University of San Carlos - Main Campus

ACCTG 509

Chapter 3

True/False Questions

1)If interest rates increase, the value of a fixed income contract decreases and vice versa.

2. At equilibrium a security's required rate of return will be less than its expected rate of return.

3. If a security's realized return is negative it must have been true that the expected return was greater than the required return.

4. If the present value of a security's cash flows is below its current market price the security is undervalued.

5. The required rate of return is the interest rate that equates the current market price of the bond with the present value of all future cash flows received.

6. A bond with an 8% coupon and a 10% required return will sell at a premium to par.

7. A bond with a 10% coupon and an 8% required return will sell at a discount from par.

8. Discount bonds are poorer buys than premium bonds.
9. The duration of a four year maturity 10% coupon bond is less than four years.

10. The longer the time to maturity the lower the security's price sensitivity to an interest rate change, ceteris paribus.

11. The greater a security's coupon the lower the security's price sensitivity to an interest rate change.

12. For a given interest rate change, a 20 year bond's price change will be twice that of a 10 year bond's price change.

13. Any security that returns a greater percentage of the price sooner is less price volatile.

14. Duration is the elasticity of a security's value to small coupon changes.

15. A coupon bond with a 3.5 year duration has the same price volatility as a 3.5 year maturity zero coupon bond.

16. The lower the level of interest rates, the greater is a bond's price sensitivity to interest rate changes.

Multiple Choice Questions

17. The interest rate used to find the fair present value of a financial security is the

1. 1. Expected rate of return
   2. Required rate of return
   3. Realized rate of return

1. 4. Realized yield to maturity
   5. Current yield

18. A security has an expected return greater than its required return. This security is

1. 1. Selling at a premium to par
   2. Selling at a discount

to par

1. 3. Selling for more than its FPV

1. 4. Selling for less than its FPV
   5. A zero coupon bond

19. A bond that you held to maturity had a realized return of 8%, but when you bought it, it had an expected return of 6%. If no default occurred, which one of the following must be true?
    1. The bond was purchased at a premium to par
    2. The coupon rate was 8%
    3. The required return was greater than 6%
    4. The coupons were reinvested at a higher rate than expected
    5. The bond must have been a zero coupon bond  

20. A 6 year annual payment corporate bond has a market price of $1050. It pays annual interest of $100 and its required rate of return is 9%. By how much is the bond mispriced?

A) $0.00

2. Overpriced by $5.14
3. Underpriced by

$5.14

4. Overpriced by

$11.32

5. Underpriced by

$11.32

21. A 10 year corporate bond pays $75 interest semiannually. What is the bond's price if the required return is 7%?

A) $1175.32

B) $1181.47

C) $1035.53

D) $1052.97

E) $1222.18

22. A corporate bond has a coupon rate of 10% and a required return of 10%. This bond's price is

A) $924.18

B) $1000.00

C) $879.68

D) $1124.83

E) Not possible to determine from the information given

23. A 10 year annual payment corporate coupon bond has an expected return of 11% and a required return of 10%. The bond's market price is

1. 1. Greater than its FPV
   2. Less than par

1. 3. Less than its Err
   4. Less than its FPV

E) $1000.00

24. An 8 year annual payment corporate bond has a required return of 10% and a 9% coupon. Its market

value is $15 over its FPV. What is the bond's Err?

A) 10.11%

B) 9.85%

C) 9.71%

D) 10.23%

E) 8.73%

25. Corporate Bond A returns 5% of its cost in PV terms in each of the first five years and 75% of its value in the sixth year. Corporate Bond B returns 8% of its cost in PV terms in each of the first five years and 60% of its cost in the sixth year. If A and B have the same required return, which of the following is/are true?

1. Bond A has a bigger coupon than Bond B
2. Bond A has a longer duration than Bond B

3. Bond A is less price volatile than Bond B
4. Bond B has a higher FPV than Bond A.

1. III only
2. I, III and IV only

3. I, II and IV only
4. II and IV only

5. I, II, II and IV are all true

26. A corporate bond returns 6% of its cost (in PV terms) in the first year, 5% in the second year, 4% in the third year and the remainder in the fourth year. What is the bond's duration in years?

1. 1. 3.68 years
   2. 2.50 years

1. 3. 4.00 years
   4. 3.75 years

1. 5. 3.88 years

27. If an N year security recovered the same percentage of its cost in PV terms each year the duration would be

1. 1. N
   2. 0

1. 3. N/2
   4. N!/N2

1. 5. None of the above

28. The                 the coupon and the                the maturity; the                 the duration of a bond, ceteris paribus.

1. 1. Larger, longer, longer
   2. Larger, longer,

shorter

1. 3. Smaller, shorter, longer

1. 4. Smaller, shorter, shorter
   5. None of the above

29. A 4 year maturity 12% coupon annual payment corporate bond with a required rate of return of 12% has a duration of (years):

A)        3.05                                  B) 2.97                                    C) 3.22                                   D) 3.71                                    E) 3.40

30. A decrease in interest rates will
    1. Decrease the bond's FPV
    2. Increase the bond's duration
    3. Lower the bond's coupon rate  

1. 4. Change the bond's payment frequency
   5. Not affect the bond's duration

31. A 10 year maturity coupon bond has a 6 year duration. An equivalent 20 year bond with the same coupon has a duration

1. 1. Equal to 12 years
   2. Less than 6 years

1. 3. Less than 12 years
   4. Equal to 6 years

1. 5. Greater than 20 years

32. A six year maturity bond has a five year duration. Over the next year maturity will decline by 1 year and duration will decline by

1. 1. Less than one year
   2. More than one year

1. 3. 1 year
   4. N years

1. 5. N/(N-1) years

33. A bond has a 6% required return. Interest rates are projected to rise 25 basis points. The bond's duration is 5 years. What is the predicted price change?

A) –1.18%

B) 4.71%

C) 1.25%

D) –1.25%

E) 1.18%

34. Convexity arises because
    1. Bond's pay interest semiannually
    2. Coupon changes are the opposite sign of interest rate changes
    3. Of Federal Reserve policy  

35. The duration of a 180 day T-Bill is (in years)

4. Present values are a nonlinear function of interest rates
5. The professor said so

A) 0.493

B) 0.246

3. 1
4. 0

5. Indeterminate

36. For large interest rate increases, duration                   the fall in security prices and for large interest rate decreases, duration                                     the rise in security prices.