Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
61. If the U.S. government’s borrowing needs increase, in the bond market this would be seen
as:
D. The bond supply curve shifting left
62. If the U.S. government’s borrowing needs increase, in the bond market this would be seen
as:
A. The bond demand curve shifting right
63. As general business conditions improve, we would witness the following in the bond
market:
A. The bond demand curve shifting left
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
64. As general business conditions deteriorate, all other factors constant:
D. Bond yields will increase
65. As general business conditions improve, all other factors constant:
D. The bond supply curve shifts left
66. As general business conditions deteriorate, all other factors constant:
D. The price of bonds will decrease
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
67. When expected inflation increases, for any given nominal interest rate:
68. When expected inflation decreases for any given nominal interest rate, all of the following
D. The price of bonds increases
69. When expected inflation increases, for any given nominal interest rate:
D. The yield on bonds will increase
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
70. When expected inflation increases, for any given nominal interest rate:
A. The real cost of repayment for bond issuers increases
71. If the federal government were to offer larger tax breaks on the purchase of new
equipment for businesses, all other factors constant, we would expect to see:
72. Which of the following would lead to an increase in bond supply?
A. A decrease in government spending relative to revenue
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
D. A decrease in liquidity
74. An increase in the nation’s wealth, all other factors constant, would cause the:
A. Bond supply curve to shift left
75. An increase in the nation’s wealth, all other factors constant, would cause:
A. Bond prices to fall and yields to increase
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
76. A decrease in the nation’s wealth, all other factors constant:
D. Would cause the bond supply curve to shift left
77. An increase in expected inflation for any given nominal interest rate will cause:
A. The bond supply curve to shift to the left
78. A decrease in expected inflation for any given nominal interest rate will cause:
D. The bond supply curve to shift to the left
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
79. An increase in expected inflation for any given nominal interest rate will cause:
D. The price of bonds to increase
80. Suppose that the expected return on bonds falls relative to other assets. In the bond market
this will result in:
A. The bond supply curve shifting left
81. Suppose that the return on assets other than bonds falls. In the bond market this will result
in:
A. A movement down the bond demand curve
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
82. The return on bonds rises relative to other assets, in the bond market this will result in:
A. The price of bonds falling and the yields increasing
83. If interest rates are expected to rise, the bond prices will:
D. Move in the same direction as the expected change in interest rates
84. If interest rates are expected to fall, bond prices will:
A. Fall as the demand for bonds decreases
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
85. Suppose that general business conditions improve, and at the same time, wealth increases.
Based on this information, we know that:
A. Bond prices increase
86. If the risk on foreign government bonds increases relative to U.S. government bonds, the
price of U.S. government bonds should:
A. Not change since U.S. government bonds are free of default risk
87. The demand for U.S. government bonds is high relative to other bond issues because:
A. The liquidity of other bond issues is high relative to U.S. government bonds
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
88. The impact of a decrease in expected inflation in the bond market will have a relatively
large effect on the prices of bonds prices because:
D. The bond demand curve will shift left as the bond supply curve shifts right
89. Which of the following statements about the result of a deterioration in business
conditions that also causes a decrease in a nation’s wealth is false?
A. The impact on bond prices will be ambiguous since both the bond demand and supply
curves shift left
90. Fly-By-Night Inc. issues $100 face value, zero-coupon, one-year bonds. The current
return on one-year, zero-coupon U.S. government bonds is 3.5%. If the Fly-By-Night bonds
are selling for $92.00, what is the risk premium for these bonds?
A. 8.7%
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
91. Default risk is the risk associated with:
D. Changes in the expected inflation rate
D. A 20-year corporate bond
93. Consider a zero-coupon bond with a $1,100 payment in one year. Suppose the interest rate
decreases from 10% to 8%. The price of this bond:
D. Decreases from $1,210 to $1,188
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
94. Consider a one-year corporate bond that has a 20% probability of default. The payoff on
the bond is $2,000 if the corporation does not default. The interest rate is 10%. If buyers of
this bond are risk-neutral, this bond will sell for:
95. A student receives a five-year loan to pay for a $2,000 used car. The lender and the
student agree to an 8% interest rate on a fixed-rate loan. Expected inflation was estimated to
equal 2.5%, but unexpectedly decreases to 2%. Which of the following is true?
D. Both the student and the lender benefit
96. Which of the following is true of interest-rate risk?
A. It is the risk that the coupon rate for a bond will change, affecting current bondholders’
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
97. U.S. government bonds that provide for bondholders to receive a fixed rate of interest plus
the change in the consumer price index were designed to remove:
98. The U.S. Treasury has introduced bonds where the return is indexed to the consumer price
index. We should expect that these bonds, relative to other U.S. Treasury bonds, will have:
A. Lower price and lower return due to the decreased risk
99. Interest-rate risk results from:
D. Inflation being uncertain
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
6-34
100. Interest-rate risk would not matter to which of the following bondholders?
A. A holder of a U.S. government bond
Short Answer Questions
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
101. Suppose a family member approaches you to borrow $2,000 for the down payment on an
automobile. You have the cash available in a savings account that currently earns 5% annual
interest. You and the family member consider the following repayment options:
(i) Borrower repays you $100 each year indefinitely.
(ii) Borrower repays $259 each year over the next ten years.
(iii) Borrower repays $300 each year over the next five years, plus a lump-sum payment of
$895 in the fifth year.
(iv) Borrower repays you $2,100 at the end of one year.
For each of the options above, show that the present values of each option are approximately
equal. Then, relate each of the options above to the four types of bonds, indicating which
option is equivalent to which type of bond. Explain why.
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
102. Consider a $1,000.00 face value bond with a $55 annual coupon and 10 years until
maturity. Calculate the current yield; the coupon rate and the yield to maturity under each of
the following:
a) The bond is purchased for $940.00
b) The bond is purchased for $1,130.00
c) The bond is purchased for $1,000.00
103. Calculate the holding period return for a $1,000 face value bond with a $60 annual
coupon purchased for $970.00 and sold three years later for $1,060.00.
104. Could the holding period return ever be less than the yield to maturity? Explain.
Chapter 06 – Bonds, Bond Prices, and the Determination of Interest Rates
105. Use the example of a consol to show how bond prices and yields are inversely related.
106. Suppose a Treasury bill has a purchase price of $9,865.50; a face value of $10,000 and
90 days to maturity. Calculate the yield to maturity and the yield on a discount basis.