Chapter 08

Interest Rates and Bond Valuation

Multiple Choice Questions

1. A bond that makes no coupon payments and is initially priced at a deep discount is called a _____ bond.

A. Treasury
B. municipal
C. floating-rate
D. junk
E. zero coupon

2. An asset characterized by cash flows that increase at a constant rate forever is called a:

A. growing perpetuity.
B. growing annuity.
C. common annuity.
D. perpetuity due.
E. preferred stock.

3. The stated interest payment, in dollars, made on a bond each period is called the bond's:

A. coupon.
B. face value.
C. maturity.
D. yield to maturity.
E. coupon rate.

4. The principal amount of a bond that is repaid at the end of the loan term is called the bond's:

A. coupon.
B. face value.
C. maturity.
D. yield to maturity.
E. coupon rate.

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5. The specified date on which the principal amount of a bond is repaid is called the bond's:

A. coupon.
B. face value.
C. maturity.
D. yield to maturity.
E. coupon rate.

6. The rate of return required by investors in the market for owning a bond is called the:

A. coupon.
B. face value.
C. maturity.
D. yield to maturity.
E. coupon rate.

7. The annual coupon of a bond divided by its face value is called the bond's:

A. coupon.
B. face value.
C. maturity.
D. yield to maturity.
E. coupon rate.

8. A bond with a face value of $1,000 that sells for $1,000 in the market is called a _____ bond.

A. par value
B. discount
C. premium
D. zero coupon
E. floating rate

9. A bond with a face value of $1,000 that sells for less than $1,000 in the market is called a _____ bond.

A. par
B. discount
C. premium
D. zero coupon
E. floating rate

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10. The relationship between nominal rates, real rates, and inflation is known as the:

A. Miller and Modigliani theorem.

B. Fisher effect.
C. Gordon growth model.
D. term structure of interest rates.
E. interest rate risk premium.

11. The relationship between nominal interest rates on default-free, pure discount securities and the time to
maturity is called the:

A. liquidity effect.
B. Fisher effect.
C. term structure of interest rates.
D. inflation premium.
E. interest rate risk premium.

12. The _____ premium is that portion of a nominal interest rate or bond yield that represents compensation for
expected future overall price appreciation.

A. default risk
B. taxability
C. liquidit
y
D. inflation
E. interest rate risk

13. A bond with a 6% coupon that pays interest semi-annually and is priced at par will have a market price of
_____ and interest payments in the amount of _____ each.

A. $1,006; $60
B. $1,060; $30
C. $1,060; $60
D. $1,000; $30
E. $1,000; $60

14. All else constant, a bond will sell at _____ when the yield to maturity is _____ the coupon rate.

A. a premium; higher than

B. a premium; equal to
C. at par; higher than
D. at par; less than
E. a discount; higher than

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15. All else constant, a coupon bond that is selling at a premium, must have:

A. a coupon rate that is equal to the yield to maturity.

B. a market price that is less than par value.
C. semi-annual interest payments.
D. a yield to maturity that is less than the coupon rate.
E. a coupon rate that is less than the yield to maturity.

16. The market price of a bond is equal to the present value of the:

A. face value minus the present value of the annuity payments.

B. annuity payments plus the future value of the face amount.
C. face value plus the present value of the annuity payments.
D. face value plus the future value of the annuity payments.
E. annuity payments minus the face value of the bond.

17. Aspens is preparing a bond offering with an 8% coupon rate. The bonds will be repaid in 10 years. The
company plans to issue the bonds at par value and pay interest semiannually. Given this, which of the
following statements are correct?

I. The initial selling price of each bond will be $1,000.

II. After the bonds have been outstanding for 1 year, you should use 9 as the number of compounding
periods when calculating the market value of the bond.
III. Each interest payment per bond will be $40.
IV. The yield to maturity when the bonds are first issued is 8%.

A. I and II only
B. II and III only
C. II, III, and IV only
D. I, II, and III only
E. I, III, and IV only

18. The newly issued bonds of the Cain Corp. offer a 6% coupon with semiannual interest payments. The bonds
are currently priced at par value. The effective annual rate provided by these bonds must be:

A. equal to 3%.
B. greater than 3% but less than 4%.
C. equal to 6%.
D. greater than 6% but less than 7%.
E. equal to 12%.

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19. You own a bond that has a 7% coupon and matures in 12 years. You purchased this bond at par value when
it was originally issued. If the current market rate for this type and quality of bond is 7.5%, then you would
expect:

A. the bond issuer to increase the amount of each interest payment on these bonds.
B. the yield to maturity to remain constant due to the fixed coupon rate.
C. to realize a capital loss if you sold the bond at the market price today.
D. today's market price to exceed the face value of the bond.
E. the current yield today to be less than 7%.

20. A bond with semi-annual interest payments, all else equal, would be priced _________ than one with annual
interest payments.

A. higher
B. lower
C. the same
D. it is impossible to tell
E. either higher or the same

21. A zero coupon bond:

A. is sold at a large premium.

B. has a price equal to the future value of the face amount given a specified rate of return.
C. can only be issued by the U.S. Treasury.
D. has less interest rate risk than a comparable coupon bond.
E. has implicit interest which is calculated by amortizing the loan.

22. The total interest paid on a zero-coupon bond is equal to:

A. zero.
B. the face value minus the issue price.
C. the face value minus the market price on the maturity date.
D. $1,000 minus the face value.
E. $1,000 minus the par value.

23. The yield to maturity is:

A. the rate that equates the price of the bond with the discounted cash flows.
B. the expected rate to be earned if held to maturity.
C. the rate that is used to determine the market price of the bond.
D. equal to the current yield for bonds priced at par.
E. All of these.

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24. Face value is:

A. always higher than current price.

B. always lower than current price.
C. the same as the current price.
D. the coupon amount.
E. None of these.

25. One basis point is equal to:

A. .01%.
B. .10%.
C. 1.0%.
D. 10%.
E. 100%.

26. The "EST SPREAD" shown in The Wall Street Journal listing of corporate bonds represents the estimated:

A. yield to maturity.
B. difference between the current yield and the yield to maturity.
C. difference between the bond's yield and the yield of a particular Treasury issue.
D. range of yields to maturity provided by the bond over its life to date.
E. difference between the yield to call and the yield to maturity.

27. A bond is listed in The Wall Street Journal as a 12 3/4s of July 2009. This bond pays:

A. $127.50 in July and January.

B. $63.75 in July and January.
C. $127.50 in July.
D. $63.75 in July.
E. None of these.

28. If its yield to maturity is less than its coupon rate, a bond will sell at a _____, and increases in market
interest rates will _____.

A. discount; decrease this discount

B. discount; increase this discount
C. premium; decrease this premium
D. premium; increase this premium
E. None of these

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29. The Fisher formula is expressed as _____ where R is the nominal rate, r is the real rate, and h is the inflation
rate.

A. 1 + r = (1 + R) ÷ (1 + h)
B. 1 + r = (1 + R) × (1 + h)
C. 1 + h = (1 + r) ÷ (1 + R)
D. 1 + R = (1 + r) ÷ (1 + h)
E. 1 + R = (1 + r) × (1 + h)

30. The Fisher Effect primarily emphasizes the effects of _____ risk on an investor's rate of return.

A. default
B. market
C. interest rate
D. inflation
E. maturity

31. Consider a bond which pays 8% semiannually and has 8 years to maturity. The market requires an interest
rate of 10% on bonds of this risk. What is this bond's price?

A. $530.58
B. $891.62
C. $893.30
D. $3129.17
E. None of these

32. The value of a 25 year zero-coupon bond when the market required rate of return is 10% (semiannual) is
____.

A. $87.20
B. $92.30
C. $95.26
D. $98.31
E. None of these

33. The bonds issued by Manson & Son bear a 6% coupon, payable semiannually. The bond matures in 8 years
and has a $1,000 face value. Currently, the bond sells at par. What is the yield to maturity?

A. 5.87%
B. 5.97%
C. 6.00%
D. 6.09%
E. 6.17%

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34. A Corporate bond has an 8% coupon and pays interest annually. The face value is $1,000 and the current
market price is $1,020.50. The bond matures in 20 years. What is the yield to maturity?

A. 7.79%
B. 7.82%
C. 8.00%
D. 8.04%
E. 8.12%

35. Otto Enterprises has a 15-year bond issue outstanding that pays a 9% coupon. The bond is currently priced
at $894.60 and has a par value of $1,000. Interest is paid semiannually. What is the yield to maturity?

A. 8.67%
B. 10.13%
C. 10.16%
D. 10.40%
E. 10.45%

36. Chocolate and Rum, Inc. offers a 7% coupon bond with semiannual payments and a yield to maturity of
7.73%. The bonds mature in 9 years. What is the market price of a $1,000 face value bond?

A. $953.28
B. $963.88
C. $1,108.16
D. $1,401.26
E. $1,401.86

37. Part of the Rock, Inc. has a 6% coupon bond that matures in 11 years. The bond pays interest semiannually.
What is the market price of a $1,000 face value bond if the yield to maturity is 12.9%?

A. $434.59
B. $580.86
C. $600.34
D. $605.92
E. $947.87

38. Guggenheim, Inc. offers a 7% coupon bond with annual payments. The yield to maturity is 5.85% and the
maturity date is 9 years. What is the market price of a $1,000 face value bond?

A. $742.66
B. $868.67
C. $869.67
D. $1,078.73
E. $1,079.59

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39. The Lo Sun Corporation offers a 6% bond with a current market price of $875.05. The yield to maturity is
7.34%. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond
matures?

A. 16 years
B. 18 years
C. 24 years
D. 30 years
E. 32 years

40. Moonhigh, Inc. has a 5%, semiannual coupon bond with a current market price of $988.52. The bond has a
par value of $1,000 and a yield to maturity of 5.29%. How many years is it until this bond matures?

A. 4.0 years
B. 4.5 years
C. 6.5 years
D. 8.0 years
E. 9.0 years

41. Your firm offers a 10-year, zero coupon bond. The yield to maturity is 8.8%. What is the current market
price of a $1,000 face value bond?

A. $430.24
B. $473.26
C. $835.56
D. $919.12
E. $1,088.00

42. Ted's Co. offers a zero coupon bond with an 11.3% yield to maturity. The bond matures in 16 years. What is
the current price of a $1,000 face value bond?

A. $178.78
B. $180.33
C. $188.36
D. $190.09
E. $192.18

43. The zero coupon bonds of MarkCo, Inc. have a market price of $394.47, a face value of $1,000, and a yield
to maturity of 6.87%. How many years is it until this bond matures?

A. 7 years
B. 10 years
C. 14 years
D. 18 years
E. 21 years

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44. A 12-year, 5% coupon bond pays interest annually. The bond has a face value of $1,000. What is the change
in the price of this bond if the market yield rises to 6% from the current yield of 4.5%?

A. 11.11% decrease
B. 12.38% decrease
C. 12.38% increase
D. 14.13% decrease
E. 14.13% increase

45. Jackson Central has a 6-year, 8% annual coupon bond with a $1,000 par value. Earls Enterprises has a 12-
year, 8% annual coupon bond with a $1,000 par value. Both bonds currently have a yield to maturity of 6%.
Which of the following statements are correct if the market yield increases to 7%?

A. Both bonds would decrease in value by 4.61%.

B. The Earls bond will increase in value by $88.25.
C. The Jackson bond will increase in value by 4.61%.
D. The Earls bond will decrease in value by 7.56%.
E. The Earls bond will decrease in value by $50.68.

46. A corporate bond is quoted at a current price of 102.767. What is the market price of a bond with a $1,000
face value?

A. $1,000.28
B. $1,002.77
C. $1,027.67
D. $1,102.77
E. $1,276.70

47. A zero coupon bond with a face value of $1,000 is issued with an initial price of $463.34. The bond matures
in 25 years. What is the implicit interest, in dollars, for the first year of the bond's life?

A. $9.08
B. $12.56
C. $14.48
D. $21.47
E. $31.25

48. The MerryWeather Firm wants to raise $10 million to expand its business. To accomplish this, it plans to
sell 30-year, $1,000 face value zero-coupon bonds. The bonds will be priced to yield 6%. What is the
minimum number of bonds it must sell to raise the $10 million it needs?

A. 47,411
B. 52,667
C. 57,435
D. 60,000
E. 117,435

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49. Which of the following amounts is closest to the value of a bond that pays $55 semiannually and has an
effective semiannual interest rate of 5%? The face value is $1,000 and the bond matures in 3 years. There
are exactly six months before the first interest payment.

A. $888
B. $1,000
C. $1,014
D. $1,025
E. $1,055

50. Emmett Corporation has issued a $1,000 face value zero-coupon bond. Which of the following values is
closest to the correct price for the bond if the appropriate discount rate is 4% and the bond matures in 8
years?

A. $730.69
B. $968.00
C. $1,000.00
D. $1,032.00
E. This problem cannot be worked without the annual interest payments provided

51. A corporate bond with a face value of $1,000 matures in 4 years and has an 8% coupon paid at the end of
each year. The current price of the bond is $932. What is the yield to maturity for this bond?

A. 5.05%
B. 6.48%
C. 8.58%
D. 10.15%
E. 11.92%

52. A bond that pays interest annually yields a 7.25% rate of return. The inflation rate for the same period is
3.5%. What is the real rate of return on this bond?

A. 3.50%
B. 3.57%
C. 3.62%
D. 3.72%
E. 3.75%

53. The bonds of Jerrod's Welding, Inc. pay an 8% coupon, have a 7.98% yield to maturity and have a face
value of $1,000. The current rate of inflation is 2.5%. What is the real rate of return on these bonds?

A. 5.32%
B. 5.35%
C. 5.37%
D. 5.42%
E. 5.48%

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54. The outstanding bonds of Boutelle, Inc. provide a real rate of return of 3.6%. The current rate of inflation is
2.5%. What is the nominal rate of return on these bonds?

A. 6.10%
B. 6.13%
C. 6.16%
D. 6.19%
E. 6.22%

55. The nominal rate of return on the bonds of Steve's Boats is 8.75%. The real rate of return is 3.4%. What is
the rate of inflation?

A. 5.17%
B. 5.28%
C. 5.35%
D. 5.43%
E. 5.49%

56. Guggenheim, Inc. offers a 9% coupon bond with annual payments. The yield to maturity is 8.13% and the
maturity date is 9 years. What is the market price of a $1,000 face value bond?

A. $833.41
B. $982.12
C. $1000.00
D. $1,054.06
E. $1,056.13

57. The Lo Sun Corporation offers a 8% bond with a current market price of $875.05. The yield to maturity is
9.18%. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond
matures?

A. 40 years
B. 52 years
C. 60 years
D. 65 years
E. 80 years

58. Moonhigh, Inc. has a 6%, semiannual coupon bond with a current market price of $988.52. The bond has a
par value of $1,000 and a yield to maturity of 6.31%. How many years is it until this bond matures?

A. 4.0 years
B. 4.28 years
C. 6.32 years
D. 8.56 years
E. 9.0 years

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59. Your firm offers a 10-year, zero coupon bond. The yield to maturity is 8.2%. What is the current market
price of a $1,000 face value bond?

A. $454.70
B. $485.62
C. $856.18
D. $931.27
E. $2199.24

60. Emmett Corporation has issued a $1,000 face value zero-coupon bond. Which of the following values is
closest to the correct price for the bond if the appropriate discount rate is 4% and the bond matures in 8
years?

A. $644.61
B. $869.32
C. $1,000.00
D. $1,058.00
E. This problem cannot be worked without the annual interest payments provided

Essay Questions

61. Calculate the YTM on a bond priced at $1,036 which has 2 years to maturity, a 10% annual coupon rate, and
a return of $1,000 at maturity.

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62. Given the opportunity to invest in one of the three bonds listed below, which would you purchase? Assume
an interest rate of 7%.

63. Explain why some bond investors are subject to liquidity risk, default risk, and/or taxability risk. How does
each of these risks affect the yield of a bond?

64. Define what is meant by interest rate risk. Assume you are the manager of a $100 million portfolio of
corporate bonds and you believe interest rates will fall. What adjustments should you make to your portfolio
based on your beliefs?

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65. Why do corporations issue 100-year bonds, knowing that interest rate risk is highest for very long-term
bonds? How does the interest rate risk affect the issuer?

66. In the early 1980s, the Treasury yield curve had a severe downward slope with short-term yields near 20%
and long-term yields below 15%. Explain how such a pattern might occur.

67. Interest rate risk is often explained by using the concept of a teeter-totter. Explain interest rate risk and how
it is related to the movements of a teeter-totter.

68. The discussion of asset pricing in the text suggests that an investor will be indifferent between two bonds
which have equal yields to maturity as long as they have equivalent default risk. Can you think of any real-
world factors which might make a given investor prefer one of these bonds over the other?

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69. Sometimes it is not clear if a particular security is debt or equity. Explain the basic difference between debt
and equity.

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