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FIN 534 Quiz 6

download Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? Answer The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage. A bank loan's nominal interest rate will always be equal to or greater than its effective annual rate. If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit. A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?Answer The periodic interest rate is greater than 3%. The periodic rate is less than 3%. The present value would be greater if the lump sum were discounted back for more periods. The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually. The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity. Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? Answer The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage. A bank loan's nominal interest rate will always be equal to or less than its effective annual rate. If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit. Which of the following investments would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero.Answer Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments). Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments). Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments). Investment D pays $2,500 at the end of 10 years (just one payment). Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)Answer The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year. The outstanding balance declines at a slower rate in the later years of the loan’s life. Which of the following statements is CORRECT?Answer A time line is not meaningful unless all cash flows occur annually.


Time lines are not useful for visualizing complex problems prior to doing actual calculations. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts. Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?Answer The periodic rate of interest is 2% and the effective rate of interest is 4%. The periodic rate of interest is 8% and the effective rate of interest is greater than 8%. The periodic rate of interest is 4% and the effective rate of interest is less than 8%. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%. The periodic rate of interest is 8% and the effective rate of interest is also 8% Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?Answer Adding additional restrictive covenants that limit management's actions. Adding a call provision. The rating agencies change the bond's rating from Baa to Aaa. Making the bond a first mortgage bond rather than a debenture. Adding a sinking fund.

An investor is considering buying one of two 10-year, $1,000 face value bonds: Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 10 years. Which of the following statements is CORRECT?Answer Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price. One year from now, Bond A’s price will be higher than it is today. Bond A’s current yield is greater than 8%. Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price. Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.

You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?Answer The price of Bond B will decrease over time, but the price of Bond A will increase over time. The prices of both bonds will remain unchanged. The price of Bond A will decrease over time, but the price of Bond B will increase over time. The prices of both bonds will increase by 7% per year. The prices of both bonds will increase over time, but the price of Bond A will increase by more.

Which of the following statements is CORRECT?Answer


You hold two bonds. One is a 10-year, zero coupon, issue and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the larger percentage decline. The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates. You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates.

A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Both bonds have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?Answer The prices of both bonds will decrease by the same amount. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. The prices of both bonds would increase by the same amount. One bond's price would increase, while the other bond’s price would decrease. The prices of the two bonds would remain constant.

Which of the following statements is CORRECT?Answer If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices. The total yield on a bond is derived from dividends plus changes in the price of the bond. Bonds are riskier than common stocks and therefore have higher required returns. Bonds issued by larger companies always have lower yields to maturity (less risk) than bonds issued by smaller companies. The market value of a bond will always approach its par value as its maturity date approaches, provided the bond’s required return remains constant.

Which of the following statements is CORRECT?Answer If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices. The total yield on a bond is derived from dividends plus changes in the price of the bond. Bonds are riskier than common stocks and therefore have higher required returns. Bonds issued by larger companies always have lower yields to maturity (less risk) than bonds issued by smaller companies. The market value of a bond will always approach its par value as its maturity date approaches, provided the bond’s required return remains constant.

Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?Answer 10-year, zero coupon bond.


20-year, 10% coupon bond. 20-year, 5% coupon bond. 1-year, 10% coupon bond. 20-year, zero coupon bond.

If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value? Answer A 1-year zero coupon bond. A 1-year bond with an 8% coupon. A 10-year bond with an 8% coupon. A 10-year bond with a 12% coupon. A 10-year zero coupon bond. Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?Answer The company’s bonds are downgraded. Market interest rates rise sharply. Market interest rates decline sharply. The company's financial situation deteriorates significantly. Inflation increases significantly.


Fin 534 quiz 6