True/False Questions: Circle the correct response. (2 points each)
1.
T
F
If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 8%, then the real rate of interest on this bond is approximately 7%.
2.
T
F
A decrease in expected inflation would make Treasury bond prices rise.
3.
T
F
You’re getting a $250,000 loan for a house and are trying to decide between a
15-year or 30-year mortage. If you go with the 15-year loan, a larger fraction of the first payment will go towards interest.
4.
T
F
Covenants and other terms of the agreement between the issuer of bonds and the lender are set forth in the bond indenture.
5.
T
F
The present value of an ordinary annuity is equal to the present value of an equivalent annuity due, divided by one plus the interest rate.
6.
T
F
Consider two bonds issued by the same company with the same maturity date.
Bond X has several protective covenants, but bond Y has none. If the market price of the two bonds is the same, bond X would likely have a larger coupon rate than bond Y.
7.
T
F
For a zero coupon bond with 2 years left to maturity, the “current yield” will greater than the “yield to maturity.”
8.
T
F
Bonds that are not recorded in the name of the bondholder are called unsecured bonds.
9.
T
F
Suppose interest rates go down. For two otherwise similar bonds (same default risk, coupon, and maturity), a callable bond will likely increase less in price than a non-callable bond.
10. T
F
A significant advantage for the holders of bonds, as opposed to other forms of debt, is liquidity or the ability to easily convert the investment into cash.
11. T
F
You have a choice between annuity payment of $50,000 at the end of each of the next 10 years, or a perpetuity that pays you $25,000 indefinitely. You are indifferent between the two choices when the interest rate is 7.18% (this is true). At interest rates above this level, you would pick the annuity.
12. T
F
Nominal and Effective annual rates are equivalent for annual compounding.
13. T
F
For U.S. Treasury TIPs the coupon rate stays fixed, but the coupon payments grow with inflation.
14. T
F
Holding everything else the same, if a corporation’s earnings rise, then the default risk on its bonds will decrease, and the expected return on its bonds will decrease.
1
Corp Finance: Quiz 2 Solutions
White Version
15. T
F
A 10-year bond is currently selling at a discount. If one year passes and the yield to maturity on the bond stays the same, the new price will be lower than the price one year ago.
16. T
F
Unless a bond defaults, investors cannot lose money investing in bonds.
17. T
F
A bond was issued two years ago. It has a par value of $1000 and the coupon payments are $75 (paid annually). Today, the yield on the bond is 7.25%. This bond should be trading at a discount.
18. T
F
If interest rates rise from 5% to 6% over the course of a year, all else equal you would prefer to have been holding a ten-year bond to a twenty-year bond.
19. T
F
Default risk yield premiums are usually smaller during periods of high economic growth.
20. T
F
Zero coupon bonds are issued at a discount from par value.
Multiple Choice Questions: Circle the correct response. (4 points each)
21. You want to buy a BMW 5-series car on your 27th birthday. You have priced these cars and found that they currently sell for $50,000. You believe that the price will increase by
3.00% per year until you are ready to buy. You can presently invest to earn 6.0%. If you just turned 21 years old, how much must you invest at the end of each of the next 6 years to be able to purchase the BMW in 6 years?
a) $5,956.75
(
)
b) $7,112.67
(
)
[
]
c) $7,168.13
d) $8,238.88
A = $8,559.12
e) $8,559.12
f) $9,479.26
g) $9,886.65
22. Suntrust offers a 2-year certificate of deposit (CD) that pays 8.0% compounded quarterly.
Bank of America offers a 2-year
