6

61. The coupon rate of a bond equals:

A. Its yield to maturityB. A percentage of its priceC. The maturity valueD. A percentage of the par value

2. Periodic receipts of interest by the bondholder are known as:

A. The coupon rateB. A zero-couponC. Coupon paymentsD. The default premium

3. Which of the following presents the correct relationship? As the coupon rate of a bond increases, the bond's:

A. Face value increasesB. Current price decreasesC. Interest payments increaseD. Maturity date is extended

4. What happens when a bond's expected cash flows are discounted at a rate lower than the bond's coupon rate?

A. The price of the bond increasesB. The coupon rate of the bond increasesC. The par value of the bond decreasesD. The coupon payments will be adjusted to the new discount rate

5. When an investor purchases a $1,000 par value bond that was quoted at 97.16, the investor:

A. Receives 97.5 percent of the stated coupon paymentsB. Receives $975 upon the maturity date of the bondC. Pays 97.5 percent of face value for the bondD. Pays $1,025 for the bond

6. How much does the $1,000 to be received upon a bond's maturity in four years add to the bond's price if the appropriate discount rate is 6 percent?

A. $209.91B. $260.00C. $760.00D. $792.09

7. The face value of a bond is received by the bondholder:

A. At the time of purchaseB. AnnuallyC. Whenever coupon payments are madeD. At maturity

8. How much should you pay for a $1,000 bond with 10 percent coupon, annual payments, and five years to maturity if the interest rate is 12 percent?

A. $927.90B. $981.40C. $1,000.00D. $1,075.82

9. How much would an investor expect to pay for a $1,000 par value bond with a 9 percent annual coupon that matures in 5 years if the interest rate is 7 percent?

A. $696.74B. $1,075.82C. $1,082.00D. $1,123.01

10. Which of the following statements is correct for a 10 percent coupon bond that has a current yield of 13 percent?

A. The face value of the bond has decreasedB. The bond's maturity value exceeds the bond's priceC. The bond's internal rate of return is 13 percentD. The bond has few years remaining until maturity

11. If an investor purchases a bond when its current yield is less than the coupon rate, then the bond's price will be expected to:

A. Decline over time, reaching par value at maturityB. Increase over time, reaching par value at maturityC. Be less than the face value at maturityD. Exceed the face value at maturity

12. The current yield of a bond can be calculated by:

A. Multiplying the price by the coupon rateB. Dividing the price by the annual coupon paymentsC. Dividing the price by the par valueD. Dividing the annual coupon payments by the price

13. What is the current yield of a bond with a 6 percent coupon, four years until maturity, and a price of $750?

A. 6.0 percentB. 8.0 percentC. 12.0 percentD. 14.7 percent

14. A bond's face value can also be called its:

A. Coupon paymentB. Present valueC. Default valueD. Par value

15. A bond's yield to maturity takes into consideration:

A. Current yield but not price changes of a bondB. Price changes but not current yield of a bondC. Both current yield and price changes of a bondD. Neither current yield nor price changes of a bond

16. The discount rate that makes the present value of a bond's payments equal to its price is termed the:

A. Rate of returnB. Yield to maturityC. Current yieldD. Coupon rate

17. What is the coupon rate for a bond with three years until maturity, a price of $1,053.46, and a yield to maturity of 6 percent?

A. 6 percentB. 8 percentC. 10 percentD. 11 percent

18. What is the yield to maturity for a bond paying $100 annually that has six years until maturity and sells for $1,000?


19. What happens to the price of a three-year bond with an 8 percent coupon when interest rates change from 8 percent to 6 percent?

A. A price increase of $51.54B. A price decrease of $51.54C. A price increase of $53.47D. No change in price

20. Which of the following factors will change when interest rates change?

A. The expected cash flows from a bondB. The present value of a bond's paymentsC. The coupon payment of a bondD. The maturity value of a bond

21. What happens to the coupon rate of a bond that pays $80 annually in interest if interest rates change from 9 percent to 10 percent?

A. The coupon rate increases to 10 percentB. The coupon rate remains at 9 percentC. The coupon rate remains at 8 percentD. The coupon rate decreases to 8 percent

22. Which of the following is fixed (e.g., cannot change) for the life of a given bond?

A. Current priceB. Current yieldC. Yield to maturityD. Coupon payment

23. What is the rate of return for an investor who pays $1,054.47 for a three-year bond with a 7 percent coupon and sells the bond one year later for $1,037.19?


24. Which of the following is correct when a bond investor's rate of return for a particular period exceeds the bond's coupon rate?

A. The bond increased in price during the periodB. The bond decreased in price during the periodC. The coupon payment increased during the periodD. It is not possible for a bondholder's rate of return to exceed the bond's coupon rate

25. What is the relationship between an investment's rate of return and its yield to maturity for an investor that does not hold a bond until maturity?

A. Rate of return is lower than yield to maturityB. Rate of return is higher than yield to maturityC. Rate of return equals yield to maturityD. There is no predetermined relationship

26. If the coupon rate is lower than current interest rates, then the yield to maturity will be:

A. Lower than current interest ratesB. Equal to the coupon rateC. Higher than the coupon rateD. Lower than the coupon rate

27. If a four-year bond with a 7 percent coupon and a 10 percent yield to maturity is currently worth $904.90, how much will it be worth one year from now if interest rates are constant?

A. $904.90B. $925.39C. $947.93D. $1,000.00

28. What price will be paid for a Canadian government bond with an ask price of 122.28?

A. $1,122.28B. $1,228.88C. $1,280.00D. $1,222.80

29. What price was reported in the financial press for a bond that was sold to an investor for $1,045.63?

A. 95.14B. 95.44C. 104.563D. 104.56

30. How does a bond dealer generate profits when trading bonds?

A. By maintaining bid prices lower than ask pricesB. By maintaining bid prices higher than ask pricesC. By retaining the bond's next coupon paymentD. By lowering the bond's coupon rate

31. Which of the following is correct for a bond priced at $1,100 that has ten years remaining until maturity, and a 10 percent coupon, with semi-annual payments?

A. Each payment of interest equals $50B. Each payment of interest equals $55C. Each payment of interest equals $100D. Each payment of interest equals $110

32. The yield curve depicts the current relationship between:

A. Bond yields and default riskB. Bond maturity and bond ratingsC. Bond yields and maturityD. Promised yields and default premiums

33. When the yield curve is upward-sloping, then:

A. Short-maturity bonds offer high coupon ratesB. Long-maturity bonds are priced above par valueC. Short-maturity bonds yield less than long-maturity bondsD. Long-maturity bonds increase in price when interest rates increase

34. Canada bond yields do not contain a:

A. Coupon interest paymentB. Nominal interest rateC. Default premiumD. Yield to maturity

35. When riskier corporations issue bonds that include a default premium, the promised yield will sometimes be:

A. less than the actual yieldB. greater than the actual yieldC. less than the yield on a default-free bondD. greater than the face value of the bond

36. The purpose of a floating-rate bond is to:

A. Save interest expense for corporate issuersB. Avoid making interest payments until maturityC. Shift the yield curveD. Offer rates adjusted to current market conditions

37. Which of the following would not be associated with a zero-coupon bond?

A. Yield to maturityB. Discount bondC. Current YieldD. Interest-rate risk

38. Which of the following bonds would be likely to exhibit a greater degree of interest-rate risk?

A. A coupon-paying bond with 5 years until maturityB. A coupon-paying bond with 20 years until maturityC. A floating-rate bond with 20 years until maturityD. A zero-coupon bond with 30 years until maturity

39. By how much will a bond increase in price over the next year if it currently sells for $925, has five years until maturity, and an annual coupon rate of 7%?

A. $8.26B. $8.92C. $12.55D. $15.00

40. Where does a "convertible bond" get its name?

A. The option of converting into shares of common stockB. The option of increasing its coupon payments when interest rates increaseC. The option of converting from zero-coupon to coupon-paying bondD. The option of increasing yield without decreasing price

41. Which one of the following identifies the distinction between a Canada bond and a corporate bond?

A. Canada bonds make coupon payments; corporate bonds do notB. Corporate bonds have default risk; Canada bonds do notC. Corporate bonds have longer termsD. Canada bonds have higher yields

42. Which of the following is correct for a bond currently selling at a premium to par?

A. Its current yield is higher than its coupon rateB. Its current yield is lower than its coupon rateC. Its yield to maturity is higher than its coupon rateD. Its default risk is extremely low

43. What is the yield to maturity of a bond with the following characteristics? Coupon rate is 8 percent with semi-annual payments; current price is $960, three years until maturity.


44. Capital losses will automatically be the case for bond investors who buy:

A. Discount bondsB. Premium bondsC. Zero-coupon bondsD. Junk bonds

45. Investors who own bonds having lower credit ratings should expect:

A. Lower yields to maturityB. Higher default possibilitiesC. Lower coupon paymentsD. Higher present value of cash flows

46. If a bond is priced at par value, then:

A. It has a very low level of default riskB. Its coupon rate equals its yield to maturityC. It must be a zero-coupon bondD. The bond is quite close to maturity

47. The existence of an upward-sloping yield curve suggests that:

A. Bonds should be selling at a discount to par valueB. Bonds will not return as much as common stocksC. Interest rates will be increasing in the futureD. Real interest rates will be increasing soon

48. Which one of the following will not happen for an investor who owns a Canada bond during a period of inflation?

A. The coupon payment will increase in nominal termsB. The maturity value will remain constant in nominal termsC. The investor's capital gain will riseD. The bond price will fall

49. What is the amount of the annual coupon payment for a bond that has six years until maturity, sells for $1,050, and has a yield to maturity of 9.37%?

A. $87.12B. $93.70C. $100.00D. $105.00

50. Many investors may be drawn to Canada bonds because of the bonds':

A. speculative-grade ratingsB. High coupon paymentsC. Long periods until maturityD. Low default risk

51. Two years ago bonds were issued with 10 years until maturity, selling at par, and a 7 percent coupon. If interest rates for that grade of bond are currently 8.25 percent, what will be the market price of these bonds?

A. $917.06B. $928.84C. $987.50D. $1,000.00

52. Which of the following is correct for a bond investor whose bond offers a 5 percent current yield and an 8 percent yield to maturity?

A. The bond is selling at a discount to par valueB. The bond has a high default premiumC. The promised yield is not likely to materializeD. The security must be a Canada bond

53. What is the total return to an investor who buys a bond for $1,100 when the bond has a 9 percent coupon rate and five years remaining until maturity, then sells the bond after one year for $1,085?


54. How much would an investor lose if she purchased a 30-year zero-coupon bond with a $1,000 par value and 10% yield to maturity, only to see market interest rates increase to 12 percent one year later? (Hint: How much would the price change from a year earlier?)

A. $19.93B. $20.00C. $23.93D. $25.66

55. Assume that a bond has been owned by four different investors during its 20-year history. Which of the following is not likely to have been shared by these different owners?

A. Coupon rateB. Cash flowsC. Par valueD. Yield to maturity

56. If an investor purchases a 3 percent, two-year Canada real return bond and the CPI increases 3 percent over each of the next two years, what does the investor receive at maturity?

A. $1,000.00B. $1,030.00C. $1,060.90D. $1,092.73

57. Which of the following is correct concerning real interest rates?

A. Real interest rates are constantB. Real interest rates must be positiveC. Real interest rates must be less than nominal interest ratesD. Real interest rates, if positive, indicate increased purchasing power

58. An investor holds two bonds, one with five years until maturity and the other with 20 years until maturity. Which of the following is more likely if interest rates suddenly decrease by 2 percent?

A. The five-year bond will increase more in priceB. The 20-year bond will increase more in priceC. Both bonds will increase in price similarlyD. Neither bond will increase in price, but yields will decrease

59. How much should you be prepared to pay for a 10-year bond with a 6 percent coupon and a yield to maturity to maturity of 7.5 percent?

A. $411.84B. $897.04C. $985.00D. $1,000.00

60. How much should you be prepared to pay for a 10-year bond with a 6 percent coupon, semi-annual payments, and a semi-annually compounded yield of 7.5 percent?

A. $895.78B. $897.04C. $938.40D. $1,312.66

61. A bond with 10 years until maturity, an 8 percent coupon, and an 8 percent yield to maturity increased in price to $1,107.83 yesterday. What apparently happened to interest rates?

A. Rates increased by 2.0 percentB. Rates decreased by 2.0 percentC. Rates increased by .72 percentD. Rates decreased by 1.5 percent

62. An investor buys a five-year, 9 percent coupon bond for $975, holds it for one year and then sells the bond for $985. What was the investor's rate of return?


63. An investor buys a ten-year, 7 percent coupon bond for $1,050, holds it for one year and then sells it for $1,040. What was the investor's rate of return?


64. Which of the following will reduce the yield to maturity from what the investor calculated at time of purchase?

A. Increasing interest rates; bonds held to maturityB. Decreasing interest rates; bonds held to maturityC. Stable interest rates; bonds sold before maturityD. Increasing interest rates; bonds sold before maturity

65. What price was quoted to an investor who paid $982.50 for a $1,000 par value bond?

A. 82.500B. 97.250C. 98.250D. 98.080

66. If the Globe and Mail shows a change in price of -12 on a $1,000 par-value bond, what we know of yield to maturity?

A. Yield to maturity fellB. Yield to maturity stayed the sameC. The new yield pushed the nominal coupon payments upD. Yield to maturity rose

67. If the Globe and Mail showed that the price of a $1,000 par-value bond increased by +6 from the previous day, what happened to yield to maturity?

A. It fellB. It roseC. It stayed the sameD. Can't tell

68. When market interest rates exceed a bond's coupon rate, the bond will:

A. Sell for less than par valueB. Sell for more than par valueC. Decrease its coupon rateD. Increase its coupon rate

69. Which of the following is likely to be correct for a CCC-rated bond, compared to a BBB-rated bond?

A. The CCC bond will sell for a higher priceB. The CCC bond will sell for a lower priceC. The CCC bond will offer a higher promised yield to maturityD. The CCC bond will offer a lower promised yield to maturity.

70. Which of the following bonds would be considered to be of speculative-grade?

A. A Caa-rated bondB. An Aaa-rated bondC. An AAA-rated bondD. A Baa-rated bond

71. If a bond offers an investor 11 percent in nominal return during a year in which the rate of inflation was 4 percent, then the investor's real return was:


72. How much would an investor need to receive in nominal return if she desires a real return of 4 percent and the rate of inflation is 5 percent?


73. If you purchase a five-year, zero-coupon bond ($1,000 maturity value) for $500, how much could it be sold for three years later if interest rates have remained stable?

A. $650.00B. $723.05C. $757.86D. $800.00

74. If you purchase a three-year, 9 percent coupon bond for $950, how much could it be sold for two years later if interest rates have remained stable?

A. $964.95B. $981.56C. $983.33D. $1,000.00

75. What causes bonds to sell for a premium compared to face value?

A. The bonds have high ratingsB. The bonds have a long period until maturityC. The bonds have a higher than market coupon rateD. The bonds are of speculative grade

76. The current yield tends to overstate a bond's total return when the bond sells for a premium because:

A. The bond's price will decline each yearB. Coupon payments can change at any timeC. Bonds selling for a premium have low default riskD. Taxes must be paid on the current yield

77. The current yield tends to understate a bond's total return when the bond sells for a discount because:

A. Increases in interest rates will increase the current yieldB. The bond's price will increase each yearC. Current yields only show nominal returnsD. The bond may have a higher face value

78. Suppose the prevailing market rate is 8 percent. A bond with a coupon rate of 6 percent will be sold at:

A. A premiumB. A discountC. ParD. $1,000

79. Suppose the current market interest rate is 10.25 percent. What is the current market price of a 5-year bond with a face value of $1,000 that has a coupon rate of 14 percent with semi-annual coupon payments?

A. $878.73B. $1,072.25C. $1,154.43D. $1,435.75

80. We have a 7 percent annual-pay bond with a face value of $1,000 and a remaining life of 8 years. If this bond is currently trading at $942.53, what is the yield to maturity?

A. 6%B. 7%C. 8%D. 9%

81. The value of a callable bond:

A. is unlimitedB. Is limited by its face valueC. Is limited by its call priceD. Is limited by high interest rates

82. A bond is currently trading at par, has an annual coupon of $100, and matures at a face value of $100. Therefore, the _________ is 10 percent.

A. Coupon rateB. Current yieldC. Yield to maturityD. All of the above terms

83. Suppose a 30-year maturity bond currently selling for $1,040 is callable in 10 years at a call price of $1,060. If its yield to maturity is 8.14%, its yield to call is:

A. Less than 8.14%B. 8.14%C. More than 8.14%D. Cannot tell based on the information provided

84. If you purchase a three-year, 9% coupon bond for $950, how much could it be sold for two years later if interest rates have remained stable?

A. $964.95B. $981.56C. $983.33D. $1,000.00

85. Suppose a 20-year maturity bond currently selling for $1,050 is callable in 5 years at a call price of $1,060. If its yield to maturity is 8.25%, its yield to call is:

A. Less than 8.14%.B. 8.14%.C. More than 8.14%D. Could be any of these

86. If you purchase a five-year, zero-coupon bond for $500, how much could it be sold for three years later if interest rates have remained stable?

A. $650.00B. $723.05C. $757.86D. $800.00

87. How much would an investor expect to pay for a $1,000 par value bond with a 9% annual coupon that matures in 5 years if the interest rate is 7%?

A. $696.74B. $1,075.82C. $1,082.00D. $1,123.01

88. What is the current yield of a bond with a 6% coupon, four years until maturity, and a price of $750?

A. 6.0%B. 8.0%C. 12.0%D. 14.7%

89. What is the coupon rate for a bond with three years until maturity, a price of $1,053.46, and a yield to maturity of 6%?

A. 6%B. 8%C. 10%D. 11%

90. What is the yield to maturity for a bond paying $100 annually that has six years until maturity and sells for $1,000?

A. 6.0%B. 8.5%C. 10.0%D. 12.5%

91. What happens to the price of a three-year bond with an 8% coupon when interest rates change from 8% to 6%?

A. A price increase of $51.54B. A price decrease of $51.54C. A price increase of $53.47D. No change in price

92. What is the rate of return for an investor who pays $1,054.47 for a three-year bond with a 7% coupon and sells the bond one year later for $1,037.19?

A. 5.00%B. 5.33%C. 6.46%D. 7.00%

93. If a four year bond with a 7% coupon and a 10% yield to maturity is currently worth $904.90, how much will it be worth one year from now if interest rates are constant?

A. $904.90B. $925.39C. $947.93D. $1,000.00

94. What is the yield to maturity of a bond with the following characteristics? Coupon rate is 8% with semi-annual payments, current price is $960, three years until maturity.

A. 4.78%B. 5.48%C. 9.57%D. 12.17%

95. By how much will a bond increase in price over the next year if it currently sells for $925, has five years until maturity, and an annual coupon rate of 7%?

A. $8.26B. $8.92C. $12.55D. $15.00

96. What is the amount of the annual coupon payment for a bond that has six years until maturity, sells for $1,050, and has a yield to maturity of 9.37%?

A. $87.12B. $93.70C. $100.00D. $105.00

97. What is the total return to an investor who buys a bond for $1,100 when the bond has a 9% coupon rate and five years remaining until maturity, then sells the bond after one year for $1,085?

A. 6.82%B. 6.91%C. 7.64%D. 9.00%

98. How much would an investor lose if she purchased a 30-year zero-coupon bond with a $1,000 par value and 10% yield to maturity, only to see market interest rates increase to 12% one year later? (Hint: How much would the price change from a year earlier?)

A. $19.93B. $20.00C. $23.93D. $25.66

99. A bond's purchase price is referred to as its face value.

True False

100.There is a negative relationship between interest rates and bond prices.

True False

101.Longer-term bond prices are more sensitive to changes in interest rates than are short-term bond prices.

True False

102.A bond's rate of return is equal to its coupon payment divided by the price paid for the bond.

True False

103.A Treasury bond's bid price will be lower than the ask price.

True False

104.When the market interest rate exceeds the coupon rate, bonds sell for less than face value to provide enough compensation to investors.

True False

105.A long-term investor would more likely be interested in current yield than internal rate of return.

True False

106.Zero-coupon bonds are issued at prices considerably below face value, and the investor's return comes from the difference between the purchase price and the payment of face value at maturity.

True False

107.Bonds selling at a premium price offer a higher current yield than bonds selling at par value.

True False

108.Speculative-grade bonds have default risk; investment grade bonds do not.

True False

109.Changes in interest rates also change coupon payments for already-issued bonds.

True False

110.Current yield overstates the return of premium bonds since investors who buy a bond at a premium face a capital loss over the life of the bond.

True False

111.If you buy and hold a bond to maturity, its coupon rate is guaranteed when you purchase, assuming no default.

True False

112.Bid and ask prices differ by the degree to which financial intermediaries profit from their role as financial middlemen.

True False

113.Most Government of Canada bonds have a rating of 'C' that indicates that these bonds pay a coupon.

True False

114.Describe the process for calculating a yield to maturity for a bond, and tell what could cause the yield to maturity to change.

115.Determine the current yield, yield to maturity, and price of the following bond as of the date of purchase and on each anniversary date of its purchase until maturity: three-year bond with a 12 percent coupon and a purchase price of $1,100.

116.Compare the price sensitivity to changes in interest rates for the following bonds: A five-year and a ten-year bond, both with a 7 percent coupon. Both bonds currently sell at par. How much will the price of each bond change if interest rates increase to 8 percent? Why is there a difference in the price change?

117.Why are long-term bonds more sensitive to changes in interest rates than short-term bonds?

118.Explain why it is necessary for bond prices to fluctuate in response to changing interest rates?

119.Describe the shape of the current yield curve. Would you consider that to be fairly typical?

120.Explain why bond investors may be interested in Canada real return bonds rather than traditional bonds.

121.Why do bonds exhibit interest rate risk?

122.What is meant by "default risk" in bonds, and how do investors respond to it?

123.How can one find the market price of a bond given its yield to maturity and find a bond's yield given its price? Why do prices and yields vary inversely?

124.Why should many investors be cautious when relying on yield to maturity?

125.Why do investors pay attention to bond ratings and demand a higher interest rate for bonds with low ratings?

126.Why might a bond's current yield offer an incomplete idea of what return the investor is receiving?

127.What are the differences between the bond's coupon rate, current yield, and yield to maturity?

128.What are the differences between the bond's coupon rate, current yield, and yield to maturity?

129.Why might a bond's current yield offer an incomplete idea of what return the investor is receiving?

130.Why are long-term bonds more sensitive to changes in interest rates than short-term bonds?

6 Key 1. D

2. C

3. C

4. A

5. C

6. D

7. D

8. A

9. C

10. B

11. A

12. D

13. B

14. D

15. C

16. B

17. B

18. C

19. C

20. B

21. C

22. D

23. A

24. A

25. D

26. B

27. B

28. D

29. C

30. A

31. A

32. C

33. C

34. C

35. B

36. D

37. C

38. D

39. C

40. A

41. B

42. B

43. C

44. B

45. B

46. B

47. C

48. A

49. D

50. D

51. B

52. A

53. A

54. A

55. D

56. D

57. D

58. B

59. B

60. A

61. D

62. D

63. A

64. D

65. C

66. D

67. A

68. B

69. C

70. A

71. A

72. D

73. C

74. B

75. C

76. A

77. A

78. B

79. C

80. C

81. C

82. D

83. C

84. B

85. C

86. C

87. C

88. B

89. B

90. C

91. C

92. A

93. B

94. C

95. C

96. C

97. A

98. A

99. FALSE

100. TRUE

101. TRUE

102. FALSE

103. TRUE

104. TRUE

105. FALSE

106. TRUE

107. TRUE

108. FALSE

109. FALSE

110. TRUE

111. TRUE

112. TRUE

113. FALSE

114. The yield to maturity for a bond is calculated by finding that discount rate that equates the present value of the bond's payments to the bond's price. Because the bond's payments are fixed, the yield to maturity will change only with changes in interest rates that affect the price of the bond. When the bond is priced at par value, its yield to maturity is equal to its coupon rate and also to the current yield. When the bond is priced above par, yield to maturity is less than the coupon rate, and when the bond is priced below par, the yield to maturity is greater than the coupon rate. It is important to realize that although interest rates may change, the yield to maturity is set at the time of purchase for any investor who holds the bond until maturity (ignoring the possibility of default). Thus, while interest rates may change, it does not affect the yield to maturity for an investor that does not sell the bond prior to maturity.

115.

The five-year bond decreases $39.27 while the 10-year bond decreases $67.10. This illustrates that longer-term bonds display more interest rate risk.

116.

117. A long-term bond is more sensitive to changes in interest rates simply because there are more coupon payments and longer time periods for each cash flow to be affected by the changed interest rate. Remembering that bond prices are determined by the sum of a present value of an annuity and the present value of a future amount, when those formulas experience different discount rates for longer periods, there is substantially more effect.

118. Bonds are long-term debt instruments that are issued with fixed coupon interest rates. At time of issue, it is likely that the coupon rate was approximately equal to the expected interest rate for a bond of this rating. However, as interest rates change during the period prior to maturity, investors may be unwilling to purchase the bond in the secondary market unless its price changes such that the investor can obtain a then-current yield to maturity on the investment. Thus, if bond prices were fixed, there may not be any opportunities for sale of the bond prior to maturity and investors would be required to make long-term, potentially disadvantageous investment decisions.

119. This question can provide a good introduction to the topic for instructors who have discussed the current economic environment. The important facet will be for students to recognize that upward-sloping yield curves are more common than downward sloping curves.

120. Government inflation-Indexed Securities will be welcomed instruments by bond investors who wish to feel protected in their real rate of return. They will lock in a real rate of return so that the purchasing power of bond investors can be maintained. Additionally, there is somewhat less price volatility in these bonds than in traditional bonds, which could prove to be an additionally welcome feature to investors who are experiencing volatility in other market segments.

121. Bond prices are subject to interest rate risk, rising when market interest rates fall and falling when market rates rise. Long-term bonds exhibit greater interest rate risk than short-term bonds.

122. Default risk refers to the probability of default by bond issuers. In the case of default, cash payments to bond investors may be delayed or omitted. Thus, investors walk a tightrope between wanting to receive as much yield as possible while still willing to bear the possibility of default. Rating agencies such as Standard & Poor's or Moody's evaluate the creditworthiness of bond issuers, and offer ratings of each issue. The lower the rating, the higher the likelihood of default and, therefore, the more of a default premium will be demanded by investors. Although bond ratings can change dramatically, it is often a case of gradual change such that investors have the opportunity of being forewarned.

123. Bonds are valued by discounting the coupon payments and the final repayment by the yield to maturity on comparable bonds. The bond payments discounted at the bond's yield to maturity equal the bond price. You may also start with the bond price and ask what interest rate the bond offers. The interest rate that equates the present value of bond payments to the bond price is the yield to maturity. Because present values are lower when discount rates are higher, price and yield to maturity vary inversely.

124. Yield to maturity is an extremely popular metric and is highly quoted among investors and analysts. However, many bond investors do not intend or, even if they do intend, will not be able, to hold their bonds until maturity. In this case it is worthwhile to remember that a yield to maturity is promised only if: a) the bond is held until maturity, and b) the issuer does not default. Many investors might be better off in calculating or forecasting a total return based upon the time period they expect to hold the bond. While this calculation is obviously made with risk, it reminds investors that bond prices can change dramatically and, if you need to raise cash quickly, the once-calculated yields to maturity can be long forgotten.

125. Investors demand higher promised yields if there is a high probability that the borrower will run into trouble and default. Credit risk implies that the promised yield to maturity on the bond is higher than the expected yield. The additional yield investors require for bearing credit risk is called the default premium. Bond ratings measure the bond's credit risk.

126. The current yield is only synonymous with yield to maturity in the coincidence that the bond price is selling at par. Therefore, capital gains and capital losses are a critical part of bond investors' analysis. A high current yield can draw suspicions that capital losses will be posted during the year. Unexpected changes in interest rates can render current yields to be of much less significance next to changes in the price of the investment itself.

127. A bond is a long-term debt of a government or corporation. When you own a bond, you receive a fixed interest payment each year until the bond matures. This payment is known as the coupon. The coupon rate is the annual coupon payment expressed as a fraction of the bond's face value. At maturity the bond's face value is repaid. In the United States most bonds have a face value of $1,000. The current yield is the annual coupon payment expressed as a fraction of the bond's price. The yield to maturity measures the average rate of return to an investor who purchases the bond and holds it until maturity, accounting for coupon income as well as the difference between purchase price and face value.

128. A bond is a long-term debt of a government or corporation. When you own a bond, you receive a fixed interest payment each year until the bond matures. This payment is known as the coupon. The coupon rate is the annual coupon payment expressed as a fraction of the bond's face value. At maturity the bond's face value is repaid. In the United States most bonds have a face value of $1,000. The current yield is the annual coupon payment expressed as a fraction of the bond's price. The yield to maturity measures the average rate of return to an investor who purchases the bond and holds it until maturity, accounting for coupon income as well as the difference between purchase price and face value.

129. The current yield is only synonymous with yield to maturity in the coincidence that the bond price is selling at par. Therefore, capital gains and capital losses are a critical part of bond investors' analysis. A high current yield can draw suspicions that capital losses will be posted during the year. Unexpected changes in interest rates can render current yields to be of much less significance next to changes in the price of the investment itself.

130. A long-term bond is more sensitive to changes in interest rates simply because there are more coupon payments and longer time periods for each cash flow to be affected by the changed interest rate. Remembering that bond prices are determined by the sum of a present value of an annuity and the present value of a future amount, when those formulas experience different discount rates for longer periods, there is substantially more effect.

6 Summary Category # of Questions

Brealey - Chapter 06 130Difficulty: Easy 24Difficulty: Hard 10Difficulty: Medium 96Learning Objective: 6.1 15Learning Objective: 6.2 84Learning Objective: 6.3 10Learning Objective: 6.4 5Learning Objective: 6.5 16Type: Multiple Choice 98Type: Short Answer 17Type: True False 15

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