Fin 221
Chapter 5
TRUE AND FALSE QUESTIONS
T F 1. Bond yields(interest rates) vary directly with changes in bond prices.
T F 2. The coupon rate varies inversely with bond prices.
T F 3. Long-term bond prices vary more than short-term bond prices for any given change in interest rates.
T F 4. Yield to maturity on a coupon bond assumes that all coupons are reinvested at the same promised rate.
T F 5. If the coupon rate equals the market rate, a bond is likely to be selling at a discount.
T F 6. A zero coupon bond has no reinvestment risk.
T F 7. The higher the coupon rate, the lower the bond price volatility.
T F 8. If market interest rates have risen since a bond was purchased, the bond’s price will have risen but the potential reinvestment yield on its coupons will have declined.
MULTIPLE-CHOICE QUESTIONS
1. In a fixed rate bond, the variable which changes to determine market rate of return is
a. price. b. coupon rate. c. coupon amount. d. face value.
2. An increase in the demand for bonds by SSUs will cause interest rates to
a. remain unchanged. b. increase. c. decrease.
3. What is the price of a $1,000 face value bond with a 10% coupon if the market rate of return is 10%?
a. more than $1,000 b. $1,000 c. less than $1,000 d. cannot ascertain
4. What is the price of the bond in the above question, if the market rate rises to 12% and the bond matures in 5 years? (Assume semiannual compounding.)
a. $829.60 b. $1,000.00 c. $926.40 d. $1,040.80
5. What is the price of the bond in question 3 above if the market rate drops to 8 percent?
a. $926.40 b. $1,000.00 c. $1,121.50 d. $1,081.11
6. What is the market price of a $1,000 face value zero coupon bond with a 5-year maturity priced to yield 11 percent, compounded annually?
a. $593.45 b. $650.00 c. $980.20 d. $1,000.00
7. The percentage change in bond price for any change in rates is called:
a. duration. b. volatility. c. reinvestment risk. d. basis point.
8. Bond price volatility is
a. inversely related to maturity and directly related to coupon rates.
b. directly related to maturity and inversely related to coupon rates.
c. inversely related to maturity and inversely related to coupon rates.
d. directly related to maturity and directly related to coupon rates.
9. Two factors that affect interest rate risk are
a. default risk and reinvestment risk.
b. price risk and interest rate risk.
c. reinvestment risk and price risk.
d. expected risk and realized risk.
10. Which of the following is true?
a. Bonds with higher coupon rates have longer durations, everything else the same.
b. The longer the maturity of a bond, the lower the duration.
c. Zero coupon bonds have durations greater than their maturities.
d. Coupon bonds have durations shorter than their maturities.
Calculations Questions :
1. What is the yield – to maturity of a corporate bond with a 8 – year maturity, 6% coupon (annual payments), and BD 1000 face value if the bond sold for BD 978?.
2. Suppose that you purchase a 5 year bond at par(1000), 8% coupon rate(annual payments), sold it after 2 years. At the time of sale, a 3years bond with similar characteristics yield is 10%.Calculate the realized yield and the capital gain or loss.
3. Suppose that you purchase a 4 year bond at par (1000), 8% coupon rate(annual payments), plan to sell it after 2 years. It is forecasted that a 2 years bond with similar characteristics yield 5% after 2 years. Calculate the expected yield.
4. Consider a 4-year bond selling at par with a 7% annual coupon. Suppose yields on similar bonds increase by 0.5% .(a) Use duration to estimate the percent change in the bond price (price volatility).
(b) Calculate the price volatility using the percentage change formula.
5. What is the duration of a bond portfolio made up of two bonds: 37 percent of a bond with duration of 7.7 years and 63 percent of a bond with duration of 16.4 years?
Do you understand questions:
1. Define price risk and reinvestment risk. Explain how the two risks offset each other.
2. To eliminate interest rate risk, should you match the maturity or the duration of your bond investment to your holding period? Explain.