Financial Management, Exercises of Financial Management

Download Financial Management and more Exercises Financial Management in PDF only on Docsity! Chapter 03 - Valuing Bonds Chapter 03 Valuing Bonds Multiple Choice Questions 1. The following entities issue bonds to raise long-term loans except: A. The federal government B. State and local governments. C. Companies D. Individuals 2. The type of bonds where the identities of bonds' owners are recorded and the coupon interest payments are sent automatically are called: A. Bearer bonds B. Government bonds C. Registered bonds D. None of the above 3. A government bond issued in Germany has a coupon rate of 5%, face value of euros 100 and maturing in five years. The interest payments are made annually. Calculate the price of the bond (in euros)if the yield to maturity is 3.5%. A. 100 B. 106.77 C. 106.33 D. none of the above 4. Generally, a bond can be valued as a package of: T) Annuity, IT) Perpetuity, Ill) Single payment A. Land II only B. Il and III only C. Land III only D. none of the above 3-1 Chapter 03 - Valuing Bonds 5. A government bond issued in Germany has a coupon rate of 5%, face value of euros 100 and maturing in five years. The interest payments are made annually. Calculate the yield to maturity of the bond (in euros) if the price of the bond is 106 euros. A. 5.00% B. 3.80% C. 3.66% D. none of the above 6. Generally, bonds issued in the following countries pay interest semi-annually. T) USA, ID UK, IID Canada, IV) Germany, & V) Japan A. 1, IL, I, & IV B. 1, I, Il, & V C. IL, I, & IV only D. None of the above 7. If a bond is paying interest semi-annually, then: A. interest is paid once a year B. interest is paid every six moths. C. interest is paid every three months D. none of the above 8. A 3-year bond with 10% coupon rate and $1000 face value yields 8% APR. Assuming annual coupon payment, calculate the price of the bond. A. $857.96 B. $951.96 C. $1000.00 D. $1051.54 9. A 5-year treasury bond with a coupon rate of 8% has a face value of $1000. What is the semi-annual interest payment? A. $80 B. $40 C. $100 D. None of the above Chapter 03 - Valuing Bonds 19. If a bond's volatility is 10% and the interest rate goes down by 0.75% (points) then the price of the bond: A. decreases by 10% B. decreases by 7.5% C. increases by 7.5% D. increases by 0.75% 20. If a bond's volatility is 5% and the interest rate changes by 0.5% (points) then the price of the bond: A. changes by 5% B. changes by 2.5% C. changes by 7.5% D. none of the above 21. Volatility of a bond is given by: T) Duration/ (1 + yield) II) Slope of the curve relating the bond price to the interest rate II) Yield to maturity A. Tonly B. Il only C. II only D. Land II only 22. The term structure of interest rates can be described as the: A. Relationship between the spot interest rates and the bond prices B. Relationship between spot interest rates and stock prices C. Relationship between spot interest rates and maturity of a bond D. None of the above 3-5 Chapter 03 - Valuing Bonds 23. Which of the following statements is true? I) The spot interest rate is a weighted average of yields to maturity II) Yield to maturity is the weighted average of spot interest rates and estimated forward rates II) The yield to maturity is always higher than the spot rates A. Tonly B. Il only C. II only D. I and III only 24. A forward rate prevailing from period three through to period four can be: I) readily observed in the market place ID) extracted from spot interest rate with 3 and 4 years to maturity II) extracted from | and 2 year spot interest rates A. Tonly B. Il only C. II only D. I and III only 25. If the 3-year spot rate is 10.5% and the 2-year spot rate is 10%, what is the one-year forward rate of interest two years from now? A. 3.7% B. 9.5% C. 11.5% D. None of the above 26. If the 5-year spot rate is 10% and the 4-year spot rate is 9%, what is the one-year forward rate of interest four years from now? A. 14.1% B. 9.5% C. 1.0% D. 11.0% 3-6 Chapter 03 - Valuing Bonds 27. If the 4-year spot rate is 7% and the 3-year spot rate is 6%, what is the one-year forward rate of interest three years from now? A. 10.0% B. 6.5% C. 9.6% D. None of the above 28. Interest represented by "ra" is: A. Spot rate on a one-year investment (APR) B. Spot rate on a two-year investment (APR) C. Expected spot rate 2 years from today D. Expected spot rate one year from today 29. How can one invest today at the 2-year forward rate of interest? I) By buying a 2-year bond and selling a 1-year bond with the same coupon II) By buying a 1-year bond and selling a 2-year bond with the same coupon II) By buying a 1-year bond and then after a year reinvesting in a further 1-year bond A. Tonly B. Il only C. II only D. IL and III only 30. The expectations hypothesis states that the forward interest rate is the: T) expected future spot rate ID) always greater than the spot rate IID) yield to maturity A. Tonly B. Il only C. II only D. IL and III only 3-7 Chapter 03 - Valuing Bonds 43. The expectations theory implies that the only reason for a declining term structure is that investors expect spot interest rates to fall. True False 44. The relationship between nominal interest rate and real interest rate is given by: (1 + Tpominal) = (1 + Trea)(1 + inflation rate) True False 45. Treasury bonds do not have default risk, but are subject to inflation risk. True False 46. Indexed bonds were completely unknown in the U.S. before 1997. True False 47. The U.S. Treasury issues inflation-indexed bonds known as TIPs. True False 48. Forward rates are always higher than spot rates. True False 49. Defaulted bonds often pay some level of residual? True False Short Answer Questions Chapter 03 - Valuing Bonds 50. Briefly explain the cash flows associated with a bond to the investor. 51. Briefly explain the term "yield to maturity." 52. What is the relationship between interest rates and bond prices? 53. Discuss the concept of duration. Chapter 03 - Valuing Bonds 54. Briefly discuss the concept of volatility. 55. Briefly explain what is meant by "the term structure of interest rates." 56. Briefly explain the expectations theory. 57. What is the relationship between real and nominal rates of interest? 3-12 Chapter 03 - Valuing Bonds 3. A government bond issued in Germany has a coupon rate of 5%, face value of euros 100 and maturing in five years. The interest payments are made annually. Calculate the price of the bond (in euros)if the yield to maturity is 3.5%. A. 100 B. 106.77 C. 106.33 D. none of the above The annual interest payment = (100) x (0.05) = 5 euros Price = PV; Using a financial Calculator: PMT = 5; 1 = 3.5; FV = 100; & N =5; Compute: PV = 106.77 euros Type: Medium 4. Generally, a bond can be valued as a package of: T) Annuity, IT) Perpetuity, Ill) Single payment A. Land IT only B. II and III only C. Land Ill only D. none of the above Type: Easy 5. A government bond issued in Germany has a coupon rate of 5%, face value of euros 100 and maturing in five years. The interest payments are made annually. Calculate the yield to maturity of the bond (in euros) if the price of the bond is 106 euros. A. 5.00% B. 3.80% C. 3.66% D. none of the above The annual interest payment = (100) x (0.05) = 5 euros Using a financial Calculator: PMT = 5; FV = 100; & N=5; & PV = -106 Compute: I = 3.66% Type: Medium Chapter 03 - Valuing Bonds 6. Generally, bonds issued in the following countries pay interest semi-annually. T) USA, ID UK, IID Canada, IV) Germany, & V) Japan A. I, IL, I, & IV B.I, I, WI, & V C. IL, Il, & IV only D. None of the above Type: Medium 7. If a bond is paying interest semi-annually, then: A. interest is paid once a year B. interest is paid every six moths C. interest is paid every three months D. none of the above Type: Easy 8. A 3-year bond with 10% coupon rate and $1000 face value yields 8% APR. Assuming annual coupon payment, calculate the price of the bond. A. $857.96 B. $951.96 C. $1000.00 D. $1051.54 PV = (100/1.08) + (100/(1.0842)) + (1 100/(1.0843)) = $1051.54 Type: Medium Chapter 03 - Valuing Bonds 9. A 5-year treasury bond with a coupon rate of 8% has a face value of $1000. What is the semi-annual interest payment? A. $80 B. $40 C. $100 D. None of the above Annual interest payment = 1000(0.08) = $80; Semi-annual payment = 80/2 = $40 Type: Easy 10. A three-year bond has 8.0% coupon rate and face value of $1000. If the yield to maturity on the bond is 10%, calculate the price of the bond assuming that the bond makes semi-annual coupon interest payments. A. $857.96 B. $949.24 C. $1057.54 D. $1000.00 PV = (40/1.05) + (40/(1.05%2)) +... + (1040/(1.056)) = $949.24 Type: Difficult 11. A four-year bond has an 8% coupon rate and a face value of $1000. If the current price of the bond is $878.31, calculate the yield to maturity of the bond (assuming annual interest payments). A. 8% B. 10% C. 12% D. 6% Use trial and error method. (80/1.12) + (80/(1.1242)) + (80/(1.12%3)) + (LO80/(1.12%4)) = $870.51. Therefore, yield to maturity is 12%. Or use a financial calculator: PV = -878.31; N = 4; PMT = 80; FV = 1000; COMPUTE: I = 12% Type: Difficult Chapter 03 - Valuing Bonds 18. A bond with duration of 5.7 years has yield to maturity of 9%. The bond's volatility is: A. 1.9% B.5.2% C.5.7% D. 9.0% Volatility = 5.7/1.09 = 5.2 Type: Difficult 19. If a bond's volatility is 10% and the interest rate goes down by 0.75% (points) then the price of the bond: A. decreases by 10% B. decreases by 7.5% C. increa: y 7.5% D. increases by 0.75% Change in bond price = (Volatility) * (change in interest rates) = 10 * 0.75 = 7.5% Type: Difficult 20. If a bond's volatility is 5% and the interest rate changes by 0.5% (points) then the price of the bond: A. changes by 5% B. changes by 2.5% C. changes by 7.5% D. none of the above 5 *0.5 =2.5% Type: Medium 3-20 Chapter 03 - Valuing Bonds 21. Volatility of a bond is given by: T) Duration/ (1 + yield) II) Slope of the curve relating the bond price to the interest rate II) Yield to maturity A. Tonly B. II only C. Ii only D. [and II only Type: Difficult 22. The term structure of interest rates can be described as the: A. Relationship between the spot interest rates and the bond prices B. Relationship between spot interest rates and stock prices C. Relationship between spot interest rates and maturity of a bond D. None of the above Type: Difficult 23. Which of the following statements is true? I) The spot interest rate is a weighted average of yields to maturity II) Yield to maturity is the weighted average of spot interest rates and estimated forward rates II) The yield to maturity is always higher than the spot rates A. Tonly B. II only C. Ii only D. Land II only Type: Difficult 3-21 Chapter 03 - Valuing Bonds 24. A forward rate prevailing from period three through to period four can be: I) readily observed in the market place ID) extracted from spot interest rate with 3 and 4 years to maturity II) extracted from | and 2 year spot interest rates A. Tonly B. II only C. Ii only D. Land II only Type: Difficult 25. If the 3-year spot rate is 10.5% and the 2-year spot rate is 10%, what is the one-year forward rate of interest two years from now? A. 3.7% B. 9.5% C. 11.5% D. None of the above forward rate = [(1.10543)/(1.142)] -1 = 11.5% Type: Difficult 26. If the 5-year spot rate is 10% and the 4-year spot rate is 9%, what is the one-year forward rate of interest four years from now? A. 14.1% B. 9.5% C. 1.0% D. 11.0% forward rate = [(1.145)/(1.0944)] -1 = 14.1% Type: Difficult 3-22 Chapter 03 - Valuing Bonds 33. What forward rate is embedded in a two year zero coupon bonds with a yield to maturity of 6% and a three year zero coupon bond and a yield to maturity of 6.5%? Assume both bonds are currently priced at par. A. 5.50% B. 6.00% C. 6.50% D. 7.50% First calculate the future value of $1 at each YTM. You get 1.1236 for the 2 year bond and 1.1910 for the 3 year bond. Now determine the IRR over between years 2 and 3. Type: Difficult 34. Which bond is more sensitive to an interest rate change of 0.75%? Bond A: YTM = 4.00%, Maturity = 8 years, Coupon = 6% or $60, Par Value = $1,000 Bond B: YTM = 3.50%, Maturity = 5 years, Coupon = 7% or $70, Par Value = $1,000 A.A B.B C. Both the same D. Cannot be determined The price of bond A decreases from 1134 to 1108. Bond B decreases in price from 1158 to 1121. A drops by 4.67% and B drops by 3.15%. Type: Difficult True / False Questions 35. The yield to maturity on a bond is really its internal rate of return. TRUE Type: Easy 3-25 Chapter 03 - Valuing Bonds 36. In the US, most bonds make coupon payments annually. FALSE E Type: Easy 37. The duration of any bond is the same as its maturity. FALSE Type: Difficult 38. The duration of a zero coupon bond is the same as its maturity. TRUE Type: Medium 39. The longer a bond's duration greater is its volatility. TRUE Type: Medium 40. The term structure of interest rate is the relationship between yield to maturity and maturity. TRUE Type: Medium 41. If the term structure of interest rate is flat the nine-year interest rate is equal to the ten-year interest rate. TRUE Type: Medium Chapter 03 - Valuing Bonds 42. Short-term and long-term interest rates always move in parallel. FALSE Type: Difficult 43. The expectations theory implies that the only reason for a declining term structure is that investors expect spot interest rates to fall. TRUE Type: Difficult 44. The relationship between nominal interest rate and real interest rate is given by: (1 + nominal) = (1 + Treai)(1 + inflation rate) TRUE Type: Medium 45. Treasury bonds do not have default risk, but are subject to inflation risk. TRUE Type: Medium 46. Indexed bonds were completely unknown in the U.S. before 1997. FALSE Type: Medium 47. The U.S. Treasury issues inflation-indexed bonds known as TIPs. TRUE Type: Medium Chapter 03 - Valuing Bonds 56. Briefly explain the expectations theory. This theory postulates that the current forward rates are the expected value of the corresponding future spot rates. Type: Medium 57. What is the relationship between real and nominal rates of interest? The exact relationship is given by: (1 + nominal rate ) = (1 + real rate) * (1 + expected Inflation rate). It can also be written as: nominal rate = real rate + Inflation rate + (real rate) * (Inflation rate) Type: Easy 58. Define the term, "real interest rate." Real interest rate is the inflation adjusted nominal interest rate. We do not observe it directly. The relationship between the two is given by: 1 + Lnominal = (1 + Treat rate)(1 + inflation rate). (An approximate formula that works for low values is: Tpominal = Treal rate + Inflation rate) Type: Medium 59. What are TIPs? Briefly explain. TIPs(Treasury Inflation-Protected Securities) are issued by the U.S. Treasury. The U.S. Treasury began issuing TIPs in 1997. These are also known as Inflation-indexed bonds. The real cash flows on TIPs are fixed, but the nominal cash flows, which includes interest and principal, are increased as the Consumer Price Index (CPI) increases. Thus the buying power of the lender in protected. Type: Medium Chapter 03 - Valuing Bonds 60. What is the relationship between spot and forward rates? A forward rate is the internal rate of return derived from the future value of bonds given spot rates from two different maturity bonds. Type: Difficult