity, and the same coupon rate will always
sell for the same price whether the interest is paid annually, semi-annually or quarterly.
5) The shorter the time to maturity, the less sensitive a bond’s price will be to changes in interest
rates.
6) A significant portion of a coupon bond’s total return is derived from the reinvestment of the
interest payments.
7) The price of a bond with an 8% coupon rate paid semi-annually and a par value of $1,000, and
fifteen years to maturity is the present value of
A) 15 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
B) 15 payments of $80 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
C) 30 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
D) 30 payments of $80 at 1 year intervals plus $1,000 received at the end of the 30th year.
8) What is the current price of a 9%, $1,000 annual coupon bond that has eighteen years to
maturity and a yield to maturity of 9.631%?
A) $898
B) $935
C) $942
D) $947
9) What is the coupon rate of an annual bond that has a yield to maturity of 8.5%, a current price
of $942.32, a par value of $1,000 and matures in thirteen years?
A) 7.67%
B) 7.75%
C) 8.33%
D) 8.50%
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Copyright © 2011 Pearson Education, Inc.
10) What is the current price of a $1,000, 6% coupon bond that pays interest semi-annually if the
bond matures in ten years and has a yield–to-maturity of 7.1325%?
A) $567
B) $920
C) $1,030
D) $1,080
11) What is the yield-to-maturity of a $1,000, 7% semi-annual coupon bond that matures in 2
years and currently sells for $997.07?
A) 6.87%
B) 7.04%
C) 7.16%
D) 7.31%
12) Which of the following are needed to determine the appropriate value of a bond?
I. required rate of return
II. time to maturity
III. frequency of interest payments
IV. coupon rate
A) II and III only
B) III and IV only
C) II, III and IV only
D) I, II, III and IV
13) A $1,000 par value, 12-year annual bond carries a coupon rate of 7%. If the current yield of
this bond is 7.995%, its market price to the nearest dollar is
A) $876.
B) $925.
C) $1,075.
D) $1,125.
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Copyright © 2011 Pearson Education, Inc.
11.4 Learning Goal 4
1) There is normally an indirect relationship between the coupon rate of a bond and the bond’s
yield.
2) Generally speaking, long-term bonds have lower yields than short-term bonds.
3) A basis point is 1/10 of 1%.
4) Bond yields are set by the bond issuer.
5) The required return defines the yield at which a bond should be trading and serves as the
discount rate in the bond valuation process.
6) A bond’s yield to maturity is equal to the internal rate of return of its cash flows.
7) The actual return earned on a bond is highly dependent upon the reinvestment rate of the
coupons.
8) Yield-to-call assumes a bond is called on the last possible date.