57) The yield to maturity for a discount bond is ________ related to the current bond price.
A) negatively
B) positively
C) not
D) directly
58) A discount bond is also called a ________ because the owner does not receive periodic
payments.
A) zero-coupon bond
B) municipal bond
C) corporate bond
D) consol
59) Another name for a consol is a ________ because it is a bond with no maturity date. The
owner receives fixed coupon payments forever.
A) perpetuity
B) discount bond
C) municipality
D) high-yield bond
60) If the interest rate is 5%, what is the present value of a security that pays you $1, 050 next
year and $1,102.50 two years from now? If this security sold for $2200, is the yield to maturity
greater or less than 5%? Why?
4.2 The Distinction Between Interest Rates and Returns
1) The ________ is defined as the payments to the owner plus the change in a security’s value
expressed as a fraction of the security’s purchase price.
A) yield to maturity
B) current yield
C) rate of return
D) yield rate
2) Which of the following are TRUE concerning the distinction between interest rates and
returns?
A) The rate of return on a bond will not necessarily equal the interest rate on that bond.
B) The return can be expressed as the difference between the current yield and the rate of capital
gains.
C) The rate of return will be greater than the interest rate when the price of the bond falls during
the holding period.
D) The return can be expressed as the sum of the discount yield and the rate of capital gains.
3) The sum of the current yield and the rate of capital gain is called the
A) rate of return.
B) discount yield.
C) perpetuity yield.
D) par value.
4) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for
$1,200 next year?
A) 5 percent
B) 10 percent
C) -5 percent
D) 25 percent
5) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900
next year?
A) 5 percent
B) 10 percent
C) -5 percent
D) -10 percent
6) The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $950 next
year is
A) -10 percent.
B) -5 percent.
C) 0 percent.
D) 5 percent.
7) Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to
maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent
over the course of the year, what is the yearly return on the bond you are holding?
A) 5 percent
B) 10 percent
C) 15 percent
D) 20 percent
8) I purchase a 10 percent coupon bond. Based on my purchase price, I calculate a yield to
maturity of 8 percent. If I hold this bond to maturity, then my return on this asset is
A) 10 percent.
B) 8 percent.
C) 12 percent.
D) there is not enough information to determine the return.
9) If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which
bond would you prefer to have been holding?
A) a bond with one year to maturity
B) a bond with five years to maturity
C) a bond with ten years to maturity
D) a bond with twenty years to maturity
10) An equal decrease in all bond interest rates
A) increases the price of a five-year bond more than the price of a ten-year bond.
B) increases the price of a ten-year bond more than the price of a five-year bond.
C) decreases the price of a five-year bond more than the price of a ten-year bond.
D) decreases the price of a ten-year bond more than the price of a five-year bond.
11) An equal increase in all bond interest rates
A) increases the return to all bond maturities by an equal amount.
B) decreases the return to all bond maturities by an equal amount.
C) has no effect on the returns to bonds.
D) decreases long-term bond returns more than short-term bond returns.
12) Which of the following are generally TRUE of bonds?
A) A bond’s return equals the yield to maturity when the time to maturity is the same as the
holding period.
B) A rise in interest rates is associated with a fall in bond prices, resulting in capital gains on
bonds whose terms to maturity are longer than the holding periods.
C) The longer a bond’s maturity, the smaller is the size of the price change associated with an
interest rate change.
D) Prices and returns for short-term bonds are more volatile than those for longer-term bonds.
13) Which of the following are generally TRUE of all bonds?
A) The longer a bond’s maturity, the greater is the rate of return that occurs as a result of the
increase in the interest rate.
B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative
if interest rates rise.
C) Prices and returns for short-term bonds are more volatile than those for longer term bonds.
D) A fall in interest rates results in capital losses for bonds whose terms to maturity are longer
than the holding period.
14) The riskiness of an asset’s returns due to changes in interest rates is
A) exchange-rate risk.
B) price risk.
C) asset risk.
D) interest-rate risk.
15) Interest-rate risk is the riskiness of an asset’s returns due to
A) interest-rate changes.
B) changes in the coupon rate.
C) default of the borrower.
D) changes in the asset’s maturity.
16) Prices and returns for ________ bonds are more volatile than those for ________ bonds,
everything else held constant.
A) long-term; long-term
B) long-term; short-term
C) short-term; long-term
D) short-term; short-term
7) There is ________ for any bond whose time to maturity matches the holding period.
A) no interest-rate risk
B) a large interest-rate risk
C) rate-of-return risk
D) yield-to-maturity risk
18) All bonds that will not be held to maturity have interest rate risk which occurs because of the
change in the price of the bond as a result of
A) interest-rate changes.
B) changes in the coupon rate.
C) default of the borrower.
D) changes in the asset’s maturity date.
19) Your favorite uncle advises you to purchase long-term bonds because their interest rate is
10%. Should you follow his advice?
4.3 The Distinction Between Real and Nominal Interest Rates
1) The ________ interest rate is adjusted for expected changes in the price level.
A) ex ante real
B) ex post real
C) ex post nominal
D) ex ante nominal
2) The ________ interest rate more accurately reflects the true cost of borrowing.
A) nominal
B) real
C) discount
D) market
3) The nominal interest rate minus the expected rate of inflation
A) defines the real interest rate.
B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest
rate.
C) is a less accurate indicator of the tightness of credit market conditions than is the nominal
interest rate.
D) defines the discount rate.
4) When the ________ interest rate is low, there are greater incentives to ________ and fewer
incentives to ________.
A) nominal; lend; borrow
B) real; lend; borrow
C) real; borrow; lend
D) market; lend; borrow
5) The interest rate that describes how well a lender has done in real terms after the fact is called
the
A) ex post real interest rate.
B) ex ante real interest rate.
C) ex post nominal interest rate.
D) ex ante nominal interest rate.
6) The ________ states that the nominal interest rate equals the real interest rate plus the
expected rate of inflation.
A) Fisher equation
B) Keynesian equation
C) Monetarist equation
D) Marshall equation
7) If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the
real rate of interest is
A) 2 percent.
B) 8 percent.
C) 10 percent.
D) 12 percent.
8) In which of the following situations would you prefer to be the lender?
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.
9) In which of the following situations would you prefer to be the borrower?
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.
10) If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is
A) 7 percent.
B) 22 percent.
C) -15 percent.
D) -8 percent.
11) If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is
A) -5 percent.
B) -2 percent.
C) 2 percent.
D) 12 percent.
12) If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is
A) -3 percent.
B) -2 percent.
C) 3 percent.
D) 7 percent.
13) In the United States during the late 1970s, the nominal interest rates were quite high, but the
real interest rates were negative. From the Fisher equation, we can conclude that expected
inflation in the United States during this period was
A) irrelevant.
B) low.
C) negative.
D) high.
14) The interest rate on Treasury Inflation Indexed Securities can be roughly interpreted as
A) the real interest rate.
B) the nominal interest rate.
C) the rate of inflation.
D) the rate of deflation.
15) Assuming the same coupon rate and maturity length, the difference between the yield on a
Treasury Inflation Indexed Security and the yield on a nonindexed Treasury security provides
insight into
A) the nominal interest rate.
B) the real interest rate.
C) the nominal exchange rate.
D) the expected inflation rate.
16) Assuming the same coupon rate and maturity length, when the interest rate on a Treasury
Inflation Indexed Security is 3 percent, and the yield on a nonindexed Treasury bond is 8
percent, the expected rate of inflation is
A) 3 percent.
B) 5 percent.
C) 8 percent.
D) 11 percent.
17) Would it make sense to buy a house when mortgage rates are 14% and expected inflation is
15%? Explain your answer.
4.4 Web Appendix: Measuring Interest-Rate Risk: Duration
1) Duration is
A) an asset’s term to maturity.
B) the time until the next interest payment for a coupon bond.
C) the average lifetime of a debt security’s stream of payments.
D) the time between interest payments for a coupon bond.
2) Comparing a discount bond and a coupon bond with the same maturity
A) the coupon bond has the greater effective maturity.
B) the discount bond has the greater effective maturity.
C) the effective maturity cannot be calculated for a coupon bond.
D) the effective maturity cannot be calculated for a discount bond.
3) The duration of a coupon bond increases
A) the longer is the bond’s term to maturity.
B) when interest rates increase.
C) the higher the coupon rate on the bond.
D) the higher the bond price.
4) All else equal, when interest rates ________, the duration of a coupon bond ________.
A) rise; falls
B) rise; increases
C) falls; falls
D) falls; does not change
5) All else equal, the ________ the coupon rate on a bond, the ________ the bond’s duration.
A) higher; longer
B) higher; shorter
C) lower; shorter
D) greater; longer
6) If a financial institution has 50% of its portfolio in a bond with a five-year duration and 50%
of its portfolio in a bond with a seven-year duration, what is the duration of the portfolio?
A) 12 years
B) 7 years
C) 6 years
D) 5 years
7) An asset’s interest rate risk ________ as the duration of the asset ________.
A) increases; decreases
B) decreases; decreases
C) decreases; increases
D) remains constant; increases