Question

Which one of the following bonds has the greatest interest rate risk?

A. 3-year; 4 percent coupon

B. 3-year; 6 percent coupon
C. 5-year; 6 percent coupon

D. 7-year; 6 percent coupon E. 7-year; 4 percent coupon

You are quoted an interest rate of 7% per year with monthly compounding on your car loan. Which of the following is a FALSE statement?
A. The effective annual interest rate (EAR) is greater than 7%.
B. The equivalent APR with daily compounding would be equal to 7%.

C. You have been quoted an Annual Percentage Rate.
D. The interest charged over one month is 7% divided by 12.
E. The equivalent annual rate with quarterly compounding would be greater than 7%.

Answer 1

E. 7-year; 4 percent coupon
Greatest interest rate risk is option E because long term bonds have higher probability of change in interest rate Higher length of bond greater the effect of interest rate and interest rate risk is higher in low coupon bonds.hence risk is higher than 6% coupon

You are quoted an interest rate of 7% per year with monthly compounding on your car loan. Which of the following is a FALSE statement?

A. The effective annual interest rate (EAR) is greater than 7%.(True) EAR= (1+r/m)^m -1 = (1.07/12)¹² -1 = 7.229%
B. The equivalent APR with daily compounding would be equal to 7%.(True) (APR doesn't change with compounding
C. You have been quoted an Annual Percentage Rate.(False ) Interest rate and APR are different.
D. The interest charged over one month is 7% divided by 12.Interest charge over 1 month . (True)
E. The equivalent annual rate with quarterly compounding would be greater than 7%.(True)
EAR= (1+r/m)^m -1 = (1+0.07/4⁴ -1 =7.1859%

Best of luck