Fire 470 Final Exam

                                        Final Exam Fire 470

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1.)           Briefly describe what a TIPS bond is.  (2-3 sentences)



2.)           Consider the following TIPS bond purchased one year ago.  The bond had an original principal value of $1,000 and pays a 10% annual coupon payment that is paid semiannual.  Inflation for the first 6 months was 2.4% while inflation for the second 6 months was 1.2%.  What is the current principal amount and what is the amount of the second coupon payment?



3.)              Consider a STRIP bond with a closing ask price of 93.888 which matures 2.5899 years later at which time the STRIP holder will receive 100% of the face value.  Assuming semi-annual compounding, what is the yield to maturity?




4-5.)        Consider a bond which pays a 8% coupon payment that is paid semiannually.  The face value is $10,000 and the clean price is $10,100.  The most recent coupon payment of $400 was paid 40 days ago.  The next coupon payment will be made in 144 days. 


Compute the accrued interest owed to the seller if settlement occurred today.



Compute the dirty price of the bond.





6.)           Briefly explain the difference between the following two types of municipal bonds: General Obligation Bond and Revenue Bond.  (1-2 sentences to describe each).




7.)           Consider a taxable bond with a yield to maturity of 9%.  For an investor with a 34% marginal tax rate, what would their after-tax yield to maturity on this bond be?







8.)           Consider a tax-free municipal bond with a yield to maturity of 4.5%.  If you are an investor with a marginal tax rate of 28%, what is your tax equivalent yield?        





9.)           Consider the following convertible bond: The bond has a face value of $1,000 and is convertible into 20 shares of the issuing firm’s common stock.  If the common stock is worth $65 per share, what is the conversion value of this bond?





10.)   True or false?  The current rate of inflation affects the expected level of interest rates.


12.)    True or false?  The market rate of interest can be viewed as the real rate of interest plus a premium for the expected rate of inflation.



13.)    True or false?  The expected real rate of interest is likely to be negative.


14.)    True or false?  The realized real rate of interest can be negative if expected inflation is less than actual inflation.


15.)    True or false?  Nominal interest rates reflect anticipated inflation.


16.)    True or false?  Expected increased inflation usually drives up bond prices.


17.)    True or false?  The Fisher Effect holds that nominal interest rate s include an expected inflation rate.



18.) __________real rates are almost always positive; _____________real rates may be negative.


  1.             Realized; expected.
  2.             Expected; realized
  3.             Government; private
  4.             Expected; expected



19.)  The Fisher effect is a theory which holds that


  1.             Nominal rates include the real rate of interest plus past annual inflation rates.
  2.             Nominal rates include the real rate of interest plus expected annual inflation rates.
  3.             Real rates are always positive.
  4.             Inflation has no impact upon interest rates.



20.)  Which of the following is expected to affect long-term bond yields?


  1.             Announcement of last year’s inflation rate.
  2.             Announcement of this month’s inflation rate.
  3.             A forecast of next month’s inflation rate.
  4.             A forecast of inflation over the next five years.


21.)    True or false?  The coupon rate may be the market rate of interest for a bond.


22.)    True or false?  The price of a bond and the market rate of interest are inversely related.


23.)   True or false?    The price of a bond is the present value of future payments discounted at the coupon rate.


24.)    True or false?  Yield to maturity assumes reinvestment of coupons at the same yield.


25.)    True or false?  The realized yield to maturity may be influenced by coupon reinvestment rates.


26.)    True or false?  If market interest rates have increased since a bond was purchased, price risk will increase the price of the bond and reinvestment risk will decrease the return on the coupons.


27.)    True or false?  A zero coupon bond has no reinvestment risk.


28.)    True or false?  The higher the coupon rate, the lower the bond price volatility.


29.)    True or false?  Short-term bonds have greater price risk compared to long-term bonds.


30.)    True or false?  Price risk is of no concern to the investor if the bond is held to maturity.


31.)    True or false?  The duration of a zero coupon bond equals the time to maturity of the bond.


32.)    True or false?  The duration of a coupon bond must be shorter than its term to maturity.


33.)    True or false?  Bonds with lower coupon rates have a shorter duration than similar bonds with high coupon rates.


34.)  Which of the following statements is true about bonds?


  1.             Bond prices and interest rates move together.
  2.             Coupon rates are fixed at the time of issue.
  3.             Short-term securities have large price swings relative to long-term securities.
  4.             The higher the coupon, the lower the price of the bond.



35.)  Duration is a measure of


  1.             A bond’s price.
  2.             A bond’s contractual maturity.
  3.             The length of time it takes to get back the original investment.
  4.             Bond price volatility.



36.)  Bond A has a duration of 5.6 years while bond B has a duration of 6.0 years.  Bond B


  1.             Will have greater price variability, given a change in interest rates, relative to bond A.
  2.             Will have a longer maturity than bond A.
  3.             Will have a higher coupon rate than bond A.
  4.             Will have less price variability, given a change in interest rates, relative to bond A.



37.)  A 3-year zero coupon bond selling for $900 and yielding 12.18% has a duration of?







38.)  As bond maturity__________, so does the___________and_____________.


  1.             Decreases; coupon rate; market price.
  2.             Decreases; duration; face value.
  3.             Increases; duration; price variability.
  4.             Increases; risk; coupon rate.



39.)  Which of the following will not affect zero coupon bonds?


  1.             Price risk.
  2.             Reinvestment risk.
  3.             Credit risk.
  4.             Default risk.


40.)  Jane needs a specific sum of money in five years.  She should invest in


  1.             High quality, 20 year Treasury bonds.
  2.             High quality coupon bonds with a duration of five years.
  3.             High quality coupon bonds maturing in five years.
  4.             High credit risk bonds maturing in five years.



41.)  An investor worried about interest rate risk should


  1.             Not purchase coupon bonds.
  2.             Select bonds whose maturity matches the investor’s investment holding period.
  3.             Select bonds whose duration matches the investor’s investment holding period.
  4.             Invest only in U.S. Treasury bonds.



42.)  An investor who selects coupon bond maturities matching his/her holding period


  1.             Has eliminated price risk, but not reinvestment risk.
  2.             Has eliminated just one part of interest rate risk.
  3.             Cannot precisely predict the rate of return on the bond.
  4.             All of the above.


43.)  There is generally a_____________relationship between term to maturity and duration.


  1.             Positive.
  2.             Favorable.
  3.             Inverse.
  4.             Large.



44.)  Bonds with___________coupon rates have a____________duration than bonds with__________coupons of the same maturity.


  1.             Higher; shorter; smaller
  2.             Lower; longer; smaller
  3.             Higher; longer; larger
  4.             Higher; shorter; larger



45.) All of the following are contractually fixed except


  1.             Par value.
  2.             Yield to maturity.
  3.             Time to maturity.
  4.             Coupon rate.


46.)  The duration of any financial instrument


  1.             Cannot exceed the instrument’s term to maturity.
  2.             Is a proxy for the instrument’s default risk.
  3.             Must exceed the instrument’s term to maturity.
  4.             Must be calculated before yield to maturity can be accurately determined.











Consider a bond with 30 years to maturity that pays an annual coupon rate of 6.6%.  The bond has a face value of $1,000 and is currently priced at $1,000.  You purchase this bond today.  Immediately after you purchase it, market rates change to 8% and remain there for the next 10 years at which time you sell the bond.  What is your realized yield to maturity?















49-50.) With respect to the bond above, what is the duration of this bond?


















51.)  The duration of Bond A is 4.55 years.  Bond A also has a yield to maturity of 13%.  Compute the modified duration of this bond.








52.)  A bond is currently priced at $1,025 and had a modified duration of 15.55 years.  If interest rates were to decline by 0.35%, what would be the predicted new bond price?



53.)  The term structure of interest rates


            a.         describes the relationship between maturity and yield for similar securities.

            b.         ranks security yield according to the default risk structure.

            c.         describes how interest rates vary over time.

            d.         describes the pattern of interest rates over the business cycle.


54.)  The yield curve is a plot of

            a.         maturity changes as risk changes.

            b.         yields by varied risk-taking of varied bond issuers.

            c.         yields by maturity of securities with similar default risk.

            d.         interest rates over time past.


55.)  The source of data for a yield curve might be

            a.         bond yield by issuers over time.

            b.         historical Treasury security yields.

            c.         realized Treasury security yields by time.

            d.         outstanding Treasury security yields by maturity.


56.)  According to the expectation theory of the term structure of interest rates

            a.         investors prefer holding short-term securities.

              b          the shape of the yield curve is determined by investors' expectations of future short-term interest rates.

            c.         institutional investors' maturity preferences determine the shape of the yield curve.

            d.         both a and b are true.


57.)  Calculate the one-year forward rate three years from now if three- and four-year rates are 5.50% and 5.80%, respectively?











58.)  If three-year securities are yielding 6% and two-year securities are yielding 5.5%, future short-term

 rates are expected to ______, and outstanding security prices are expected to ______.

            a.         fall; fall.

            b.         rise; fall.

            c.         fall; rise.

            d.         rise; rise


59.)  The major determinants of the bond ratings assigned by Moody's or Standard and Poor is

            a.         marketability.

            b.         tax treatment.

            c.         term to maturity.

            d.         default risk.


60.)  Default risk premiums vary _______ with the ________ of the security?

            a.         directly; default risk

            b.         inversely; default risk

            c.         similar; price

            d.         forward; size


61.)  Bond A is not callable; bond B is callable.  Investors will want a higher yield on bond __ and will pay ____ for the bond.

            a.         A; less

            b.         A; more

            c.         B; less

            d.         B; more


62.)  Federal Agency securities have higher yields than similar Treasury securities because they

            a.         have greater default risk.

            b.         have greater tax liability.

            c.         are less marketable.

            d.         both a and c


63.)  Current interest rates are 7 percent.  If inflationary expectations increased from the current 5 percent

to 3 percent, what would be the new market interest rates?

            a.           9 percent

            b.           5 percent

            c.         10 percent

            d.           4 percent














Answer the questions 64-69 with reference to the following data.


Treasury Bills, 90 days                                                   4.20%

Commercial Paper, 90 days                                            4.84%

Treasury Bill, 1 year                                                       4.67%

Treasury Note, 2 year                                                      5.25%

Corporate Bond AA, 20 year                                          8.23%

Municipal Bond AA, 20 year                                          6.42%

Expected Annual Inflation Rate                                      3.00%


64.)  With reference to the data above, the default risk premium on the 90-day commercial paper above is








65.)  With reference to the above data, what is the expected real rate of return on the 90-day commercial








66.)  With reference to the data above, the implied one-year forward rate (expected one-year rate one year

from now) on Treasuries is








67.)  With reference to the above data, at what marginal tax rate would an investor be indifferent between

owning the corporate bond and the municipal bond?








68.)  With reference to the above data, what is the approximate expected pre-tax real rate of return on the

one-year Treasury bill?






69.)  With reference to the data above, what is the expected after-tax real rate of return on the one-year

Treasury Bill for an investor in the 33 percent marginal tax bracket?









70.)  Yield differences between two securities may be explained by differences in

            a.         maturity.

            b.         default risk.

            c.         marketability.

            d.         call provision.

            e.         all of the above


71.)  Applying the expectations theory, a bank depositor has the option of purchasing a one-year CD at 5

percent and a 5.5 percent two-year CD.  If indifferent between the two, the depositor must expect one

-year CDs one year from now to have a rate of

            a.         6.5 percent.

            b.         4.5 percent.

            c.         6 percent.

            d.         5 percent.


72.)  Bonds are called speculative grade or junk bond if their Moody's and Standard & Poor's rating is

            a.         above Baa (BBB).

            b.         Baa (BBB) and below.

            c.         B1 (B+) and below.

            d.         A1 (A+) and below


73.)  All but one of the following are considered when assigning a bond rating?

            a.         the variability of earnings

            b.         the expected cash flow

            c.         the rating on the prior issue of securities sold

            d.         the amount of the fixed contractual cash payments