# Multiple choice questions on bonds, yields

13. Hanratty Inc.'s stock and the stock market have generated the following returns over the past five years:

Year Hanratty Market (kM)

1 13% 9%

2 18 15

3 -5 -2

4 23 19

5 6 12

On the basis of these historical returns, what is the estimated beta of Hanratty Inc.'s stock?

a. 0.7839

b. 0.9988

c. 1.2757

d. 1.3452

e. 1.5000

14. The one-year spot rate is 10% and the two-year spot rate is 8%. If the one-

year spot rate expected in one year is 6%, according to the liquidity

preference theory, what must be the one -year liquidity premium

commencing one year from now?

a. .0353 b. .0373 c. .0363 d .0463

15. A 10-year Treasury bond currently yields 8 percent. The real risk-free rate of interest, k*, is 4 percent. The maturity risk premium has been estimated to be 0.1(t)%, where t = the maturity of the bond. Inflation is expected to average 2 percent a year for each of the next five years. What is the expected average rate of inflation between years five and ten?

a. 4% b. 4.5% c. 5% d. 5.5% e. 6%

16. The 10-year bonds of Gator Corporation are yielding 9 percent per year. Treasury bonds with the same maturity are yielding 7.5 percent per year. The real risk-free rate (k*) has not changed in recent years and is 3 percent. The average inflation premium is 2.5 percent and the maturity risk premium takes the form: MRP = 0.l(t - l)%, where t = number of years to maturity. If the liquidity premium is 0.6 percent, what is the default risk premium on the corporate bond?

a. 1% b. .9% c. .8% d. 0.7% e. .6%

17. Which of the following statements is most correct?

a. Downward sloping yield curves are inconsistent with the expectations theory.

b. The shape of the yield curve depends only on expectations about future inflation.

c. If the expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.

d. Statements a and c are correct.

e. None of the statements above is correct.

18. The real risk-free rate of interest is expected to remain constant at 3 percent for the foreseeable future. However, inflation is expected to steadily increase over the next 20 years, so the Treasury yield curve is upward sloping. Assume that the expectations theory holds. You are considering two corporate bonds: a 5-year corporate bond and a 10-year corporate bond, each of which has the same default risk and liquidity risk. Given this information, which of the following statements is most correct?

a. Since the expectations theory holds, this implies that 10-year Treasury bonds must have the same yield as 5-year Treasury bonds.

b. Since the expectations theory holds, this implies that the 10-year corporate bonds must have the same yield as the 5-year corporate bonds.

c. Since the expectations theory holds, this implies that the 10-year corporate bonds must have the same yield as 10-year Treasury bonds.

d. The 10-year Treasury bond must have a higher yield than the 5-year corporate bond.

e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.

19. Which of the following statements is most correct?

a. The yield on a 2-year corporate bond will always exceed the yield on a 2-year Treasury bond.

b. The yield on a 3-year corporate bond will always exceed the yield on a 2-year corporate bond.

c. The yield on a 3-year Treasury bond will always exceed the yield on a 2-year Treasury bond.

d. All of the statements above are correct.

e. Statements a and c are correct.

20. You are given the following data:

k* = real risk-free rate: 4%

Constant inflation premium: 7%

Maturity risk premium: 1%

Default risk premium for AAA bonds: 3%

Liquidity premium for long-term T-bonds: 2%

Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant. Given these conditions, the nominal risk-free rate for T-bills (SHORT-TERM) is , and the rate on long-term Treasury bonds is .

a. 4%; 14%

b. 4%; 15%

c. 11%; 14%

d. 11%; 15%

e. 11%; 17%

21. You observe the following yields on Treasury securities of various maturities:

Maturity Yield

1 year 6.0%

3 years 6.4

6 years 6.5

9 years 6.8

12 years 7.0

15 years 7.2

Using the expectations theory, forecast the interest rate on 9-year Treasuries, six years from now. (That is, what will be the yield on 9-year Treasuries, issued in 6 years' time?)

a. 6.50%

b. 6.65%

c. 6.80%

d. 7.67%

e. 8.00%

22. The real risk-free rate is expected to remain at 3 percent. Inflation is expected to be 3 percent this year and 4 percent next year. The maturity risk premium is estimated to be equal to 0.1(t - 1)%, where t = the maturity of a bond (in years). All Treasury securities are highly liquid, and therefore have no liquidity premium. Three-year Treasury bonds yield 0.5 percentage points (0.005) more than 2-year Treasury bonds (that is, 2-year bond yield plus 0.5%). What is the expected level of inflation in Year 3?

a. 4.5%

b. 4.7%

c. 5.0%

d. 5.6%

e. 6.3%

23. If the Federal Reserve sells $50 billion of short-term U. S. Treasury securities to the public, other things held constant, what will this tend to do to short-term security prices and interest rates?

a. Prices and interest rates will both rise.

b. Prices will rise and interest rates will decline.

c. Prices and interest rates will both decline.

d. Prices will decline and interest rates will rise.

e. There will be no changes in either prices or interest rates.

https://brainmass.com/business/bond-valuation/3500

#### Solution Preview

The formatting is preserved in word file. Please see the word file too.

13. Hanratty Inc.'s stock and the stock market have generated the following returns over the past five years:

Year Hanratty Market (kM)

1 13% 9%

2 18 15

3 -5 -2

4 23 19

5 6 12

On the basis of these historical returns, what is the estimated beta of Hanratty Inc.'s stock?

a. 0.7839

b. 0.9988

c. 1.2757

d. 1.3452

e. 1.5000

beta = covariance of stock and market/ variance of market

=0.006824/ 0.005064=1.34

Beta is equal to 1.34

Answer d is correct.

14. The one-year spot rate is 10% and the two-year spot rate is 8%. If the one- year spot rate expected in one year is 6%, according to the liquidity preference theory, what must be the one -year liquidity premium

commencing one year from now?

a. .0353 b. .0373 c. .0363 d .0463

forward rate={ (1.08) x (1.08)/ 1.10}-1=6.0363%

Liquidity premium= 6.0363 %- 6%= 0.0363%

Answer c is correct

15. A 10-year Treasury bond currently yields 8 percent. The real risk-free rate of interest, k*, is 4 percent. The maturity risk premium has been estimated to be 0.1(t)%, where t = the maturity of the bond. Inflation is expected to average 2 percent a year for each of the next five years. What is the expected average rate of inflation between years five and ten?

a. 4% b. 4.5% c. 5% d. 5.5% e. 6%

inflation premium= 8%- 4%-1%(maturity risk premium)=3 %

(1+3%) 10 = (1+2%) 5 X (1+x%) 5

Solving for x gives x= 4%

Answer a is correct

16. The 10-year bonds of Gator Corporation are yielding 9 percent per year. Treasury bonds with the same maturity are yielding 7.5 percent per year. The real risk-free rate (k*) has not changed in recent years and is 3 percent. The average inflation premium is 2.5 percent and the maturity risk premium takes the form: MRP = 0.l(t - l)%, where t = number of years to maturity. If the liquidity premium is 0.6 percent, what is the default risk premium on the corporate bond?

a. ...

#### Solution Summary

There are answers and explanations to multiple choice questions related to beta, bonds, risk premiums.

Finance/Accounting multiple choice questions on bonds, interest rates, YTM, Yield to Call etc.

1. One of the basic relationships in interest rate theory is that, other things held constant, for a given change in the required rate of return, the the time to maturity, the the change in price.

a. longer; smaller.

b. shorter; larger.

c. longer; greater.

d. shorter; smaller.

e. Statements c and d are correct.

2. Assume that a 10-year Treasury bond has a 12 percent annual coupon, while a 15-year Treasury bond has an 8 percent annual coupon. The yield curve is flat; all Treasury securities have a 10 percent yield to maturity. Which of the following statements is most correct?

a. The 10-year bond is selling at a discount, while the 15-year bond is selling at a premium.

b. The 10-year bond is selling at a premium, while the 15-year bond is selling at par.

c. If interest rates decline, the price of both bonds will increase, but the 15-year bond will have a larger percentage increase in price.

d. If the yield to maturity on both bonds remains at 10 percent over the next year, the price of the 10-year bond will increase, but the price of the 15-year bond will fall.

e. Statements c and d are correct.

3. Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If you require a nominal annual rate of return of 12 percent, with quarterly compounding, how much should you be willing to pay for this bond? (Hint: The PVIFA and PVIF for 3 percent, 60 periods are 27.6748 and 0.1697, respectively.)

a. $ 821.92 b. $1,207.57 c. $ 986.43 d. $1,120.71 e. $1,358.24

4. You just purchased a 15-year bond with an 11 percent annual coupon. The bond has a face value of $1,000 and a current yield of 10 percent. Assuming that the yield to maturity of 9.7072 percent remains constant, what will be the price of the bond one year from now?

a. $1,000 b. $1,064 c. $1,097 d. $1,100 $1,150

5. Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest paid semiannually. The required nominal rate on this debt has now risen to 16 percent. What is the current value of this bond?

a. $1,273

b. $1,000

c. $7,783

d. $ 550

e. $ 450

6. A corporate bond with 12 years to maturity has a 9 percent semiannual coupon and a face value of $1,000. (That is, the semiannual coupon payments are $45.) The bond has a nominal yield to maturity of 7 percent. The bond can be called in three years at a call price of $1,045. What is the bond's nominal yield to call?

a. 4.62%

b. 10.32%

c. 17.22%

d. 5.16%

e. 2.31%

7. A 10-year bond has a face value of $1,000. The bond has a 7 percent semiannual coupon. The bond is callable in 7 years at a call price of $1,040. The bond has a nominal yield to call of 6.5 percent. What is the bond's nominal yield to maturity?

a. 3.14%

b. 6.05%

c. 7.62%

d. 6.27%

e. 6.55%

8. Meade Corporation bonds mature in 6 years and have a yield to maturity of 8.5 percent. The par value of the bonds is $1,000. The bonds have a 10 percent coupon rate and pay interest on a semiannual basis. What are the current yield and capital gains yield on the bonds for this year? (Assume that interest rates do not change over the course of the year).

a. Current yield = 8.50%; capital gains yield = 1.50%

b. Current yield = 9.35%; capital gains yield = 0.65%

c. Current yield = 9.35%; capital gains yield = -0.85%

d. Current yield = 10.00%; capital gains yield = 0.00%

e. Current yield = 10.50%; capital gains yield = -1.50%

9. A 16-year bond with a 10 percent annual coupon has a current yield of 8 percent. What is the bond's yield to maturity (YTM)?

a. 6.9%

b. 7.1%

c. 7.3%

d. 7.5%

e. 7.7%

10. Which of the following statements is most correct?

a. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.

b. Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.

c. Reinvestment rate risk is worse from a typical investor's standpoint than interest rate risk.

d. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10 percent rate of return, and if interest rates then dropped to the point where kd = YTM = 5%, we could be sure that the bond would sell at a premium over its $1,000 par value.

e. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10 percent rate of return, and if interest rates then dropped to the point where kd = YTM = 5%, we could be sure that the bond would sell at a discount below its $1,000 par value.