Question

1) A ten-year T-bond has an eight percent coupon, and an eight-year T-bond has a ten percent coupon. These bonds are not callable and both have the same risk. If the yield to maturity (required rate of return) of both bonds increases by the same amount, which of the following statements would be CORRECT?

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

b) The prices of both bonds would increase by the same amount.

c) Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.

d) One bond's price would increase, while the other bond’s price would decrease.

2) Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by one percent? (be able to explain something like this in the exam)

a) 10-year, zero coupon bond.

b) 1-year, 10% coupon bond.

c)  20-year, 5% coupon bond.

d) 20-year, zero coupon bond.

3) An investor is considering buying one of two 10-year, $1,000 face value, non-callable bonds: Bond Alpha has a seven percent annual coupon, while Bond Beta has a nine percent annual coupon. Both bonds have a yield to maturity of eight percent, and the YTM is expected to remain constant for the next ten years. Which of the following statements is CORRECT?

a)  Bond Alpha has a higher price than Bond B today, but one year from now the bonds will have the same price.

b) Bond Beta has a higher price than Bond Alpha today, but one year from now the bonds will have the same price.

c) Bond Alpha’s current yield is greater than 8%.

d)  One year from now, Bond Alpha’s price will be higher than it is today.

4) Bond Apple has a nine percent annual coupon, while Bond Intel has a seven percent annual coupon. Both bonds have the same maturity, a face value of $1,000, an eight percent YTM, and are non-callable. Which of the following statements is CORRECT?

a) Bond Apple’s capital gains yield is greater than Bond Intel’s capital gains yield.

b)  If the yield to maturity for both bonds immediately decreases to 6%, Bond Apple’s bond will have a larger percentage increase in value.

c)  Bond Apple trades at a discount, whereas Bond Intel trades at a premium.

d) Bond Apple’s current yield is greater than that of Bond Intel.

Answer 1

1) The correct option is c) Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.

Reason : Bond prices are sensitive to interest rate. The relationship between bond prices and interest rates is inverse. Hence, in the long run owing to changes in the market the price of the bonds will decrease. However, since the maturity of the 10 year bond is higher, it will decrease at a greater percentage.

2) The correct option is 20-year, zero coupon bond.

Reason: Again a similar reason of Bond prices are sensitive to interest rate. The relationship between bond prices and interest rates is inverse. Hence, if the economy falls by 1% , treasury bonds will have a high demand due to high expected return and safety.

3) The correct option is d)  One year from now, Bond Alpha’s price will be higher than it is today.

4) The correct option is d) Bond Apple’s current yield is greater than that of Bond Intel.