Money Banking and Financial Markets 4th Edition Cecchetti Test Bank 1

Money Banking and Financial
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Chapter 06
Bonds, Bond Prices, and the Determination of Interest Rates
Multiple Choice Questions
6-1
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
1. A zero-coupon bond refers to a bond which:
A. does not pay any coupon payments because the issuer is in default.
B. promises a single future payment.
C. pays coupons only once a year.
D. pays coupons only if the bond price is above face value.
2. A consol is:
A. another name for a zero-coupon bond.
B. a bond with a maturity date exceeding 10 years.
C. a bond that makes periodic interest payments forever.
D. a form of a bond that is issued quite often by the U.S. Treasury.
3. A pure discount bond is also known as a:
A. consol.
B. fixed payment loan.
C. coupon bond.
D. zero-coupon bond.
4. The most common form of zero-coupon bonds found in the United States is:
A. AAA rated corporate bonds.
B. U.S. Treasury bills.
C. 30-year U.S. Treasury bonds.
D. municipal bonds.
6-2
5. Which of the following best expresses the formula for determining the price of a U.S.
Treasury bill that matures n periods from now per $100 of face value when the interest rate is
i?
A. $100/(1 + i)n
B. $100(1 + i)
C. $100/(1 + i)
D. 1 + $100/(1 + i)n
6. Once you buy a coupon bond, which of the following can change?
A. Coupon rate
B. Coupon payment
C. Face value
D. Yield to maturity
7. Which of the following makes fixed payments indefinitely?
A. Amortized loan
B. Consol
C. Coupon bond
D. Zero-coupon bond
6-3
8. A 10-year Treasury note as a face value of $1,000, price of $1,200, and a 7.5% coupon rate.
Based on this information, we know the:
A. present value is greater than its price.
B. current yield is equal to 8.33%.
C. coupon payment on this bond is equal to $75.
D. coupon payment on this bond is equal to $90.
9. If the annual interest rate is 5%(.05), the price of a one-year Treasury bill per $100 of face
value would be:
A. $95.00
B. $97.50
C. $95.24
D. $96.10
10. If the annual interest rate is 5%(.05), the price of a six-month Treasury bill would be:
A. $97.50
B. $97.59
C. $95.25
D. $95.00
11. If the annual interest rate is 5%(.05), the price of a three-month Treasury bill would be:
A. $98.79
B. $95.00
C. $98.75
D. $97.59
6-4
12. The relationship between the price and the interest rate for a zero coupon bond is best
described as:
A. volatile.
B. fluctuating.
C. inverse.
D. non-existent.
13. When a loan is amortized, it means the:
A. borrower is in default.
B. principal and interest are paid off by the borrower over the life of the loan.
C. interest is due entirely at the maturity date.
D. principal in never repaid, only interest.
14. Most home mortgages are good examples of:
A. consols.
B. zero-coupon bonds.
C. coupon bonds.
D. fixed-payment loans.
15. The price of a coupon bond can best be described as the:
A. present value of the face value.
B. future value of the coupon payments.
C. future value of the coupon payments and the face value.
D. present value of the face value plus the present value of the coupon payments.
6-5
16. The difference in the prices of a zero-coupon bond and a coupon bond with the same face
value and maturity date is simply:
A. zero, since they are the same.
B. the present value of the final payment.
C. the present value of the coupon payments.
D. the future value of the coupon payments.
17. The price (P) of a consol offering an annual coupon payment (C) is best expressed by:
A. F/C
B. C(1 + i)
C. C/(1 + i)
D. C/i
18. If a consol is offering an annual coupon of $50 and the annual interest rate is 6%, the price of
the consol is:
A. $47.17
B. $813.00
C. $833.33
D. $8333.33
6-6
19. Which of the following statements is most accurate?
A. Yield to maturity is equal to the coupon rate if the bond is held to maturity.
B. Yield to maturity is the same as the coupon rate.
C. Yield to maturity will exceed the coupon rate if the bond is purchased for face value.
D. Yield to maturity is the same as the coupon rate if the bond is purchased for face value
and held to maturity.
20. When the price of a bond is above face value the yield to maturity:
A. is below the coupon rate.
B. will be above the coupon rate.
C. will equal the current yield.
D. will equal the coupon rate.
21. When the price of a bond is below the face value, the yield to maturity:
22. When the price of a bond equals the face value the:
A. yield to maturity will be above the coupon rate.
B. yield to maturity will be below the coupon rate.
C. current yield is equal to the coupon rate.
D. yield to maturity is greater than the current yield.
6-7
23. If the purchase price of a bond exceeds the face value, the yield to maturity:
A. is greater than the coupon rate because the capital gain is positive.
B. will equal the current yield.
C. will be less than the coupon rate because the capital gain will be negative.
D. will be greater than the current yield.
24. The current yield of a bond:
A. is another term for the coupon rate.
B. is another term for the yield to maturity.
C. equals zero for a zero-coupon bond since these bonds have no coupon payments.
D. is the difference between its future value and its present value.
25. A $1,000 face value bond purchased for $965.00, with an annual coupon of $60, and 20 years
to maturity has a:
A. current yield equal to 6.22%.
B. current yield equal to 6.00%.
C. coupon rate equal to 6.22%.
D. yield to maturity and current yield equal to 6.00%.
26. A $1,000 face value bond purchased for $965.00, with an annual coupon of $60, and 20 years
to maturity has a:
A. current yield and coupon rate equal to 6.22% and a coupon rate above this.
B. current yield equal to 6.22% and a coupon rate below this.
C. coupon rate equal to 6.00% and a current yield below this.
6-8
27. In calculating the current yield for a bond the:
A. coupon payment is ignored.
B. present value of the capital gain/loss is ignored.
C. present value of the final payment is the only important consideration.
D. present value of the coupon payments is the only important consideration.
A. coupon payment and purchase price is all that is needed.
29. When the current yield and the coupon rate are equal, the bond is:
A. purchased at a discount.
B. purchased at a price that equals the face value.
C. a zero-coupon bond.
D. purchased at a price that exceeds its face value.
30. If a bond's purchase price equals the face value the:
A. coupon rate equals the current yield, which is less than the yield to maturity.
B. current yield equals the yield to maturity, which exceeds the coupon rate.
C. coupon rate equals the yield to maturity, which equals the current yield.
D. coupon rate does not equal the current yield, which does not equal the yield to maturity.
6-9
31. Which of the following is not a reason why the yield to maturity can differ from the current
yield?
A. Because the yield to maturity considers the capital gain/loss.
B. Because the current yield focuses only on the coupon payment and the purchase price.
C. Because most bonds are not purchased for face value.
D. Because the current yield moves in the opposite direction from price.
32. A $1000 face value bond, with one year to maturity that sells for $950 and has a $40 annual
coupon has a:
A. current yield and yield to maturity of 4.00%.
B. yield to maturity that equals the current yield.
C. coupon rate of 4.00% and a current yield that is below this.
D. current yield of 4.21%.
33. A $1,000 face value bond, with an annual coupon of $40, one year to maturity and a purchase
price of $980 has a:
A. current yield that equals 4.00%.
B. coupon rate that equals 4.08%.
C. current yield that equals 4.08% and a yield to maturity that equals 6.12%.
D. current yield that equals 4.08% and a yield to maturity that equals 4.0%.
6-10
34. A 30-year Treasury bond as a face value of $1,000, price of $1,200 with a $50 coupon
payment. Assume the price of this bond decreases to $1,100 over the next year. The one-year
holding period return is equal to:
A. -9.17%.
B. -8.33%.
C. -4.17%.
D. -3.79%.
35. The bid price for a bond quote is:
A. the price at which the bond dealer is willing to sell the bond.
B. the price at which the bond dealer is willing to purchase the bond.
C. fixed over the life of a bond.
D. determined solely by the time left to maturity.
36. In reading bond quotes:
A. the bid price is usually above the asked price.
B. the asked price is fixed over the life of the bond.
C. the asked price is usually above the bid price.
D. bid and asked prices must be equal as set forth by SEC regulations.
37. The bond dealer's spread is:
A. the asking price less the bid price.
B. the difference between the current yield and the yield to maturity.
C. the bid price less the asking price.
D. usually negative; the dealer makes a profit holding the bonds.
6-11
38. The size of the bond dealer's spread is mainly a function of the:
A. purchase price of the bond.
B. current yield.
C. liquidity of the bond market.
D. face value of the bond.
39. The larger the bond dealer's spread the:
A. less liquid is the market for that bond.
B. greater is the coupon rate for that bond.
C. more liquid is the market for that bond.
D. less risk there is for the dealer to hold that bond.
40. The holding period return on a bond:
A. can never be more than the yield to maturity.
B. will equal the yield to maturity if the bond is purchased for face value and sold at a lower
price.
C. will be less than the yield to maturity if the bond is sold for more than face value.
D. will be less than the yield to maturity if the bond is sold for less than face value.
6-12
41. One characteristic that distinguishes holding period return from the coupon rate, the current
yield, and the yield to maturity is:
A. all of the other returns can be calculated at the time the bond is purchased, but holding
period return cannot.
B. holding period return will always be the highest return.
C. holding period return will usually be less than the other returns.
D. only the holding period return includes the capital gain/loss.
42. Which of the following best expresses the equation for holding period return?
A. Current yield + coupon rate
B. Yield to maturity - current yield
C. Current yield + capital gain
D. Coupon rate + capital gain
43. In considering the holding period return, the longer the term of the bond the:
A. less important is the capital gain and the more important in the current yield.
B. less important is the coupon rate and the more important is the current yield.
C. less important is the capital gain.
D. more important is the capital gain.
44. The holding period return has relevance because:
A. most bonds are held by the original purchaser until maturity.
B. most bonds are held by the original purchaser until they mature.
C. bonds are frequently traded.
D. current yields are not that important to bondholders.
6-13
45. Suppose there is a decrease in the price at which a bondholder sells her bond. In this case,
the holding period return will:
A. increase, since yields and prices are inversely related.
B. decrease, since this lowers the capital gain.
C. be negative.
D. equal the coupon rate.
46. If a one-year zero-coupon bond has a face value of $100, is purchased for $94, and is held to
maturity the:
A. holding period return will exceed the yield to maturity.
B. yield to maturity will exceed the holding period return.
C. yield to maturity will be 6.38%.
D. holding period return is 6.0%.
47. Bond prices and yields:
A. move together in the same direction.
B. do not change if the coupon is fixed.
C. move together inversely.
D. are independent of each other.
48. As bond prices increase:
A. the quantity of bonds supplied increases.
B. the quantity of bonds supplied decreases.
C. the quantity of bonds demanded increases.
D. yields increases.
6-14
49. The bond supply curve slopes upward because:
A. as bond prices rise people holding bonds are more tempted to hold them.
B. as bond prices rise yields increase.
C. for companies seeking financing, the higher the price of bonds the more attractive it is to
sell bonds.
D. as bond prices rise yields decrease.
50. The bond demand curve slopes downward because:
A. at lower prices the reward for holding the bond increases.
B. as bond prices fall so do yields.
C. as bond prices fall bonds are less attractive.
D. as bond prices rise yields increase.
51. If the quantity of bonds supplied exceeds the quantity of bonds demanded, bond prices
would:
A. rise and yields would fall.
B. fall and yields would rise.
C. rise but yields will remain constant.
D. fall and yields would fall.
52. If the quantity of bonds demanded exceeds the quantity of bonds supplied, bond prices:
A. would rise and yields would fall.
B. would fall and yields would increase.
C. will rise and yields will remain constant.
D. will rise and yields would increase.
6-15
53. If the U.S. government's borrowing needs increase, all other factors constant the:
A. demand for bonds will decrease.
B. price of bonds will increase.
C. supply of bonds will increase.
D. yields on bonds will decrease.
54. If the U.S. government's borrowing needs decrease, all other factors constant the:
A. supply of bonds will increase.
B. demand for bonds will decrease.
C. price of bonds will decrease.
D. price of bonds will increase.
A. price of bonds will increase.
B. supply of bonds will increase.
C. demand for bonds will decrease.
D. supply of bonds and the demand for bonds will both increase.
56. If the U.S. government's borrowing needs increase, in the bond market this would be seen as
the:
A. bond demand curve shifting right.
B. bond supply curve shifting right.
C. bond demand curve shifting left.
D. bond supply curve shifting left.
6-16
57. 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.
B. a movement up the bond supply curve.
C. the bond demand curve shifting left.
D. the bond supply curve shifting right.
58. As general business conditions improve, we would witness the following in the bond market:
A. the bond demand curve shifting left.
B. the bond supply curve shifting left.
C. bond prices decreasing.
D. bond prices increasing.
59. As general business conditions deteriorate, all other factors constant:
A. the demand for bonds will decrease.
B. the supply of bonds will increase.
C. bond prices will decrease.
D. bond yields will increase.
60. As general business conditions improve, all other factors constant the:
B. yield on bonds will increase.
C. bond demand curve shifts right.
D. bond supply curve shifts left.
6-17
A. the bond supply curve will shift left.
B. there will be a movement down the existing bond supply curve.
C. the bond demand curve shifts left.
D. the price of bonds will decrease.
62. When expected inflation increases, for any given nominal interest rate the:
A. cost of borrowing increases and the desire to borrow decreases.
B. real interest rate increases.
C. bond supply curve shifts to the left.
D. cost of borrowing decreases and the desire to borrow increases.
63. When expected inflation decreases for any given nominal interest rate, all of the following
occur except the:
A. real interest rate decreases.
B. bond supply curve shifts to the left.
C. cost of borrowing increases and the desire to borrow decreases.
D. price of bonds increases.
A. bond demand curve shifts right.
B. bond supply curve shifts right.
C. price of bonds increases.
D. yield on bonds will increase.
6-18
A. real cost of repayment for bond issuers increases.
B. real return for bondholders increases.
C. real cost of repayment for bond issuers decreases.
D. bond demand curve shifts right.
66. 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 the:
A. bond demand curve shift right.
B. bond supply curve shift left.
C. bond supply curve shift right.
D. bond demand curve shift left.
67. Which of the following would lead to an increase in bond supply?
A. A decrease in government spending relative to revenue.
B. An increase in corporate taxes.
C. A decrease in expected inflation.
D. An improvement in general business conditions.
68. Which of the following would lead to a decrease in bond demand?
A. An increase in expected inflation.
B. An increase in wealth.
C. A decrease in risk.
D. A decrease in liquidity.
6-19
69. An increase in the nation's wealth, all other factors constant, would cause the:
A. bond supply curve to shift left.
B. bond demand curve to shift left.
C. bond supply curve to shift right.
D. bond demand curve to shift right.
70. An increase in the nation's wealth, all other factors constant, would cause:
A. bond prices to fall and yields to increase.
B. bond prices and yields to increase.
C. bond prices to rise and yields to decrease.
D. the bond supply curve to shift right.
71. A decrease in the nation's wealth, all other factors constant, would cause:
A. the bond demand curve to shift left.
B. bond prices to rise.
C. interest rates to decrease.
D. the bond supply curve to shift left.
72. An increase in expected inflation for any given nominal interest rate will cause the:
A. bond supply curve to shift to the left.
B. bond demand curve to shift to the right.
C. price of bonds to decrease.
D. price of bonds to increase.
6-20
73. A decrease in expected inflation for any given nominal interest rate will cause:
A. bond prices to increase and interest rates to decrease.
B. bond prices to decrease and interest rates to increase.
C. the bond demand curve to shift to the left.
D. the bond supply curve to shift to the left.
74. An increase in expected inflation for any given nominal interest rate will cause:
A. the real return to bondholders to decrease.
B. a movement down the bond demand curve, but no change in the bond demand curve.
C. the bond demand curve to shift right.
D. the price of bonds to increase.
75. 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.
B. a movement down the bond demand curve.
C. a shift to the left of the bond demand curve.
D. an increase in the price of bonds.
76. Suppose that the return on assets other than bonds falls. In the bond market this will result
in a(n):
A. movement down the bond demand curve.
B. shift to the left of the bond demand curve.
C. increase in the price of bonds.
D. shift to the left of the bond supply curve.
6-21
77. 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.
B. a rightward shift in the bond supply curve.
D. an increase in bond prices.
78. If interest rates are expected to rise, the bond prices will:
A. not change until interest rates actually change.
B. fall, due to the demand for bonds decreasing.
C. rise, as people seek capital gains.
D. move in the same direction as the expected change in interest rates.
79. If interest rates are expected to fall, bond prices will:
A. fall as the demand for bonds decreases.
B. remain constant until interest rates actually change.
C. fall as people fear capital losses in the future.
D. increase due to the demand for bonds increasing.
80. Suppose that general business conditions improve, and at the same time, wealth increases.
Based on this information, we know that:
A. bond prices increase.
B. yield to maturity decreases.
C. the real interest rate increases.
D. the quantity of bonds increases.
6-22
81. 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.
B. decrease since people will bail out of all government bonds.
C. increase as the demand for these bonds increases.
D. not be affected because the two types of bonds are traded in different markets.
82. The demand for U.S. government bonds is high relative to other bond issues because:
A. liquidity of other bond issues is high relative to U.S. government bonds.
B. U.S. bond market has low transaction spreads due to high illiquidity.
C. market for U.S. government bonds is more liquid than most if not all other bond markets.
D. U.S. government bonds have higher default.
83. 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 the bond demand curve:
A. will shift right as will the bond supply curve.
B. will shift right but the bond supply curve shifts left.
C. and supply curves will shift left.
D. will shift left as the bond supply curve shifts right.
6-23
84. 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.
B. The price of bonds will increase if bond supply decreases more than bond demand.
C. Interest rates will increase if bond demand decreases more than bond supply.
D. Neither bond demand nor bond supply will shift.
85. The market for bonds is initially described by the supply of bonds - S0, and the demand for
bonds - D0, with the equilibrium price and quantity being P0 and Q0. An increase in the
nation's wealth, all else constant, would cause the
A. Bond supply curve to shift to S1.
B. Bond demand curve to shift to D1.
C. Bond supply curve to shift to S2.
D. Bond demand curve to shift to D2.
6-24
bonds - D0, with the equilibrium price and quantity being P0 and Q0. Suppose that the
expected return on bonds falls relative to other assets. In the bond market this will result in:
A. Bond supply curve to shift to S1
B. Bond demand curve to shift to D1
C. Bond supply curve to shift to S2
D. Bond demand curve to shift to D2
6-25
bonds - D0, with the equilibrium price and quantity being P0 and Q0. 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:
6-26
bonds - D0, with the equilibrium price and quantity being P0 and Q0. If the U.S. government's
borrowing needs decrease, all other factors constant:
89. 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%
B. 1.5%
C. 5.2%
D. 8.0%
6-27
90. Default risk is the risk associated with:
A. the bond issuer not being able to make the promised payments.
B. the illiquidity associated with small issues.
C. the effect on bond prices caused by changes in market rates of interest.
D. changes in the expected inflation rate.
91. Consider the bonds below. Which is subject to the greatest interest-rate risk?
A. A 30-year fixed-rate mortgage (fixed payment loan)
B. A consol
C. A Treasury bill
D. A 20-year corporate bond
92. 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:
A. increases from $1,000 to $1,018.
B. increases from $1,000 to $1,375.
C. decreases from $110 to $88.
D. decreases from $1,210 to $1,188.
6-28
93. 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:
A. $400
B. $909.09
C. $1,454.54
D. $1,600
94. 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?
A. The real interest rate decreased.
B. The student is made worse off because her real cost of borrowing is higher.
C. The lender is made worst off because his real return on the car loan is lower.
D. Both the student and the lender benefit.
95. 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'
coupon payments.
B. It refers to the probability that a borrower will default on debt obligations.
C. It is the risk that the face value of a bond will change before maturity.
D. Individuals owning long-term bonds are exposed to greater interest-rate risk.
6-29
96. 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:
A. default risk.
B. liquidity risk.
C. inflation risk.
D. interest-rate risk.
97. The U.S. Treasury issues 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.
B. lower price and a lower fixed return since the demand for them should be higher.
C. higher price and higher fixed return since we always seem to have some inflation.
D. higher price and lower return due to the decreased risk from inflation in holding these
bonds.
98. Interest-rate risk results from:
A. bond prices being fixed over the life of the bond.
B. a mismatch between an individual's investment horizon and a bond's maturity.
C. the fact that most people hold bonds until they mature.
D. inflation being uncertain.
6-30
99. Interest-rate risk would not matter to which of the following bondholders?
A. A holder of a U.S. government bond.
B. A holder of a U.S. government bond indexed for inflation.
C. A holder of a U.S. government bond who plans on selling it in one year.
D. A holder of a U.S. government bond that plans on holding it until it matures.
Short Answer Questions
100.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 $259 each year over the next ten years.
(ii) Borrower repays $300 each year over the next five years, plus a lump-sum payment of
$895 in the fifth year.
(iii) 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.
6-31
101.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
102.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.
6-32
103.Could the holding period return ever be less than the yield to maturity? Explain.
104.Use the example of a consol to show how bond prices and yields are inversely related.
6-33
105.Notice the following model of a bond market. In each situation given, explain what happens
to the bond price and yield and why.
a) Expected inflation increases

b) The return on bonds rises relative to other assets
c) The federal government deficit increases
6-34
106.Calculate the price of a zero coupon bond that has an interest rate of 6.65% (.0665), a face
value of $100.00 and six-months to maturity.
107.Calculate the monthly payment for a 30-year mortgage, where the amount borrowed is
$100,000 and the annual interest rate is 6.0%.
108.Calculate the price of a $1,000 face value bond that offers a $45 annual coupon, and has six
years to maturity, when the interest rate is 6.0% (0.060).
6-35
109.Which bond will have a higher yield to maturity, a $1,000 face value bond, with a 5.0% coupon
rate that sells for $900; or a $1000 face value bond, with a $50 annual coupon that sells for
$1,050? Explain your choice.
110.Compute the change in the price of a five-year (until maturity) $1,000 face value zero-coupon
bond that currently yields 7% when expected inflation increases from 3% to 4%.
6-36
111.Suppose that the interest rate on a conventional 30-year mortgage is currently 8%. You
receive a call from a mortgage broker who offers you a 30-year adjustable rate mortgage at
2% that is adjusted once each year. Evaluate each mortgage in terms of the following: risk
that the monthly payment will change over the next 30 years and interest-rate risk.
112.Explain the relationship between coupon rate (or coupon yield) and current yield.
6-37
113.Explain why the bid-ask spread on most municipal bonds would be greater than the spread
on U.S. Treasury bonds.
114.The U.S. Treasury offers several ways to purchase U.S. government bonds. There are the
traditional coupon bonds and Treasury Inflation-Indexed Securities. How do these bonds
differ from their traditional counterparts?
6-38
115.In the late 1990s, the U.S. government ran a surplus for the first time in decades. It instituted
a buyback program, whereby the Treasury bought outstanding government bonds. How
would this program affect the bond market price, yield, and quantity of bonds? How might it
affect the liquidity of government bonds?
116.Explain why holding period return, as an economic measure, does not have the same
significance as current yield or yield to maturity.
6-39
117.Suppose that a bond is purchased at a discount (meaning that it is sold for less than face
value). Could the yield to maturity ever be less than the coupon rate? Could the holding
period return be less than the coupon rate? Explain.
118.In mid-2004 there was speculation that the Federal Reserve would be raising interest rates
before the end of the year. How would this news affect the bond market and why?
6-40
119.Use our model of the bond market (supply and demand) to explain what happens if the U.S.
economy continues to grow at robust rates.
120.How can a bond mutual fund report a return of over 13% when the coupon rate of the bonds
they are holding are just 7% and interest rates are falling?
6-41
121.At the time the government of Bulgrovia issued new bonds, they issued them at a price that
reflected the risk-free rate because investors had no concerns regarding default risk, so did
not require a risk premium. That risk-free rate was 4%. These bonds currently have one year
to maturity and you notice the yield is 20%. Can you calculate the probability that the
Bulgrovian government will default?
122.Consider two investors: one is risk-neutral and the other is risk-averse. How do they each
assess a risk premium?
6-42
123.Explain why two countries with the same average rate of inflation may not present the same
inflation risk for holders of those countries' bonds?
124.The text identified the various sources of risk for bonds. Are U.S. Treasury TIPS bonds free
from risk? Explain.
6-43
125.If you were going to issue bonds, would you prefer to be in a country where the average
inflation rate is 3% inflation but fluctuates wildly, or in a country with a higher, 4% expected
inflation rate that is stable (meaning it's always 4%). Explain.
Essay Questions
126.You win your state lottery. The lottery officials offer you the option of taking your winnings in
one lump-sum payment, or fixed annual payments for the next 20 years. The sum of the 20
annual payments is larger than the lump-sum payment. Before deciding, what are the key
factors you will want to consider that could influence your decision?
6-44
127.Consider the factors that affect bond demand and bond supply. Describe how the following
are likely to change during a period of robust economic growth: wealth, default risk, and
general business conditions. For each, state how the factor is likely to change, and discuss
the implications for bond demand/supply, bond price, and yield. Bond prices tend to
decrease during periods of high economic growth. What does this reveal about which of
these factors is important?
128.Many people are worried that, with the growing number of people that will retire in the U.S.
over the next 40 years, the federal government will need to borrow large amounts of money
to finance the Social Security System. If we assume that Social Security taxes and the
current eligibility age remain constant, explain the likely impact this will have on bond
markets.
6-45
Chapter 06 Bonds, Bond Prices, and the Determination of Interest
Rates Answer Key
Multiple Choice Questions
1. A zero-coupon bond refers to a bond which:
A. does not pay any coupon payments because the issuer is in default.
B. promises a single future payment.
C. pays coupons only once a year.
D. pays coupons only if the bond price is above face value.
AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 06-01 Understand present value and bond pricing.
Topic: Bond Prices
6-46
2. A consol is:
A. another name for a zero-coupon bond.
B. a bond with a maturity date exceeding 10 years.
C. a bond that makes periodic interest payments forever.
D. a form of a bond that is issued quite often by the U.S. Treasury.

Blooms: Remember
Difficulty: 1 Easy
Topic: Bond Prices
3. A pure discount bond is also known as a:
A. consol.
B. fixed payment loan.
C. coupon bond.
D. zero-coupon bond.

Blooms: Remember
Difficulty: 1 Easy
Topic: Bond Prices
6-47
4. The most common form of zero-coupon bonds found in the United States is:
A. AAA rated corporate bonds.
B. U.S. Treasury bills.
C. 30-year U.S. Treasury bonds.
D. municipal bonds.

Blooms: Remember
Difficulty: 1 Easy
Topic: Bond Prices
5. Which of the following best expresses the formula for determining the price of a U.S.
Treasury bill that matures n periods from now per $100 of face value when the interest
rate is i?
A. $100/(1 + i)n
B. $100(1 + i)
C. $100/(1 + i)
D. 1 + $100/(1 + i)n

Blooms: Remember
Difficulty: 2 Medium
Topic: Bond Prices
6-48
6. Once you buy a coupon bond, which of the following can change?
A. Coupon rate
B. Coupon payment
C. Face value
D. Yield to maturity

Blooms: Understand
Topic: Bond Prices
7. Which of the following makes fixed payments indefinitely?
A. Amortized loan
B. Consol
C. Coupon bond
D. Zero-coupon bond

Blooms: Remember
Difficulty: 1 Easy
Topic: Bond Prices
6-49
8. A 10-year Treasury note as a face value of $1,000, price of $1,200, and a 7.5% coupon rate.
Based on this information, we know the:
A. present value is greater than its price.
B. current yield is equal to 8.33%.
C. coupon payment on this bond is equal to $75.
D. coupon payment on this bond is equal to $90.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Topic: Bond Prices
9. If the annual interest rate is 5%(.05), the price of a one-year Treasury bill per $100 of face
value would be:
A. $95.00
B. $97.50
C. $95.24
D. $96.10
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Topic: Bond Prices
6-50
10. If the annual interest rate is 5%(.05), the price of a six-month Treasury bill would be:
A. $97.50
B. $97.59
C. $95.25
D. $95.00
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Topic: Bond Prices
11. If the annual interest rate is 5%(.05), the price of a three-month Treasury bill would be:
A. $98.79
B. $95.00
C. $98.75
D. $97.59
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Topic: Bond Prices
6-51
12. The relationship between the price and the interest rate for a zero coupon bond is best
described as:
A. volatile.
B. fluctuating.
C. inverse.
D. non-existent.

Blooms: Understand
Difficulty: 1 Easy
Topic: Bond Prices
13. When a loan is amortized, it means the:
A. borrower is in default.
B. principal and interest are paid off by the borrower over the life of the loan.
C. interest is due entirely at the maturity date.
D. principal in never repaid, only interest.
AACSB: Analytic
Blooms: Remember
Topic: Bond Prices
6-52
14. Most home mortgages are good examples of:
A. consols.
B. zero-coupon bonds.
C. coupon bonds.
D. fixed-payment loans.

Blooms: Remember
Difficulty: 1 Easy
Topic: Bond Prices
15. The price of a coupon bond can best be described as the:
A. present value of the face value.
B. future value of the coupon payments.
C. future value of the coupon payments and the face value.
D. present value of the face value plus the present value of the coupon payments.

Blooms: Understand
Topic: Bond Prices
6-53
16. The difference in the prices of a zero-coupon bond and a coupon bond with the same face
value and maturity date is simply:
A. zero, since they are the same.
B. the present value of the final payment.
C. the present value of the coupon payments.
D. the future value of the coupon payments.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Prices
17. The price (P) of a consol offering an annual coupon payment (C) is best expressed by:
A. F/C
B. C(1 + i)
C. C/(1 + i)
D. C/i

Blooms: Remember
Topic: Bond Prices
6-54
18. If a consol is offering an annual coupon of $50 and the annual interest rate is 6%, the price
of the consol is:
A. $47.17
B. $813.00
C. $833.33
D. $8333.33
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Topic: Bond Prices
19. Which of the following statements is most accurate?
A. Yield to maturity is equal to the coupon rate if the bond is held to maturity.
B. Yield to maturity is the same as the coupon rate.
C. Yield to maturity will exceed the coupon rate if the bond is purchased for face value.
D. Yield to maturity is the same as the coupon rate if the bond is purchased for face value
and held to maturity.

Blooms: Create
Learning Objective: 06-02 Understand the relationship of prices; yields; and returns.
Topic: Bond Yields
6-55
20. When the price of a bond is above face value the yield to maturity:
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
21. When the price of a bond is below the face value, the yield to maturity:
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
6-56
22. When the price of a bond equals the face value the:
A. yield to maturity will be above the coupon rate.
B. yield to maturity will be below the coupon rate.
C. current yield is equal to the coupon rate.
D. yield to maturity is greater than the current yield.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
23. If the purchase price of a bond exceeds the face value, the yield to maturity:
A. is greater than the coupon rate because the capital gain is positive.
B. will equal the current yield.
C. will be less than the coupon rate because the capital gain will be negative.
D. will be greater than the current yield.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
6-57
24. The current yield of a bond:
A. is another term for the coupon rate.
B. is another term for the yield to maturity.
C. equals zero for a zero-coupon bond since these bonds have no coupon payments.
D. is the difference between its future value and its present value.

Blooms: Understand
Difficulty: 1 Easy
Topic: Bond Yields
25. A $1,000 face value bond purchased for $965.00, with an annual coupon of $60, and 20
years to maturity has a:
A. current yield equal to 6.22%.
B. current yield equal to 6.00%.
C. coupon rate equal to 6.22%.
AACSB: Analytic
Blooms: Apply
Topic: Bond Yields
6-58
26. A $1,000 face value bond purchased for $965.00, with an annual coupon of $60, and 20
years to maturity has a:
A. current yield and coupon rate equal to 6.22% and a coupon rate above this.
B. current yield equal to 6.22% and a coupon rate below this.
C. coupon rate equal to 6.00% and a current yield below this.
AACSB: Analytic
Blooms: Apply
Topic: Bond Yields
A. coupon payment is ignored.

Blooms: Understand
Topic: Bond Yields
6-59
A. coupon payment and purchase price is all that is needed.

Blooms: Understand
Topic: Bond Yields
29. When the current yield and the coupon rate are equal, the bond is:
A. purchased at a discount.
B. purchased at a price that equals the face value.
C. a zero-coupon bond.
D. purchased at a price that exceeds its face value.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
6-60
30. If a bond's purchase price equals the face value the:
A. coupon rate equals the current yield, which is less than the yield to maturity.
B. current yield equals the yield to maturity, which exceeds the coupon rate.
C. coupon rate equals the yield to maturity, which equals the current yield.
D. coupon rate does not equal the current yield, which does not equal the yield to
maturity.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
31. Which of the following is not a reason why the yield to maturity can differ from the current
yield?
A. Because the yield to maturity considers the capital gain/loss.
B. Because the current yield focuses only on the coupon payment and the purchase price.
C. Because most bonds are not purchased for face value.
D. Because the current yield moves in the opposite direction from price.

Blooms: Understand
Topic: Bond Yields
6-61
32. A $1000 face value bond, with one year to maturity that sells for $950 and has a $40
annual coupon has a:
A. current yield and yield to maturity of 4.00%.
B. yield to maturity that equals the current yield.
C. coupon rate of 4.00% and a current yield that is below this.
D. current yield of 4.21%.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
33. A $1,000 face value bond, with an annual coupon of $40, one year to maturity and a
purchase price of $980 has a:
A. current yield that equals 4.00%.
B. coupon rate that equals 4.08%.
C. current yield that equals 4.08% and a yield to maturity that equals 6.12%.
D. current yield that equals 4.08% and a yield to maturity that equals 4.0%.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
6-62
34. A 30-year Treasury bond as a face value of $1,000, price of $1,200 with a $50 coupon
payment. Assume the price of this bond decreases to $1,100 over the next year. The one-
year holding period return is equal to:
A. -9.17%.
B. -8.33%.
C. -4.17%.
D. -3.79%.
AACSB: Analytic
Blooms: Apply
Topic: Bond Yields
35. The bid price for a bond quote is:
A. the price at which the bond dealer is willing to sell the bond.
B. the price at which the bond dealer is willing to purchase the bond.
C. fixed over the life of a bond.
D. determined solely by the time left to maturity.

Blooms: Remember
Topic: Bond Yields
6-63
36. In reading bond quotes:
A. the bid price is usually above the asked price.
B. the asked price is fixed over the life of the bond.
C. the asked price is usually above the bid price.
D. bid and asked prices must be equal as set forth by SEC regulations.

Blooms: Understand
Topic: Bond Yields
37. The bond dealer's spread is:
A. the asking price less the bid price.
B. the difference between the current yield and the yield to maturity.
C. the bid price less the asking price.
D. usually negative; the dealer makes a profit holding the bonds.

Blooms: Remember
Difficulty: 1 Easy
Topic: Bond Yields
6-64
38. The size of the bond dealer's spread is mainly a function of the:
A. purchase price of the bond.
B. current yield.
C. liquidity of the bond market.
D. face value of the bond.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
39. The larger the bond dealer's spread the:
A. less liquid is the market for that bond.
B. greater is the coupon rate for that bond.
C. more liquid is the market for that bond.
D. less risk there is for the dealer to hold that bond.
AACSB: Analytic
Blooms: Create
Topic: Bond Yields
6-65
40. The holding period return on a bond:
A. can never be more than the yield to maturity.
B. will equal the yield to maturity if the bond is purchased for face value and sold at a
lower price.
C. will be less than the yield to maturity if the bond is sold for more than face value.
D. will be less than the yield to maturity if the bond is sold for less than face value.

Blooms: Understand
Topic: Bond Yields
41. One characteristic that distinguishes holding period return from the coupon rate, the
current yield, and the yield to maturity is:
A. all of the other returns can be calculated at the time the bond is purchased, but holding
period return cannot.
B. holding period return will always be the highest return.
C. holding period return will usually be less than the other returns.
D. only the holding period return includes the capital gain/loss.
AACSB: Analytic
Blooms: Create
Topic: Bond Yields
6-66
42. Which of the following best expresses the equation for holding period return?
A. Current yield + coupon rate
B. Yield to maturity - current yield
C. Current yield + capital gain
D. Coupon rate + capital gain

Blooms: Remember
Topic: Bond Yields
43. In considering the holding period return, the longer the term of the bond the:
A. less important is the capital gain and the more important in the current yield.
B. less important is the coupon rate and the more important is the current yield.
C. less important is the capital gain.
D. more important is the capital gain.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
6-67
44. The holding period return has relevance because:
A. most bonds are held by the original purchaser until maturity.
B. most bonds are held by the original purchaser until they mature.
C. bonds are frequently traded.
D. current yields are not that important to bondholders.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
45. Suppose there is a decrease in the price at which a bondholder sells her bond. In this
case, the holding period return will:
A. increase, since yields and prices are inversely related.
B. decrease, since this lowers the capital gain.
C. be negative.
D. equal the coupon rate.
AACSB: Analytic
Blooms: Analyze
Topic: Bond Yields
6-68
46. If a one-year zero-coupon bond has a face value of $100, is purchased for $94, and is held
to maturity the:
A. holding period return will exceed the yield to maturity.
B. yield to maturity will exceed the holding period return.
C. yield to maturity will be 6.38%.
D. holding period return is 6.0%.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Topic: Bond Yields
47. Bond prices and yields:
A. move together in the same direction.
B. do not change if the coupon is fixed.
C. move together inversely.
D. are independent of each other.

Blooms: Understand
Topic: Bond Yields
6-69
48. As bond prices increase:
A. the quantity of bonds supplied increases.
B. the quantity of bonds supplied decreases.
C. the quantity of bonds demanded increases.
D. yields increases.
AACSB: Analytic
Blooms: Apply
Learning Objective: 06-03 Understand key drivers of bond prices.
Topic: The Bond Market and the Determination of Interest Rates
49. The bond supply curve slopes upward because:
A. as bond prices rise people holding bonds are more tempted to hold them.
B. as bond prices rise yields increase.
C. for companies seeking financing, the higher the price of bonds the more attractive it is
to sell bonds.
D. as bond prices rise yields decrease.

Blooms: Understand
6-70
50. The bond demand curve slopes downward because:
A. at lower prices the reward for holding the bond increases.
B. as bond prices fall so do yields.
C. as bond prices fall bonds are less attractive.
D. as bond prices rise yields increase.

Blooms: Understand
51. If the quantity of bonds supplied exceeds the quantity of bonds demanded, bond prices
would:
A. rise and yields would fall.
B. fall and yields would rise.
C. rise but yields will remain constant.
D. fall and yields would fall.
AACSB: Analytic
Blooms: Analyze
6-71
52. If the quantity of bonds demanded exceeds the quantity of bonds supplied, bond prices:
A. would rise and yields would fall.
B. would fall and yields would increase.
C. will rise and yields will remain constant.
D. will rise and yields would increase.
AACSB: Analytic
Blooms: Analyze
A. demand for bonds will decrease.
B. price of bonds will increase.
C. supply of bonds will increase.
D. yields on bonds will decrease.
AACSB: Analytic
Blooms: Apply
6-72
54. If the U.S. government's borrowing needs decrease, all other factors constant the:
A. supply of bonds will increase.
B. demand for bonds will decrease.
C. price of bonds will decrease.
D. price of bonds will increase.
AACSB: Analytic
Blooms: Apply
B. supply of bonds will increase.
C. demand for bonds will decrease.
D. supply of bonds and the demand for bonds will both increase.
AACSB: Analytic
Blooms: Apply
6-73
as the:
A. bond demand curve shifting right.
B. bond supply curve shifting right.
C. bond demand curve shifting left.
D. bond supply curve shifting left.

Blooms: Understand
as:
A. the bond demand curve shifting right.
B. a movement up the bond supply curve.
C. the bond demand curve shifting left.
D. the bond supply curve shifting right.

Blooms: Understand
6-74
58. As general business conditions improve, we would witness the following in the bond
market:
A. the bond demand curve shifting left.
B. the bond supply curve shifting left.
C. bond prices decreasing.
D. bond prices increasing.

Blooms: Understand
A. the demand for bonds will decrease.
B. the supply of bonds will increase.
C. bond prices will decrease.
D. bond yields will increase.

Blooms: Understand
6-75
60. As general business conditions improve, all other factors constant the:
B. yield on bonds will increase.
C. bond demand curve shifts right.
D. bond supply curve shifts left.

Blooms: Understand
A. the bond supply curve will shift left.
B. there will be a movement down the existing bond supply curve.
C. the bond demand curve shifts left.
D. the price of bonds will decrease.

Blooms: Understand
6-76
A. cost of borrowing increases and the desire to borrow decreases.
B. real interest rate increases.
C. bond supply curve shifts to the left.
D. cost of borrowing decreases and the desire to borrow increases.

Blooms: Understand
63. When expected inflation decreases for any given nominal interest rate, all of the following
occur except the:
A. real interest rate decreases.
B. bond supply curve shifts to the left.
C. cost of borrowing increases and the desire to borrow decreases.
D. price of bonds increases.
AACSB: Analytic
Blooms: Apply
6-77
A. bond demand curve shifts right.
B. bond supply curve shifts right.
C. price of bonds increases.
D. yield on bonds will increase.
AACSB: Analytic
Blooms: Apply
A. real cost of repayment for bond issuers increases.
B. real return for bondholders increases.
C. real cost of repayment for bond issuers decreases.
D. bond demand curve shifts right.
AACSB: Analytic
Blooms: Apply
6-78
66. 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 the:
A. bond demand curve shift right.
B. bond supply curve shift left.
C. bond supply curve shift right.
D. bond demand curve shift left.
AACSB: Analytic
Blooms: Analyze
67. Which of the following would lead to an increase in bond supply?
A. A decrease in government spending relative to revenue.
B. An increase in corporate taxes.
C. A decrease in expected inflation.
D. An improvement in general business conditions.

Blooms: Understand
6-79
68. Which of the following would lead to a decrease in bond demand?
A. An increase in expected inflation.
B. An increase in wealth.
C. A decrease in risk.
D. A decrease in liquidity.

Blooms: Understand
69. An increase in the nation's wealth, all other factors constant, would cause the:
A. bond supply curve to shift left.
B. bond demand curve to shift left.
C. bond supply curve to shift right.
D. bond demand curve to shift right.
AACSB: Analytic
Blooms: Apply
6-80
70. An increase in the nation's wealth, all other factors constant, would cause:
A. bond prices to fall and yields to increase.
B. bond prices and yields to increase.
C. bond prices to rise and yields to decrease.
D. the bond supply curve to shift right.
AACSB: Analytic
Blooms: Apply
71. A decrease in the nation's wealth, all other factors constant, would cause:
A. the bond demand curve to shift left.
B. bond prices to rise.
C. interest rates to decrease.
D. the bond supply curve to shift left.
AACSB: Analytic
Blooms: Apply
6-81
72. An increase in expected inflation for any given nominal interest rate will cause the:
A. bond supply curve to shift to the left.
B. bond demand curve to shift to the right.
C. price of bonds to decrease.
D. price of bonds to increase.
AACSB: Analytic
Blooms: Analyze
73. A decrease in expected inflation for any given nominal interest rate will cause:
A. bond prices to increase and interest rates to decrease.
B. bond prices to decrease and interest rates to increase.
C. the bond demand curve to shift to the left.
D. the bond supply curve to shift to the left.
AACSB: Analytic
Blooms: Apply
6-82
74. An increase in expected inflation for any given nominal interest rate will cause:
A. the real return to bondholders to decrease.
B. a movement down the bond demand curve, but no change in the bond demand curve.
C. the bond demand curve to shift right.
D. the price of bonds to increase.
AACSB: Analytic
Blooms: Apply
75. 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.
B. a movement down the bond demand curve.
D. an increase in the price of bonds.
AACSB: Analytic
Blooms: Analyze
6-83
76. Suppose that the return on assets other than bonds falls. In the bond market this will
result in a(n):
A. movement down the bond demand curve.
B. shift to the left of the bond demand curve.
C. increase in the price of bonds.
D. shift to the left of the bond supply curve.
AACSB: Analytic
Blooms: Apply
77. 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.
B. a rightward shift in the bond supply curve.
D. an increase in bond prices.
AACSB: Analytic
Blooms: Analyze
6-84
78. If interest rates are expected to rise, the bond prices will:
A. not change until interest rates actually change.
B. fall, due to the demand for bonds decreasing.
C. rise, as people seek capital gains.
D. move in the same direction as the expected change in interest rates.
AACSB: Analytic
Blooms: Analyze
79. If interest rates are expected to fall, bond prices will:
A. fall as the demand for bonds decreases.
B. remain constant until interest rates actually change.
C. fall as people fear capital losses in the future.
D. increase due to the demand for bonds increasing.
AACSB: Analytic
Blooms: Analyze
6-85
80. Suppose that general business conditions improve, and at the same time, wealth
increases. Based on this information, we know that:
A. bond prices increase.
B. yield to maturity decreases.
C. the real interest rate increases.
D. the quantity of bonds increases.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
81. 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.
B. decrease since people will bail out of all government bonds.
C. increase as the demand for these bonds increases.
D. not be affected because the two types of bonds are traded in different markets.
AACSB: Analytic
Blooms: Analyze
6-86
82. The demand for U.S. government bonds is high relative to other bond issues because:
A. liquidity of other bond issues is high relative to U.S. government bonds.
B. U.S. bond market has low transaction spreads due to high illiquidity.
C. market for U.S. government bonds is more liquid than most if not all other bond
markets.
D. U.S. government bonds have higher default.

Blooms: Understand
83. 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 the bond demand curve:
A. will shift right as will the bond supply curve.
B. will shift right but the bond supply curve shifts left.
C. and supply curves will shift left.
D. will shift left as the bond supply curve shifts right.
AACSB: Analytic
Blooms: Apply
6-87
84. 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.
B. The price of bonds will increase if bond supply decreases more than bond demand.
C. Interest rates will increase if bond demand decreases more than bond supply.
D. Neither bond demand nor bond supply will shift.
AACSB: Analytic
Blooms: Analyze
6-88
bonds - D0, with the equilibrium price and quantity being P0 and Q0. An increase in the
nation's wealth, all else constant, would cause the
A. Bond supply curve to shift to S1.
B. Bond demand curve to shift to D1.
C. Bond supply curve to shift to S2.
D. Bond demand curve to shift to D2.
AACSB: Analytic
Blooms: Analyze
6-89
bonds - D0, with the equilibrium price and quantity being P0 and Q0. Suppose that the
expected return on bonds falls relative to other assets. In the bond market this will result
in:
AACSB: Analytic
Blooms: Analyze
6-90
bonds - D0, with the equilibrium price and quantity being P0 and Q0. 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:
AACSB: Analytic
Blooms: Analyze
6-91
bonds - D0, with the equilibrium price and quantity being P0 and Q0. If the U.S.
government's borrowing needs decrease, all other factors constant:
AACSB: Analytic
Blooms: Analyze
6-92
89. 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%
B. 1.5%
C. 5.2%
D. 8.0%
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 06-04 Understand risks of default; inflation; and interest rate changes.
Topic: Why Bonds are Risky
90. Default risk is the risk associated with:
A. the bond issuer not being able to make the promised payments.
B. the illiquidity associated with small issues.
C. the effect on bond prices caused by changes in market rates of interest.
D. changes in the expected inflation rate.

Blooms: Understand
Difficulty: 1 Easy
6-93
91. Consider the bonds below. Which is subject to the greatest interest-rate risk?
A. A 30-year fixed-rate mortgage (fixed payment loan)
B. A consol
C. A Treasury bill
D. A 20-year corporate bond

Blooms: Understand
92. 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:
A. increases from $1,000 to $1,018.
B. increases from $1,000 to $1,375.
C. decreases from $110 to $88.
D. decreases from $1,210 to $1,188.
AACSB: Analytic
Blooms: Apply
6-94
93. 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:
A. $400
B. $909.09
C. $1,454.54
D. $1,600
AACSB: Analytic
Blooms: Apply
94. 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?
A. The real interest rate decreased.
B. The student is made worse off because her real cost of borrowing is higher.
C. The lender is made worst off because his real return on the car loan is lower.
D. Both the student and the lender benefit.
AACSB: Analytic
Blooms: Analyze
6-95
95. 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'
coupon payments.
B. It refers to the probability that a borrower will default on debt obligations.
C. It is the risk that the face value of a bond will change before maturity.
D. Individuals owning long-term bonds are exposed to greater interest-rate risk.

Blooms: Understand
96. 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:
A. default risk.
B. liquidity risk.
C. inflation risk.
D. interest-rate risk.

Blooms: Understand
6-96
97. The U.S. Treasury issues 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.
B. lower price and a lower fixed return since the demand for them should be higher.
C. higher price and higher fixed return since we always seem to have some inflation.
D. higher price and lower return due to the decreased risk from inflation in holding these
bonds.
AACSB: Analytic
Blooms: Apply
98. Interest-rate risk results from:
A. bond prices being fixed over the life of the bond.
B. a mismatch between an individual's investment horizon and a bond's maturity.
C. the fact that most people hold bonds until they mature.
D. inflation being uncertain.

Blooms: Understand
6-97
99. Interest-rate risk would not matter to which of the following bondholders?
A. A holder of a U.S. government bond.
B. A holder of a U.S. government bond indexed for inflation.
C. A holder of a U.S. government bond who plans on selling it in one year.
D. A holder of a U.S. government bond that plans on holding it until it matures.
AACSB: Analytic
Blooms: Analyze
Short Answer Questions
6-98
100. 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 $259 each year over the next ten years.
(ii) Borrower repays $300 each year over the next five years, plus a lump-sum payment of
$895 in the fifth year.
(iii) 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.
The present values are calculated as follows:
(i) Fixed-payment loan. The borrower repays a loan in fixed annual payments for a pre-
determined period of time.
Present value of fixed payment loan =
= Fixed payment/(1 + i) + Fixed payment/(1 + i)2 +…+ Fixed payment/(1 + i)n
= $259/(1 + 0.05) + $259/(1 + 0.05)2 +…+ $259/(1 + 0.05)10 = $2,000
(ii) Coupon bond. The borrower repays the loan in fixed annual payments ("coupons") and
pays a one-time lump sum payment in the last year of the loan ("face value").
Present value of coupon bond = PCB
PCB = Coupon payment/(1 + i) + Coupon payment/(1 + i)2 +…+ Coupon payment/(1 +
i)n + Face value/(1 + i)n
= $300/(1 + 0.05) + $300/(1 + 0.05)2 +…+ $300/(1 + 0.05)5 + $895/(1 + 0.05)5
= $2,000
(iii) Zero-coupon bond. The borrower repays the principal plus interest in one annual
payment, with no intermediate payments.
Price of zero coupon bond = Payment/(1 + i) = $2100/(1 + 0.05) = $2,000
6-99
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Topic: Bond Prices
101. 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
We can use a financial calculator to solve for each of these. The easiest answer is to
realize the coupon rate will not change; it is $55/$1000 or 5.50% (.055). The current yield,
which is the coupon divided by the purchase price will vary for each: for a) the current
yield is 5.85%; for b) it is 4.87% and for c) it is 5.50%. The yield to maturity will also vary:
for a) it is 6.33% for b) it is 3.90% and for c) it is 5.50%.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Topic: Bond Prices
6-100
102. 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.
9.02%. Here we have to consider the present value of the three coupon payments as well
as the present value of the capital gain that results from purchasing the bond for $970 and
selling it for $1,060.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Topic: Bond Prices
103. Could the holding period return ever be less than the yield to maturity? Explain.
This is possible under the condition that the bond is sold before it matures for an amount
less than the face value. If this happened then the holding period return would be less
than the yield to maturity.

Blooms: Analyze
Topic: Bond Yields
6-101
104. Use the example of a consol to show how bond prices and yields are inversely related.
A consol is a bond that pays a fixed payment forever but does not mature. In calculating
the price of a consol we use the formula Price = Coupon/interest rate. This simple formula
shows the inverse relationship between price and interest rate since price is on the left
and interest rate is in the denominator on the right.
AACSB: Analytic
Blooms: Create
Topic: Bond Yields
6-102
105. Notice the following model of a bond market. In each situation given, explain what
happens to the bond price and yield and why.
a) Expected inflation increases

b) The return on bonds rises relative to other assets
c) The federal government deficit increases
a) If expected inflation increases the demand for bonds will decrease and the supply will
increase. Both of these will reinforce each other, causing the bond prices to fall and
interest rates to increase.
b) If the return on bonds rises relative to other assets, the bond demand curve will shift to
the right, causing bond prices to increase and interest rates to decrease.
c) If the federal budget deficit increases, the bond supply curve will shift to the right,
causing the bond prices to fall and interest rates to increase.
AACSB: Analytic
Blooms: Apply
6-103
106. Calculate the price of a zero coupon bond that has an interest rate of 6.65% (.0665), a face
value of $100.00 and six-months to maturity.
We can use the formula from the text where Price (P) = Face value/(1 + i)n. In this case,
P = $100/(1 + .0665)0.5, which equals $96.83.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
107. Calculate the monthly payment for a 30-year mortgage, where the amount borrowed is
$100,000 and the annual interest rate is 6.0%.
If we use 360 months for the 30 years and convert the 6.0% annual rate to a monthly rate
of 0.48676%, [this is found by solving (1 + im) = (1.06)1/12 where im = 0.0048676]. Using
a financial calculator, we find the monthly payment equals $589.37.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Topic: Bond Prices
6-104
108. Calculate the price of a $1,000 face value bond that offers a $45 annual coupon, and has
six years to maturity, when the interest rate is 6.0% (0.060).
Using a financial calculator the price of the bond is $926.24. We insert $1000 for the face
(future) value; $45 for the annual payment, 6.0 for the annual interest rate, 6 for the N (or
years) and solve for P (or PV on most calculators).
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Topic: Bond Prices
109. Which bond will have a higher yield to maturity, a $1,000 face value bond, with a 5.0%
coupon rate that sells for $900; or a $1000 face value bond, with a $50 annual coupon that
sells for $1,050? Explain your choice.
The bond that is selling for $900 will. Both bonds have the same coupon rate, 5%, and they
have the same maturity, so the bondholder's returns from the coupons are equal. What
differentiates the two is that the bondholder who purchases the bond for $900 will also
receive a capital gain which increases his/her yield to maturity.

Blooms: Apply
Topic: Bond Yields
6-105
110. Compute the change in the price of a five-year (until maturity) $1,000 face value zero-
coupon bond that currently yields 7% when expected inflation increases from 3% to 4%.
The bond currently will sell for $712.99. Once the expected inflation increases by 1%, the
bondholders would want to keep the same real return, which would drive the bond yield up
to 8%. This increase in bond yield will drive the price down to $680.58, or a decrease of
more than 4.8% of the bond's price.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Topic: Bond Yields
6-106
111. Suppose that the interest rate on a conventional 30-year mortgage is currently 8%. You
receive a call from a mortgage broker who offers you a 30-year adjustable rate mortgage
at 2% that is adjusted once each year. Evaluate each mortgage in terms of the following:
risk that the monthly payment will change over the next 30 years and interest-rate risk.
The fixed-rate mortgage protects the borrower and the lender from any risk that the
monthly payment will change. Whether the interest rate increases (reducing the present
value to the lender) or decreases (increasing the present value to the lender), the payment
is always the same. The risk that the present value of the mortgage will change because
of a change in interest rates is the interest-rate risk. The adjustable rate mortgage has no
interest-rate risk (because the present value is adjusted), but there is considerable risk
that the monthly payment will change.
AACSB: Analytic
Blooms: Create
Difficulty: 3 Hard
Topic: Bond Yields
6-107
112. Explain the relationship between coupon rate (or coupon yield) and current yield.
The coupon rate is simply the annual coupon divided by the face value. The current yield is
the annual coupon divided by the price of the bond. The only time these should equal each
other is when the price of the bond equals the face value. If the price is greater than the
face value the current yield should be less than the coupon rate. If the price of the bond is
less than the face value, the current yield should be greater than the coupon rate.

Blooms: Understand
Topic: Bond Yields
113. Explain why the bid-ask spread on most municipal bonds would be greater than the
spread on U.S. Treasury bonds.
Spreads are the difference between the dealer's bid and asked prices. Since dealers are
ready to buy or sell the bond, they must carry an inventory, which means they accept risk
just like any other bondholder would. One of these risks is liquidity risk, which is the risk of
not being able to sell the bond when you would like. Since the market for U.S. Treasury
bonds is far more liquid than would be the market for any single municipal bond, the
dealer of the municipal bond would face greater liquidity risk and require a larger spread.
AACSB: Analytic
Blooms: Analyze
6-108
114. The U.S. Treasury offers several ways to purchase U.S. government bonds. There are the
traditional coupon bonds and Treasury Inflation-Indexed Securities. How do these bonds
differ from their traditional counterparts?
Inflation-indexed securities protect the borrower against inflation risk. If inflation is higher
than expected, this will reduce bond prices for the traditional government bonds, but not
the inflation-indexed bonds.
AACSB: Analytic
Blooms: Create
Topic: Bond Prices
115. In the late 1990s, the U.S. government ran a surplus for the first time in decades. It
instituted a buyback program, whereby the Treasury bought outstanding government
bonds. How would this program affect the bond market price, yield, and quantity of bonds?
How might it affect the liquidity of government bonds?
The buyback of government bonds would reduce bond supply, increasing the bond price,
reducing the yield, and decreasing the quantity of bonds.
AACSB: Analytic
Blooms: Create
Difficulty: 3 Hard
6-109
116. Explain why holding period return, as an economic measure, does not have the same
significance as current yield or yield to maturity.
One of the things economists do is try to explain behavior, or decisions people make.
Current yield and yield to maturity are a priori measures, meaning we can calculate these
prior to actually making the purchase of the bond. The holding period return cannot be
calculated a priori, it is only calculated after the bond is purchased; to a certain degree it
represents a "sunk" cost.
AACSB: Analytic
Blooms: Create
Topic: Bond Yields
6-110
117. Suppose that a bond is purchased at a discount (meaning that it is sold for less than face
value). Could the yield to maturity ever be less than the coupon rate? Could the holding
period return be less than the coupon rate? Explain.
If a bond is purchased for less than face value, the yield to maturity will always exceed the
coupon rate. For the yield to maturity to be less than the coupon rate the price of the bond
would have to exceed the face value. On the other hand, the holding period return could be
less than the coupon rate. Even if a bond is purchased for less than face value, there is no
guarantee it will sell before the maturity date for an amount that is at or above the face
value; in fact it could sell for an amount well below the actual purchase price.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Topic: Bond Yields
6-111
118. In mid-2004 there was speculation that the Federal Reserve would be raising interest
rates before the end of the year. How would this news affect the bond market and why?
The speculated increase in interest rates by the Federal Reserve would cause the value of
bonds to decrease. As we saw in the text, an increase in the expected future interest rate
makes bonds less attractive. This will lower the demand for bonds, causing bond prices to
decrease and yields to increase. Moreover, the change in bond prices and yields will occur
before the actual interest rate changes since existing and prospective bondholders will act
on their expectations.
AACSB: Analytic
Blooms: Analyze
6-112
119. Use our model of the bond market (supply and demand) to explain what happens if the
U.S. economy continues to grow at robust rates.
Growth in the economy should result in greater supply of bonds, the bond supply curve
shifting right, as more firms seek resources to finance expansion and inventories. The
increase in supply by itself would result in lower bond prices and higher interest rates.
From the demand side, the robust economy should also cause an increase in wealth. The
increases in wealth would cause bond demand to increase (the curve shifts right), which
would drive up bond prices and decrease interest rates. The net effect will be determined
by which shift is larger. If supply shifts by an amount greater than demand, the bond
prices will fall and yields will rise. On the other hand, if demand increases by more than
supply, the bond prices will rise and yields will fall.
AACSB: Analytic
Blooms: Create
6-113
120. How can a bond mutual fund report a return of over 13% when the coupon rate of the
bonds they are holding are just 7% and interest rates are falling?
The bond mutual fund is advertising its holding period return. As illustrated in the text, if a
20-year, 7-percent coupon bond with a face value of $100 is sold before maturity when
interest rates have fallen to 6.5%, the price of that bond will rise to $106.50. The $6.50 of
capital gain plus the $7.00 coupon payment represent a one-year holding period return of
13.5%. As the text notes, this is why past performance cannot guarantee future returns; if
rates rise instead of fall the holding period return will not be as favorable.
AACSB: Analytic
Blooms: Create
Topic: Bond Yields
6-114
121. At the time the government of Bulgrovia issued new bonds, they issued them at a price
that reflected the risk-free rate because investors had no concerns regarding default risk,
so did not require a risk premium. That risk-free rate was 4%. These bonds currently have
one year to maturity and you notice the yield is 20%. Can you calculate the probability that
the Bulgrovian government will default?
The simple answer is no. A risk-premium is a measure of the premium required by

investors to accept risk; it is not a direct measure of the risk of default. We could only
determine this if investors are risk-averse. If that were true then, we can calculate the
probability fairly easily by realizing the probability the bond will not default can be
expressed by 1.04/1.20, which equals 0.867. If we subtract this from 1.0 we obtain the
probability of default which is 0.133.
AACSB: Analytic
Blooms: Create
Difficulty: 3 Hard
6-115
122. Consider two investors: one is risk-neutral and the other is risk-averse. How do they each
assess a risk premium?
The risk-neutral investor seeks a risk premium that has the price of the bond (and its
subsequent yield) such that the price equals the expected value (the sum of the payoffs
times the probabilities). The risk-averse investor would offer a price less than this (and
therefore seek a higher yield) since he/she requires additional compensation for risk.
Therefore, the risk-averse investor's risk premium would be greater.
AACSB: Analytic
Blooms: Analyze
123. Explain why two countries with the same average rate of inflation may not present the
same inflation risk for holders of those countries' bonds?
As the text points out, while the expected (or average) inflation can be the same, the
standard deviation around this expected rate presents different amounts of risk. The
higher the standard deviation, the greater the risk. For countries where inflation is volatile,
the standard deviation around their average expected rate will be greater, and therefore
their bonds will present greater inflation risk.
AACSB: Analytic
Blooms: Analyze
6-116
124. The text identified the various sources of risk for bonds. Are U.S. Treasury TIPS bonds free
from risk? Explain.
These bonds are free from two of the main sources of risk that make holding bonds risky.
U.S. Treasury bonds are free from default risk, and the TIPS bonds also remove the
inflation risk. However, the risk still present with these bonds is the interest-rate risk. If
the bondholder does not plan on holding these bonds until maturity, changes in the
interest rate (specifically increases) can result in capital losses or returns less than
expected.
AACSB: Analytic
Blooms: Analyze
6-117
125. If you were going to issue bonds, would you prefer to be in a country where the average
inflation rate is 3% inflation but fluctuates wildly, or in a country with a higher, 4%
expected inflation rate that is stable (meaning it's always 4%). Explain.
Even though the 4% expected rate is higher, it is stable. As we saw, the inflation risk isn't
really the risk from inflation; it is the risk that results from unexpected changes in inflation
which then can significantly alter the real interest rate, and therefore the real returns
bondholders receive. Because bondholders tend to be risk-averse, they would want to be
compensated for the inflation risk, and since the inflation risk results from the fluctuations
in the rate of inflation, the returns required by bondholders in the country where the
average expected rate is 3% but volatile are likely to be higher than the required returns on
the bonds in the higher but stable inflation country. This explains, at least partially, why
the central banks in many developed countries strive for inflation stability. Stable prices
will lead to lower inflation risk and a more efficient bond market.
AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Essay Questions
6-118
126. You win your state lottery. The lottery officials offer you the option of taking your winnings
in one lump-sum payment, or fixed annual payments for the next 20 years. The sum of the
20 annual payments is larger than the lump-sum payment. Before deciding, what are the
key factors you will want to consider that could influence your decision?
Although this is certainly a pleasant decision to think about, the options presented do
require serious thought. You should start by finding the interest rate that equates the
present value of the 20 payments with the lump sum. Next, compare this rate to the
interest rate you think you could safely earn on the lump-sum if you invested it. If the
market offers a higher interest rate, then this is a reason you may wish to take the lump
sum. Although morbid, you should also consider your own life expectancy. If you do not
think you are going to live another 20 years, you would certainly want to take your
winnings early. Lifestyle is also important as is the degree of risk aversion you exhibit. One
advantage to taking the payments over 20 years is that it is a form of expenditure
discipline that may prevent you from going through the funds quickly (though it is highly
likely that you will find plenty of sources that will loan you funds for the assignment of the
winnings to them). If you are a person that benefits from external discipline, the 20-year
payout may be more attractive. While this certainly is not an exhaustive list, it does show
that many of the factors discussed in the chapter come into play in making a decision such
as this on needs external discipline, the 20-year payout may be more attractive. While this
certainly is not an exhaustive list, it does show that many of the factors discussed in the
chapter come into play in making a decision such as this one.
AACSB: Analytic
Blooms: Create
Topic: Bond Prices
6-119
127. Consider the factors that affect bond demand and bond supply. Describe how the
following are likely to change during a period of robust economic growth: wealth, default
risk, and general business conditions. For each, state how the factor is likely to change,
and discuss the implications for bond demand/supply, bond price, and yield. Bond prices
tend to decrease during periods of high economic growth. What does this reveal about
which of these factors is important?
(i) Wealth affects bond demand and is likely to increase during an economic expansion.
Households experience an increase in the value of their total assets (including stocks, for
example). This leads to an increase in bond demand, increase in bond price, and decrease
in yield.
(ii) Default risk affects bond demand. The risk of default is likely to decrease during an
economic expansion because borrowers are more likely to honor their debts. This leads to
an increase in bond demand, increase in bond price, and decrease in yield.
(iii) General business conditions affect bond supply. These improve during economic
booms. This leads to an increase in bond supply, decrease in bond price, and increase in
yield.
If bond prices tend to decrease during periods of robust growth, this tells us that the
improvement in general business conditions has a larger effect on the bond market than
changes in wealth or default risk.
AACSB: Analytic
Blooms: Analyze
6-120
128. Many people are worried that, with the growing number of people that will retire in the
U.S. over the next 40 years, the federal government will need to borrow large amounts of
money to finance the Social Security System. If we assume that Social Security taxes and
the current eligibility age remain constant, explain the likely impact this will have on bond
markets.
If the Social Security Administration (SSA) finds that it will need to borrow to finance its
obligations this will cause the bond supply to increase, a shift to the right of the bond
supply curve. All other factors constant, this will cause bond prices to fall and yields to
increase. The yields on all bonds will rise, however, since the U.S. government, and the
SSA is a government agency, is usually viewed as the risk-free rate from a default
standpoint. Since the yields on these bonds will likely increase, this will cause the yields
on all bonds to rise since all other bonds have their respective risk premiums which are
then added to the risk-free return associated with U.S. government bonds.
AACSB: Analytic
Blooms: Create
6-121

Money Banking and Financial Markets 4th Edition Cecchetti Test Bank 1

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Money Banking and Financial Markets 4th Edition Cecchetti Test Bank 1

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Money Banking and Financial

Markets 4th Edition Cecchetti Test

Test Bank: https://testbankpack.com/p/test-bank-for-money-

Solution Manual: https://testbankpack.com/p/solution-manual-

Bonds, Bond Prices, and the Determination of Interest Rates

Multiple Choice Questions

B. promises a single future payment.

C. pays coupons only once a year.

D. pays coupons only if the bond price is above face value.

A. another name for a zero-coupon bond.

B. a bond with a maturity date exceeding 10 years.

C. a bond that makes periodic interest payments forever.

D. a form of a bond that is issued quite often by the U.S. Treasury.

3. A pure discount bond is also known as a:

B. fixed payment loan.

A. AAA rated corporate bonds.

B. U.S. Treasury bills.

C. 30-year U.S. Treasury bonds.

7. Which of the following makes fixed payments indefinitely?

A. present value is greater than its price.

B. current yield is equal to 8.33%.

C. coupon payment on this bond is equal to $75.

D. coupon payment on this bond is equal to $90.

13. When a loan is amortized, it means the:

C. interest is due entirely at the maturity date.

D. principal in never repaid, only interest.

14. Most home mortgages are good examples of:

15. The price of a coupon bond can best be described as the:

A. present value of the face value.

B. future value of the coupon payments.

C. future value of the coupon payments and the face value.

A. zero, since they are the same.

B. the present value of the final payment.

C. the present value of the coupon payments.

D. the future value of the coupon payments.

B. Yield to maturity is the same as the coupon rate.

A. is below the coupon rate.

B. will be above the coupon rate.

C. will equal the current yield.

D. will equal the coupon rate.

A. is below the coupon rate.

B. will be above the coupon rate.

C. will equal the current yield.

D. will equal the coupon rate.

A. yield to maturity will be above the coupon rate.

B. yield to maturity will be below the coupon rate.

C. current yield is equal to the coupon rate.

D. yield to maturity is greater than the current yield.

B. will equal the current yield.

D. will be greater than the current yield.

24. The current yield of a bond:

A. is another term for the coupon rate.

B. is another term for the yield to maturity.

A. current yield equal to 6.22%.

B. current yield equal to 6.00%.

C. coupon rate equal to 6.22%.

D. yield to maturity and current yield equal to 6.00%.

B. current yield equal to 6.22% and a coupon rate below this.

C. coupon rate equal to 6.00% and a current yield below this.

D. yield to maturity and current yield equal to 6.00%.

A. coupon payment is ignored.

B. present value of the capital gain/loss is ignored.

C. present value of the final payment is the only important consideration.

D. present value of the coupon payments is the only important consideration.