Question 1

Assume bond portfolio managers actively manage their portfolios. If they expect interest rates to ____, they would shift toward ____.

Accepted Answer

When bond portfolio managers expect interest rates to decrease, they would shift toward long-maturity bonds with zero-coupon rates because the prices of these bonds are more sensitive to changes in interest rates, potentially offering higher capital gains as interest rates fall.

Question 2

Any announcement that signals stronger than expected economic growth tends to increase bond prices. ​

Accepted Answer

Announcements signaling stronger than expected economic growth typically lead to a decrease in bond prices, as investors anticipate higher inflation and potential interest rate increases, which negatively affect bond prices.

Question 3

International diversification of bonds reduces the sensitivity of a bond portfolio to any single country's interest rate movements.

Accepted Answer

International diversification of bonds spreads the investment across various countries, thereby reducing the impact of interest rate movements in any single country on the overall portfolio. This is because different countries may have varying economic conditions and monetary policies, leading to different interest rate movements.

Question 4

As interest rates increase, prices of short-term bonds will decline by a greater degree than prices of long-term bonds. ​

Accepted Answer

Long-term bonds are generally more sensitive to interest rate changes than short-term bonds, so their prices tend to decline more when interest rates increase.

Question 5

Foreign investors anticipating dollar depreciation are less willing to hold U.S. bonds because the coupon payments will convert to less of their home currency.

Accepted Answer

When foreign investors expect the dollar to depreciate, the value of the coupon payments they receive from U.S. bonds (which are paid in dollars) will decrease when converted back to their home currency, making U.S. bonds less attractive.

Question 6

If the Treasury issues an unusually large amount of bonds in the primary market, it places ____ pressure on bond prices and ____ pressure on yields to be earned by investors that purchase bonds and plan to hold them to maturity.

Accepted Answer

When the Treasury issues a large amount of bonds, it increases the supply of bonds in the market, which typically leads to a decrease in bond prices (downward pressure on prices). As bond prices fall, the yields (which move inversely to prices) increase, meaning there is upward pressure on yields for investors planning to hold the bonds to maturity.

Question 7

If the level of inflation is expected to decrease, there will be upward pressure on interest rates and on the required rate of return on bonds.

Accepted Answer

When inflation is expected to decrease, interest rates typically fall, which means there is downward pressure on the required rate of return on bonds, making their prices rise.

Question 8

The valuation of bonds is generally perceived to be more difficult than the valuation of equity securities.

Accepted Answer

The valuation of bonds is generally considered to be simpler than the valuation of equity securities because bonds have defined cash flows (interest payments and the return of principal) and a finite maturity, making their future income streams easier to predict. In contrast, equities (stocks) do not have a predetermined return, making their valuation more complex due to the need to estimate future earnings and dividends, which are influenced by a wide range of unpredictable factors.

Question 9

If the coupon rate of a bond is above the investor's required rate of return, the price of the bond should be below its par value.

Accepted Answer

If the coupon rate of a bond is above the investor's required rate of return, the price of the bond will be above its par value because it offers more attractive returns compared to the market's required rate.

Question 10

The market price of a bond is partly determined by the timing of the payments made to bondholders.

Accepted Answer

The market price of a bond is influenced by the timing of interest payments (coupon payments) and the repayment of the principal, as these cash flows are discounted back to their present value.

Question 11

An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return and therefore causes bond prices to increase. ​

Accepted Answer

An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return, which causes bond prices to decrease, not increase, due to the inverse relationship between bond prices and interest rates.

Question 12

Which of the following is most likely to cause a decrease in bond prices?

Accepted Answer

A decrease in money supply growth and an increase in the demand for loanable funds typically lead to higher interest rates, which inversely affect bond prices, causing them to decrease.

Question 13

The long-term, risk-free interest rate is driven by inflationary expectations, economic growth, the money supply, and the budget deficit. ​

Accepted Answer

The long-term, risk-free interest rate is influenced by various factors including inflationary expectations, economic growth, the money supply, and the budget deficit, as these elements affect the overall demand for and supply of funds in the economy, thereby influencing interest rates.

Question 14

A zero-coupon bond makes no coupon payments.

Accepted Answer

A zero-coupon bond does not make periodic interest payments (or "coupons") throughout its life; instead, it is sold at a discount to its face value and pays its face value at maturity.

Question 15

A bond portfolio containing a large portion of zero-coupon bonds will be more favorably affected by declining interest rates than a bond portfolio containing no zero-coupon bonds. ​

Accepted Answer

Zero-coupon bonds have a higher duration than bonds that pay periodic interest, making them more sensitive to changes in interest rates. Therefore, a portfolio of zero-coupon bonds will benefit more from declining interest rates through higher price appreciation compared to a portfolio without zero-coupon bonds.

Question 16

The appropriate price of a bond is simply the sum of the cash flows to be received.

Accepted Answer

The appropriate price of a bond is the present value of all future cash flows (coupon payments and principal repayment) discounted back to the present using the required rate of return, not just the simple sum of the cash flows.

Question 17

Duration is a measure of the life of a bond on a present value basis. ​

Accepted Answer

Duration measures the sensitivity of a bond's price to changes in interest rates, effectively representing the weighted average time it takes to receive all cash flows (including both principal and interest payments) on a present value basis.

Question 18

Bonds that sell below their par value are called premium bonds.

Accepted Answer

Bonds that sell below their par value are called discount bonds, not premium bonds. Premium bonds sell above their par value.

Question 19

In a laddered strategy, investors create a bond portfolio that will generate periodic income that can match their expected periodic expenses.

Accepted Answer

The answer of In a laddered strategy, investors create a...

Question 20

Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return. ​

Accepted Answer

Bond price elasticity, also known as bond duration, measures the sensitivity of bond prices to changes in interest rates, calculated as the percentage change in bond price divided by the percentage change in yield or required rate of return.

Quiz 8: Bond Valuation and Risk

Assume bond portfolio managers actively manage their portfolios. If they expect interest rates to , they would shift toward .

Any announcement that signals stronger than expected economic growth tends to increase bond prices.

International diversification of bonds reduces the sensitivity of a bond portfolio to any single country's interest rate movements.

As interest rates increase, prices of short-term bonds will decline by a greater degree than prices of long-term bonds.

Foreign investors anticipating dollar depreciation are less willing to hold U.S. bonds because the coupon payments will convert to less of their home currency.

If the Treasury issues an unusually large amount of bonds in the primary market, it places pressure on bond prices and pressure on yields to be earned by investors that purchase bonds and plan to hold them to maturity.

If the level of inflation is expected to decrease, there will be upward pressure on interest rates and on the required rate of return on bonds.

The valuation of bonds is generally perceived to be more difficult than the valuation of equity securities.

If the coupon rate of a bond is above the investor's required rate of return, the price of the bond should be below its par value.

The market price of a bond is partly determined by the timing of the payments made to bondholders.

An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return and therefore causes bond prices to increase.

Which of the following is most likely to cause a decrease in bond prices?

The long-term, risk-free interest rate is driven by inflationary expectations, economic growth, the money supply, and the budget deficit.

A zero-coupon bond makes no coupon payments.

A bond portfolio containing a large portion of zero-coupon bonds will be more favorably affected by declining interest rates than a bond portfolio containing no zero-coupon bonds.

The appropriate price of a bond is simply the sum of the cash flows to be received.

Duration is a measure of the life of a bond on a present value basis.

Bonds that sell below their par value are called premium bonds.

In a laddered strategy, investors create a bond portfolio that will generate periodic income that can match their expected periodic expenses.

Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return.

Quiz 8: Bond Valuation and Risk

Assume bond portfolio managers actively manage their portfolios. If they expect interest rates to ____, they would shift toward ____.

Any announcement that signals stronger than expected economic growth tends to increase bond prices. ​

International diversification of bonds reduces the sensitivity of a bond portfolio to any single country's interest rate movements.

As interest rates increase, prices of short-term bonds will decline by a greater degree than prices of long-term bonds. ​

Foreign investors anticipating dollar depreciation are less willing to hold U.S. bonds because the coupon payments will convert to less of their home currency.

If the Treasury issues an unusually large amount of bonds in the primary market, it places ____ pressure on bond prices and ____ pressure on yields to be earned by investors that purchase bonds and plan to hold them to maturity.

If the level of inflation is expected to decrease, there will be upward pressure on interest rates and on the required rate of return on bonds.

The valuation of bonds is generally perceived to be more difficult than the valuation of equity securities.

If the coupon rate of a bond is above the investor's required rate of return, the price of the bond should be below its par value.

The market price of a bond is partly determined by the timing of the payments made to bondholders.

An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return and therefore causes bond prices to increase. ​

Which of the following is most likely to cause a decrease in bond prices?

The long-term, risk-free interest rate is driven by inflationary expectations, economic growth, the money supply, and the budget deficit. ​

A zero-coupon bond makes no coupon payments.

A bond portfolio containing a large portion of zero-coupon bonds will be more favorably affected by declining interest rates than a bond portfolio containing no zero-coupon bonds. ​

The appropriate price of a bond is simply the sum of the cash flows to be received.

Duration is a measure of the life of a bond on a present value basis. ​

Bonds that sell below their par value are called premium bonds.

In a laddered strategy, investors create a bond portfolio that will generate periodic income that can match their expected periodic expenses.

Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return. ​

Assume bond portfolio managers actively manage their portfolios. If they expect interest rates to , they would shift toward .

Any announcement that signals stronger than expected economic growth tends to increase bond prices.

As interest rates increase, prices of short-term bonds will decline by a greater degree than prices of long-term bonds.

If the Treasury issues an unusually large amount of bonds in the primary market, it places pressure on bond prices and pressure on yields to be earned by investors that purchase bonds and plan to hold them to maturity.

An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return and therefore causes bond prices to increase.

The long-term, risk-free interest rate is driven by inflationary expectations, economic growth, the money supply, and the budget deficit.

A bond portfolio containing a large portion of zero-coupon bonds will be more favorably affected by declining interest rates than a bond portfolio containing no zero-coupon bonds.

Duration is a measure of the life of a bond on a present value basis.

Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return.