Question

1. If inflation is expected to be relatively low, then interest rates will tend to be relatively low, other things held constant.

A. True B. False

2. Ms Parker found two opportunities of investment A (rate of return 3%, standard deviation 6%) and investment B (rate of return 8%, standard deviation 4%). Investment B is better than Investment A (hints: calculate each CV and then compare each other).

A. True B. False

3. The larger the standard deviation is, the lower the probability that actual returns will be close to expected returns.

A. True B. False

4. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.

A. True B. False

5. A 15-year bond with a face value of $1,000 currently sells for $1,200. So, the bond's yield to maturity or discount rate is less than its coupon rate.

A. True B. False

6. Moore Corporation has 6-year bonds. Inflation premium (IP) on a 6year bond is 1.00%. The real risk-free rate is r* = 2.80%, the default risk premium for Moore's bonds is DRP = 0.85% versus zero for T-bonds, the liquidity premium on Moore's bonds is LP = 1.20%, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) x 0.1%, where t = number of years to maturity. What is the yield on Moore Corporation’s 6-year bonds?

7. Davis Inc.'s bonds currently sell for $800 and have a par value of $1,000. They pay a $100 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,200. What is their Capital Gain Yield (CGY)?

8. A 10-year, 5% semiannual coupon bond selling for $1,135.90 can be called in 4 years for $1,200 (hint: par value is $1,000). What is its yield to maturity (YTM)?

9. A 10-year, 5% semiannual coupon bond selling for $1,135.90 can be called in 4 years for $1,200 (hint: par value is $1,000). What s its current yield (CY)?

10. A 10-year, 10% semiannual coupon bond selling for $1,135.90 can be called in 4 years for $1,200 (hint: par value is $1,000). What is its yield to call (YTC)?

11. Davis Inc.'s bonds currently sell for $800 and have a par value of $1,000. They pay a $100 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,200. What is their yield to maturity (YTM)?

12. Davis Inc.'s bonds currently sell for $800 and have a par value of $1,000. They pay a $60 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,200. What is their Expected Current Yield (CY)?

13. Davis Inc.'s bonds currently sell for $800 and have a par value of $1,000. They pay a $60 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,200. What is their yield to Call (YTC)?

14. Kimberly’ Motors has a beta of 1.40, the T-bill rate is 3.00%, and the Tbond rate is 7.0%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 10.00%. Based on the SML, what is the firm's required return?

15. Suppose the interest rate (return rate) on a 1-year T-bond is 3.0% and that on a 2-year T-bond is 6.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now?

16. Stacker’s Corporation's bonds have a 10-year maturity, a 10.00% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 2.00%, based on semiannual compounding. What is the bond’s price?

17. If the pure expectations theory holds, what does the market expect will be the interest rate (expected return rate) on one-year securities, three years from now? (1year maturity yield is 6.0%; 2year maturity yield is 6.1%; 3year maturity yield is 6.3%; 4year maturity yield is 6.3 %; 5year maturity yield is 6.3%)? (Hints: Draw the timeline and then calculate the interest rate (expected return rate) on two-year securities, two years from now.)

Answer 1

1) If inflation is expected to be relatively low, then interest rates will tend to be relatively low, other things held constant

Solution: False

Explanation: When the inflation tends to be relatively low, then rates of interest are expected to be relatively low, other things remaining unchanged

2) Solution: True

Explanation: CV = Standard Deviation / Rate of return

Investment A = 0.06 / 0.03 = 2

Investment B = 0.04 / 0.08 = 0.5

The lower CV is better

3) The larger the standard deviation is, the lower the probability that actual returns will be close to expected returns.

Solution: True

Explanation: When standard deviation is larger there will be lower probability; and actual returns will be close to expected returns

4) If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.

Solution: True

Explanation: When inflation tends to increase in future and MRP value is higher than zero, it depicts that Treasury bond yield curve will be upward sloping