Chapter 11

Fundamentals of Investing, 12e (Smart/Gitman/Joehnk)
Chapter 11 Bond Valuation
11.1 Learning Goal 1
1) The real rate of interest is the risk free rate minus the inflation premium.
Answer: TRUE
Learning Outcome: F-05 Explain what determines interest rates and how changes in rates
influence investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
2) The risk premium component of a bond's market interest rate is related to the characteristics of
the particular bond and its issuer.
Answer: TRUE
3) The risk-free rate of return considers the expected rate of inflation.

Answer: TRUE
4) Actions by the Federal Reserve can keep the risk-free rate below the rate of inflation, at least
temporarily.
Answer: TRUE
Question Status: New Question
5) Municipal bonds usually have higher yields than bonds issued by the U. S. Government.
Answer: FALSE
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6) The higher a bond's Moody's or Standard & Poor's rating, the higher its yield.
Answer: FALSE
7) Changes in the inflation rate have a direct and pronounced effect on market interest rates.
Answer: TRUE
8) The required return on a bond is equal to

A) the real rate of return plus a risk premium plus an expected inflation premium.
B) the real rate of return plus the coupon rate plus an inflation rate.
C) the risk-free rate plus a risk premium plus an expected inflation premium.
D) the real rate plus a risk premium.
Answer: A
9) The risk-free rate of return is equal to the

A) real rate plus a risk premium.
B) required return minus the inflation premium.
C) real rate plus the inflation premium.
D) required return minus the real rate.
Answer: C
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10) Rank the following taxable bonds from lowest yielding to highest yielding.
I. U.S. Treasury bonds
II. corporate bonds
III. agency bonds
A) I, II, III
B) II, I, III
C) III, II, I
D) I, III, II
Answer: D
11) Which of the following factors will tend to cause the risk free rate to rise?
I. an increase in the money supply
II. an increase in the federal budget deficit
III. an increase in the level of economic activity
IV. falling rates in foreign markets
A) I, II, III only
B) II, III only
C) I and IV
D) I, II, III and IV
Answer: B
12) Which of the following factors influence short-term interest rates on government securities?
I. Federal Reserve actions
II. interest rate risk
III. expected future inflation
IV. the real rate of return
A) I and III only
B) II and IV only
C) I, II and IV only
D) I, III and IV only
Answer: D
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13) Which of the following risks are included in the risk premium?
I. interest rate risk
II. liquidity risk
III. financial risk
IV. purchasing power risk
A) I and II only
B) II and III only
C) III and IV only
D) I and IV only
Answer: B
14) Which one of the following will tend to cause domestic interest rates to rise?
A) an increase in the money supply
B) a decrease in the rate of inflation
C) a decrease in the federal budget deficit
D) an increase in interest rates overseas
Answer: D
15) The single most important factor that influences the behavior of market interest rates is
A) inflation.
B) business profits.
C) the supply of new bonds.
D) the stock market.
Answer: A
16) Which one of the following statements concerning interest rates is correct?
A) A decrease in the money supply will cause interest rates to decline.
B) A federal budget surplus will cause interest rates to decline.
C) Economic expansions will cause interest rates to decline.
D) Rising interest rates in foreign countries will cause U.S. interest rates to decline.
Answer: B
4
1) The relationship between the rate of return and the time to maturity of similar-risk securities is
known as the term structure of interest rates.
Answer: TRUE
2) A yield curve depicts the term structure of interest rates for similar-risk securities.
Answer: TRUE
3) Predicting the direction of interest rate movements is relatively easy.

Answer: FALSE
4) Treasury bond yields are commonly used as the basis for yield curves because they are low
risk and homogeneous in nature.
Answer: TRUE
5) A normal yield curve is flat or downward sloping.

Answer: FALSE
6) A downward sloping yield curve (short-term rates are higher than long-term rates) often
precedes a recession.
Answer: TRUE
5
7) The real rate of return is the same for all maturities.
Answer: TRUE
8) According to the expectations hypothesis, if investors anticipate higher rates of inflation in the
future, the yield curve will be downsloping.
Answer: FALSE
9) According to the liquidity preference theory, borrowers should pay a higher interest rate for
long-term borrowing than for short-term borrowing.
Answer: TRUE
10) A down-sloping yield curve indicates that interest rates are about to rise.
Answer: FALSE
11) A steep yield curve is generally considered a bullish sign for bonds.
Answer: TRUE
12) The yield curve depicts the relationship between a bond's yield to maturity and its
A) duration.
B) term to call.
C) term to maturity.
D) volatility.
Answer: C
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13) An inverted yield curve
A) means that long-term bonds are yielding more than short-term bonds.
B) exists when intermediate-term bonds have higher yields than either short-term or long-term
bonds.
C) rewards long-term investors for the additional risk they are assuming.
D) generally results from actions by the Federal Reserve to control inflation.
Answer: D
14) The expectations hypothesis states that investors

A) require higher long-term interest rates today if they expect higher inflation rates in the future.
B) expect higher long-term interest rates because of the lack of liquidity for long-term bonds.
C) require the real rate of return to rise in direct proportion to the length of time to maturity.
D) normally expect the yield curve to be downsloping.
Answer: A
15) According to expectations theory if the 1 year interest is 3% this year and expected to be 5%
next year, the 2 year interest rate should be approximately
A) 8%.
B) 5%.
C) 4%.
D) 3%.
Answer: C
16) According to the expectations hypothesis, investors' expectations of decreasing inflation will
result in
A) a downward-sloping yield curve.
B) an upward-sloping yield curve.
C) a flat yield curve.
D) a humped yield curve.
Answer: A
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17) Downward sloping or flat yield curves often indicate
A) a recession in the near future.
B) an economic expansion in the near future.
C) higher inflation in the near future.
D) a weaker dollar in the foreign exchange markets.
Answer: A
18) Long-term bonds are ________ than short-term bonds.

A) less risky
B) more liquid
C) subject to more uncertainty
D) less sensitive to interest rate changes
Answer: C
19) When compared to the yield curve for Treasury securities, the yield curve for corporate
securities should
A) slope in the opposite direction.
B) be similar in shape but higher.
C) be similar in shape but lower.
D) be nearly identical.
Answer: B
20) The liquidity preference theory supports ________ yield curves.

A) upward sloping
B) flat
C) humped
D) downward sloping
Answer: A
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21) The market segmentation theory holds that
A) an increase in demand for long-term borrowings leads to an inverted yield curve.
B) expectations about the future level of interest rates is the major determinant of the shape of
the yield curve.
C) the yield curve reflects the maturity preferences of financial institutions and investors.
D) the shape of the yield curve is always downsloping.
Answer: C
22) Market segmentation theory explains the typical upward sloping shape of yield curves as a
function of
A) normally greater demand for long-term bonds than for short-term notes.
B) normally greater demand for short term notes than for long-term bonds.
C) expectations that inflation will be higher in the future than it is now.
D) the greater liquidity of short-term notes as compared to long-term bonds.
Answer: B
23) At any given time, the yield curve is affected by

I. lender preferences.
II. inflationary expectations.
III. liquidity preferences.
IV. short- and long-term supply and demand conditions.
A) I and IV only
B) II, III and IV only
C) I, II and III only
Answer: D
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24) Which of the following theories is consistent with yield curves sloping upward most of the
time?
I. market segmentation theory.
II. expectations theory.
III. liquidity preference theory.
IV. theory of evolution.
A) I and III only
C) I, II and III only
Answer: A
25) If the yield curve begins to rise sharply, it is usually an indication that
A) stocks are offering low returns as the economy enters a recession.
B) inflation rates have peaked and are about to decline.
C) bond prices are expected to increase.
D) inflation is starting to increase, or is expected to do so in the near future.
Answer: D
26) Evidence indicates that the theory of interest rates with the most predictive power is
A) market segmentation theory.
B) expectations theory.
C) liquidity preference theory.
D) a combination of expectations, market expectations and liquidity preference.
Answer: D
27) If inflation is expected to increase significantly, cautious bondholders should

A) expect interest rates to rise.
B) expect a flat yield curve for the intermediate-term.
C) buy long-term bonds today.
D) move to the short-end of the yield curve.
Answer: D
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28) Explain how a yield curve is constructed and what its shape reveals about interest rates.
Answer: A yield curve plots a bond's term to maturity to its yield to maturity at any given point
in time. A particular yield curve exists for only a short period of time. As the markets change, so
do yield curves. Yield curves are constructed by plotting the yields for a group of bonds that are
similar in all respects except maturity. The most common yield curve is upward-sloping, which
means that long-term yields are higher than short-term yields. An inverted curve indicates that
short-term interest rates are higher than long-term rates. A humped curve indicates that
intermediate-term bonds have the highest yields. A flat curve indicates that yields are pretty
much the same regardless of the bond term.
1) If a bond's yield to maturity is lower than its coupon rate, the bond will sell at a discount.
Answer: FALSE
Learning Outcome: F-06 Compare and contrast different types of bonds and explain why bond
prices change
2) A bond's discount or premium will tend to increase as the bond approaches its maturity date.
Answer: FALSE
prices change
3) The price of a bond is equal to the present value of the bond's future cash flows.
Answer: TRUE
prices change
4) As a bond approaches its maturity date, its price necessarily approaches par value.
Answer: TRUE
prices change
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5) The longer the time to maturity, the less sensitive a bond's price will be to changes in interest
rates.
Answer: FALSE
prices change
Question Status: Revised
6) A significant portion of a coupon bond's total return is derived from the reinvestment of the
interest payments.
Answer: TRUE
prices change
7) A bond has a coupon rate of 6%, matures in 6 years, and currently sells for $1,000 (par value).
Therefore the yield to maturity is also 6%.
Answer: TRUE
prices change
8) The price of a bond with an 8% coupon rate paid semi-annually, a par value of $1,000, and
fifteen years to maturity is the present value of
A) 15 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
B) 15 payments of $80 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
C) 30 payments of $40 at 6 month intervals plus $1,000 received at the end of the fifteenth year.
D) 30 payments of $80 at 1 year intervals plus $1,000 received at the end of the 30th year.
Answer: C
prices change
9) What is the current price of a 9%, $1,000 annual coupon bond that has eighteen years to
maturity and a yield to maturity of 9.631%?
A) $898
B) $935
C) $942
D) $947
Answer: D
prices change
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10) What is the coupon rate of an annual bond that has a yield to maturity of 8.5%, a current
price of $942.32, a par value of $1,000 and matures in thirteen years?
A) 7.67%
B) 7.75%
C) 8.33%
D) 8.50%
Answer: B
prices change
11) What is the current price of a $1,000, 6% coupon bond that pays interest semi-annually if the
bond matures in ten years and has a yield-to-maturity of 7.1325%?
A) $567
B) $920
C) $1,030
D) $1,080
Answer: B
prices change
12) What is the yield-to-maturity of a $1,000, 7% semi-annual coupon bond that matures in 2
years and currently sells for $997.07?
A) 6.87%
B) 7.04%
C) 7.16%
D) 7.31%
Answer: C
prices change
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13) Which of the following are needed to determine the appropriate value of a bond?
I. required rate of return
II. time to maturity
III. frequency of interest payments
IV. coupon rate
A) II and III only
B) III and IV only
C) II, III and IV only
Answer: D
prices change
14) A $1,000 par value, 12-year annual bond carries a coupon rate of 7%. If the current yield of
this bond is 7.995%, its market price to the nearest dollar is
A) $876.
B) $925.
C) $1,075.
D) $1,125.
Answer: A
prices change
1) There is normally an indirect relationship between the coupon rate of a bond and the bond's
yield.
Answer: FALSE
prices change
2) Generally speaking, short-term bonds have lower yields than long-term bonds.
Answer: TRUE
prices change
Question Status: Revised
14
3) A basis point is 1/10 of 1%.
Answer: FALSE
prices change
4) Bond yields are set by the bond issuer.

Answer: FALSE
prices change
5) The required return defines the yield at which a bond should be trading and serves as the
discount rate in the bond valuation process.
Answer: TRUE
prices change
6) A bond's yield to maturity is equal to the internal rate of return of its cash flows.
Answer: TRUE
prices change
7) A bond's current yield is equal to the interest payment divided by par value.
Answer: FALSE
prices change
8) The actual return earned on a bond is highly dependent upon the reinvestment rate of the
coupons.
Answer: TRUE
prices change
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9) Yield-to-call assumes a bond is called on the last possible date.
Answer: FALSE
prices change
10) The greater of the yield-to-call or the yield-to-maturity is used as the appropriate indicator of
value.
Answer: FALSE
prices change
11) Yield to call is a useful measure for bonds selling at a premium, but not for bonds selling at a
discount.
Answer: TRUE
prices change
12) Which one of the following statements is correct concerning bond investors?
A) Aggressive investors want to lock in high interest rates.
B) Aggressive investors purchase bonds when they believe interest rates will rise.
C) Conservative investors seek capital gains.
D) Conservative investors buy bonds when interest rates are high.
Answer: D
prices change
13) If you are an income-oriented investor and you feel that interest rates are relatively high and
will decline in the future, you should purchase
A) zero-coupon, long-term bonds.
B) long-term, non-callable bonds.
C) short-term, zero-coupon bonds.
D) long-term, freely callable bonds.
Answer: B
prices change
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14) Which of the following statements concerning the current yield is correct?
A) It is of great interest to aggressive bond investors seeking capital gains.
B) It is of great interest to conservative bond investors seeking current income.
C) It shows the rate of return an investor will receive by holding a bond to maturity.
D) It can be determined by dividing interest income by the par value of a bond.
Answer: B
prices change
15) A bond is most likely to be called

A) when investors must reinvest at lower rates.
B) when the bond sells at a large discount.
C) when market yields are close to coupon rates.
D) when investors can reinvest at higher rates.
Answer: A
prices change
16) Which of the following statements are correct concerning yield-to-maturity (YTM)?
I. YTM considers both interest income and price appreciation.
II. YTM assumes the bond is called at the earliest possible date.
III. YTM is a compounded rate of return.
IV. YTM assumes all interest payments are reinvested at the YTM rate.
A) I and IV only
B) I, III and IV only
D) I, II and III only
Answer: B
prices change
17) Which one of the following statements is true about a $1,000, 6% annual coupon bond that is
selling for $1,012?
A) The current yield is less than 6%.
B) The current yield is 6%.
C) The yield-to-maturity is greater than 6%.
D) The yield-to-maturity is 6%.
Answer: A
prices change
17
18) Dylan purchased 20 GIA Inc. bonds in 2008 when the yield to maturity was 12.5%. Because
of falling interest rates she had to reinvest the coupon payments at 8%, 6%, 4% and finally, 3%.
The internal rate of return on her investment will be
A) greater than the coupon rate but less than the original yield to maturity.
B) less than the original yield to maturity.
C) greater than the original yield to maturity.
D) the reinvestment rate has no effect on the internal rate of return.
Answer: B
prices change
19) Yield to call on a bond with a coupon rate of 8% paid semi-annually, 10 years to maturity, a
par value of $1,000 and a selling price of $1,071, callable after 5 years at $1,010 is
A) 3.5%.
B) 6.49%.
C) 7.0%.
D) 8.16%.
Answer: B
prices change
20) The current yield on a bond is most similar to

A) the discount rate on a Treasury Bill.
B) the effective annual rate on a certificate of deposit.
C) the dividend yield on a stock.
D) the internal rate of return if the bond is held to maturity.
Answer: C
prices change
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21) The actual return on a bond is dependent upon which of the following?
I. the coupon rate
II. the reinvested interest rate
III. any changes in par value
IV. any changes in market price
A) I, II and III only
C) I, III and IV only
D) I, II and IV only
Answer: D
prices change
22) The reinvestment rate assumption is more important

I. the longer the time to maturity.
II. the shorter the time to maturity.
III. the higher the coupon rate.
IV. the lower the coupon rate.
A) I and III
B) I and IV
C) II and III
D) II and IV
Answer: A
prices change
23) Yield-to-call is
A) commonly used for bonds with deferred-call provisions.
B) calculated using the time to call and the par value of the bond.
C) based solely on the call premium and ignores interest payments.
D) always less than the yield-to-maturity.
Answer: A
prices change
19
24) Hunter bought a bond with an 8% coupon rate for $1,100 and sold it one year later for
$1,150. His holding period return was
A) 11.8%.
B) 11.3%.
C) 13.0%.
D) 7.27%.
Answer: A
prices change
25) Nathan bought a zero coupon bond in 2003 for $485.19. In 2013 he redeemed it for $1,000.
His internal rate of return on this investment was
A) 206.1%.
B) 20.6%.
C) 7.5%.
D) 0.00%.
Answer: C
prices change
26) The yield-to-maturity (YTM) approach fails to consider which of the following risks?
I. reinvestment risk
II. price or market risk
A) I only
B) II only
C) Both I and II
D) Neither I nor II
Answer: C
prices change
27) Explain the differences between yield-to-maturity and yield-to-call.

Answer: The yield-to-maturity is based on holding a bond until it matures at which time the face
value is paid. The yield-to-call is based on holding a bond until the first date at which the bond is
freely callable at which time the call price will be paid. This price could be equal to the face
value or it could include a call premium.
prices change
20
1) Bond duration refers to the remaining life of a bond.

Answer: FALSE
prices change
2) An increase in interest rates has a negative effect on bond prices and a positive effect on the
reinvestment of coupons.
Answer: TRUE
prices change
3) The duration of a bond portfolio is the weighted average of the durations of the individual
bonds included in the portfolio.
Answer: TRUE
prices change
4) With exception of zero coupon bonds, a bond's duration is always shorter than its time to
maturity.
Answer: TRUE
prices change
5) When yield swings are relatively small, a bond's duration is a viable predictor of its price
volatility.
Answer: TRUE
prices change
21
6) A bond portfolio manager believes that interest rates are about to increase. Given this belief,
the manager should buy long duration bonds and sell short duration bonds.
Answer: FALSE
prices change
7) When the weighted-average duration of an investor's bond portfolio is exactly equal to the
investor's desired investment horizon, then the bond portfolio is said to be immunized.
Answer: TRUE
prices change
8) As applied to bonds, duration refers to

A) the average maturity of a diversified portfolio of corporate bonds.
B) the point in the life of a bond when its price exactly offsets its reinvestment risk.
C) the average price and annual reinvestment rate of return for a bond.
D) the point in the life of a bond when its yield-to-maturity equals its expected yield.
Answer: B
prices change
9) Based on the concept of bond duration, which one of the following statements is correct?
A) Lower coupons result in shorter durations.
B) Longer maturities mean shorter durations.
C) Higher yields (YTMs) lead to longer durations.
D) Longer durations mean greater volatility.
Answer: D
prices change
22
10) Which one of the following bonds would have a duration that exactly matches its time to
maturity?
A) discount bond
B) premium bond
C) zero-coupon bond
D) U.S. Treasury bond
Answer: C
prices change
11) Which of the following statements concerning duration are correct?

I. Duration is a weighted-average life of a bond.
II. The Macaulay duration considers the timing of a bond's cash flows.
III. The Macaulay duration uses the YTM of a bond to discount the cash flows.
IV. For coupon bonds, duration will be less than the actual time to maturity.
C) I, III and IV only
Answer: D
prices change
12) Which of the following risks can be essentially eliminated by immunizing a bond portfolio?
I. default risk
II. price risk
III. reinvestment risk
IV. liquidity risk
B) II and III only
Answer: B
prices change
23
13) The duration of a bond will increase as the time to maturity ________ and/or as the YTM on
the bond ________.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases
Answer: B
prices change
14) A $1,000, 7% annual coupon bond matures in three years. The bond is currently priced at
$974.23 and has a YTM of 8.0%. What is the Macaulay duration?
A) 1.95 years
B) 2.60 years
C) 2.81 years
D) 3.00 years
Answer: C
prices change
15) A portfolio consists of three bonds as follows.
What is the duration of the bond portfolio?

A) 7.12 years
B) 8.07 years
C) 8.69 years
D) 11.4 years
Answer: A
prices change
24
16) A bond matures in 30 years, has a 20 year duration and a yield to maturity of 9.32%. The
market interest rate has increased by 0.47%. The modified duration is
A) 9.4 years.
B) 14.1 years.
C) 18.29 years.
D) 27.44 years.
Answer: C
prices change
17) A bond matures in 30 years, has a 20 year duration and a yield to maturity of 9.32%. The
change in the level of the market interest rate is 0.47%. The modified duration is ________ and
the percentage change in price is ________.
A) 9.4 years, -.47%
B) 14. years, 4.7%
C) 18.29 years., -8.6%
D) 18.29 years., 8.6%
Answer: C
prices change
18) The mathematical link between a bond's price and interest rate changes is the
A) Macaulay duration.
B) modified duration.
C) yield to market.
D) yield-to-call.
Answer: B
prices change
19) A bond has a YTM of 6.5%, a modified duration of 16.9 years, a duration of 18 years and a
30 year maturity. By what percentage will the bond's price change if market interest rates
increase by 0.75%?
A) -0.750 percent
B) +0.750 percent
C) +12.675 percent
D) -12.675 percent
Answer: D
prices change
25
20) If the bond market undergoes a large change in yield (for example, more than 100 basis
points), then a bond's duration will
A) understate both the price appreciation when rates fall and the price decline when rates
increase.
B) overstate both the price appreciation when rates fall and the price decline when rates increase.
C) overstate the price appreciation when rates fall and understate the price decline when rates
increase.
D) understate the price appreciation when rates fall and overstate the price decline when rates
increase.
Answer: D
prices change
21) The practical application of bond portfolio immunization to investors is that immunization
A) allows aggressive traders to eliminate the price effects caused by interest rate changes.
B) allows investors to derive a specified rate of return from bond investments for a given
investment horizon.
C) eliminates the possibility of losing money due to a company defaulting on its bond payments.
D) allows investors to passively manage their bond portfolio once it is initially immunized.
Answer: B
prices change
22) Explain the basic concept of bond duration and why this measure is meaningful to investors.
Answer: Changes in interest rates affect both the price of a bond and the reinvestment rate of the
interest payments. A bond's duration is the time-weighted average of its cash flows discounted at
the prevailing yield to maturity on the bond. Duration addresses these opposing effects and
provides investors with a means of determining how a change in interest rates will affect the
price of a bond.
prices change
26
23) Explain the concept of bond immunization and the benefits derived from using this
technique.
Answer: Bond immunization is based on the offsetting reactions of bond prices and the
reinvestment of interest payments. These reactions are in response to interest rate changes.
Immunization is achieved when these two forces equally offset each other. The primary benefit
of immunization is the ability of an investor to earn a specified rate of return on a bond portfolio
regardless of what happens to market interest rates over the course of the holding period.
prices change
1) In building a bond ladder, an investor invests an equal amount in a series of bonds with
staggered maturities.
Answer: TRUE
prices change
2) A major advantage of passive bond strategies is low transaction costs.

Answer: TRUE
prices change
3) When conducting a tax swap, an investor must use identical issues in order for the swap to be
allowed by the IRS.
Answer: FALSE
prices change
4) Buying bonds in anticipation of an expected decline in interest rates is a risky strategy.

Answer: TRUE
prices change
27
5) Once a bond portfolio is initially immunized, an investor should maintain the portfolio as it is
until the end of the investment horizon.
Answer: FALSE
prices change
6) The main purpose of a bond ladder is to

A) lessen the effects of changes in interest rates.
B) achieve the highest level of capital gains possible.
C) maintain a highly liquid portfolio.
D) offset the effects of bond duration.
Answer: A
prices change
7) Active bond trading strategies include

I. buy and hold.
II. trading on forecasted interest rate behavior.
III. bond ladders.
IV. bond swaps.
A) I and III
B) II and IV
C) I, II and III
D) II, III and IV
Answer: B
prices change
8) Reasons for using a bond ladder strategy include

I. typically higher rates on long-term bonds.
II. uncertainty concerning future interest rates.
III. lower tax rates on bonds held to maturity.
IV. reducing the amount of time spent managing the bond portfolio.
A) I and III
B) II and IV
C) I, II and III
D) I, II and IV
Answer: D
prices change
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9) Some common types of bond swaps are
I. tax swaps.
II. yield pickup swaps.
III. substitution swaps.
IV. credit default swaps.
A) I and III
B) II and IV
C) I, II and III
D) I, II and IV
Answer: C
prices change
10) Suppose you sell the 10-year, A-rated 7 percent bonds you own, which are yielding 8
percent, and replace them with an equal amount of 10-year, A-rated 8 percent bonds that are
priced to yield 9 percent. In this situation, you are executing
A) an immunization deal.
B) a yield pickup swap.
C) a laddered bid.
D) a spread bid.
Answer: B
prices change
11) In a tax swap, a bond investor typically

A) sells an issue which has a capital loss and replaces it with a comparable security.
B) sells an issue that has a capital gain and replaces it with a comparable security.
C) swaps a lower-yielding security for a higher-yielding security.
D) swaps a higher-yielding security for a lower-yielding security.
Answer: A
prices change
29
12) Explain the technique and the purpose of building bond ladders.
Answer: Investors build bond ladders by purchasing roughly equal amounts of bonds with
staggered maturities ranging from short-term to some long-term investment horizon. As the
short-term bonds mature, they are replaced with long term bonds. In this way, the investor is
protected from changes in long-term interest rates while enjoying the the typically higher yields
on long-term bonds. The technique is essentially a form of dollar cost averaging.
prices change
30

Chapter 11

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Chapter 11

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Fundamentals of Investing, 12e (Smart/Gitman/Joehnk)

Chapter 11 Bond Valuation

11.1 Learning Goal 1

3) The risk-free rate of return considers the expected rate of inflation.

8) The required return on a bond is equal to

9) The risk-free rate of return is equal to the

3) Predicting the direction of interest rate movements is relatively easy.

5) A normal yield curve is flat or downward sloping.

14) The expectations hypothesis states that investors

18) Long-term bonds are ________ than short-term bonds.

20) The liquidity preference theory supports ________ yield curves.

23) At any given time, the yield curve is affected by

27) If inflation is expected to increase significantly, cautious bondholders should

11.3 Learning Goal 3

11.4 Learning Goal 4

4) Bond yields are set by the bond issuer.

15) A bond is most likely to be called

20) The current yield on a bond is most similar to

22) The reinvestment rate assumption is more important

27) Explain the differences between yield-to-maturity and yield-to-call.

1) Bond duration refers to the remaining life of a bond.

8) As applied to bonds, duration refers to

11) Which of the following statements concerning duration are correct?

15) A portfolio consists of three bonds as follows.

What is the duration of the bond portfolio?

11.6 Learning Goal 6

2) A major advantage of passive bond strategies is low transaction costs.

4) Buying bonds in anticipation of an expected decline in interest rates is a risky strategy.

6) The main purpose of a bond ladder is to

7) Active bond trading strategies include

8) Reasons for using a bond ladder strategy include

11) In a tax swap, a bond investor typically

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