CHAPTER 7

BONDS AND THEIR VALUATION

(Difficulty: E = Easy, M = Medium, and T = Tough)

Multiple Choice: Conceptual

Easy:
Interest rates Answer: e Diff: E
1. One of the basic relationships in interest rate theory is that, other
things held constant, for a given change in the required rate of return,
the the time to maturity, the the change in price.

a. longer; smaller.
b. shorter; larger.
c. longer; greater.
d. shorter; smaller.
e. Statements c and d are correct.

Interest rates and bond prices Answer: c Diff: E

2. Assume that a 10-year Treasury bond has a 12 percent annual coupon,
while a 15-year Treasury bond has an 8 percent annual coupon. The yield
curve is flat; all Treasury securities have a 10 percent yield to
maturity. Which of the following statements is most correct?

a. The 10-year bond is selling at a discount, while the 15-year bond is

selling at a premium.
b. The 10-year bond is selling at a premium, while the 15-year bond is
selling at par.
c. If interest rates decline, the price of both bonds will increase, but
the 15-year bond will have a larger percentage increase in price.
d. If the yield to maturity on both bonds remains at 10 percent over the
next year, the price of the 10-year bond will increase, but the price
of the 15-year bond will fall.
e. Statements c and d are correct.
Interest rates and bond prices Answer: c Diff: E
3. A 12-year bond has an annual coupon rate of 9 percent. The coupon rate
will remain fixed until the bond matures. The bond has a yield to maturity
of
7 percent. Which of the following statements is most correct?

a. The bond is currently selling at a price below its par value.

b. If market interest rates decline today, the price of the bond will
also decline today.
c. If market interest rates remain unchanged, the bond’s price one year
from now will be lower than it is today.
d. All of the statements above are correct.
e. None of the statements above is correct.

Chapter 7 - Page 1
Interest rates and bond prices Answer: d Diff: E
4. A 10-year Treasury bond has an 8 percent coupon. An 8-year Treasury
bond has a 10 percent coupon. Both bonds have the same yield to
maturity. If the yields to maturity of both bonds increase by the same
amount, which of the following statements is most correct?

a. The prices of both bonds will increase by the same amount.

b. The prices of both bonds will decrease by the same amount.
c. The prices of the two bonds will remain the same.
d. Both bonds will decline in price, but the 10-year bond will have a
greater percentage decline in price than the 8-year bond.
e. Both bonds will decline in price, but the 8-year bond will have a
greater percentage decline in price than the 10-year bond.

Interest vs. reinvestment rate risk Answer: e Diff: E

5. Which of the following statements is most correct?

a. All else equal, long-term bonds have more interest rate risk than
short-term bonds.
b. All else equal, high-coupon bonds have more reinvestment rate risk
than low-coupon bonds.
c. All else equal, short-term bonds have more reinvestment rate risk
than do long-term bonds.
d. Statements a and c are correct.
e. All of the statements above are correct.

Interest vs. reinvestment rate risk Answer: c Diff: E

6. Which of the following statements is most correct?

a. Relative to short-term bonds, long-term bonds have less interest rate

risk but more reinvestment rate risk.
b. Relative to short-term bonds, long-term bonds have more interest rate
risk and more reinvestment risk.
c. Relative to coupon-bearing bonds, zero coupon bonds have more
interest rate risk but less reinvestment rate risk.
d. If interest rates increase, all bond prices will increase, but the
increase will be greatest for bonds that have less interest rate
risk.
e. One advantage of zero coupon bonds is that you don’t have to pay any
taxes until you sell the bond or it matures.

Price risk Answer: a Diff: E

7. Which of the following bonds will have the greatest percentage increase
in value if all interest rates decrease by 1 percent?

a. 20-year, zero coupon bond.

b. 10-year, zero coupon bond.
c. 20-year, 10 percent coupon bond.
d. 20-year, 5 percent coupon bond.
e. 1-year, 10 percent coupon bond.

Chapter 7 - Page 2