Indicate whether each of the following statements are true, false, or uncertain and explain your answer....

Indicate whether each of the following statements are true, false, or uncertain and explain your answer.

a. Consider two zero-coupon bonds, one with a short maturity, and one with a longer maturity. The value of the long-maturity bond is more sensitive (in % terms) to changes in interest rates than the short-maturity bond' s value.

b. If the Internal Rate of Return (IRR) of an investment project is above its cost of capital, then the NPV of the project (calculated at the cost of capital) must be positive.

c. An increase in bond yields is associated with an increase in bond prices.

d. If the yield curve is upward sloping, then the yield of a 4-year coupon-paying bond (with semi-annual coupon payments) is below the yield of a 4-year zero coupon bond.

Solutions

Expert Solution

Ans a) True - zero coupon bond with longer duration are more sensitive to interest rate change risk,exposing them to duration risk.If the interest rates rises, value of zero coupon bond will fall and vice-versa.

Ans b) True. IRR is rate of return on the project and cost of capital is cost associated with the project. If the IRR is higher then cost of capital, project adds value to the business.Thus, In case IRR>Cost of capital, NPV will be positive.

Ans c) False. Bond yield is calculated as bonds coupon payment divided by market prices.So,Increase in bond yield is associated with fall in bond prices.Suppose, if interest rates fall then bond prices will increase because coupon payments on bonds is more attractive.

Ans d) False. In case of upward sloping curve, yield of 4 years coupon paying bond would be higher then zero coupon paying bond. Upward sloping curve indicates higher future interest rates.In case of higher interest rate, higher inflation, bond yield will rise across the yield curve as investor demands higher yield to compensate for inflation risk.

jeff jeffy answered 1 year ago

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