Question 1

Which of the following is not a factor affecting the market price of a foreign bond held by a U.S. investor?

Accepted Answer

All of the above factors -foreign interest rate movements, credit risk, and exchange rate fluctuations- affect the market price of a foreign bond held by a U.S. investor.

Question 2

When the European Central Bank provides credit to a country that is experiencing debt repayment problems, the ECB commonly:

Accepted Answer

When the ECB provides credit to a country experiencing debt problems, it typically imposes austerity conditions to enable the government to reduce its budget deficit. This often includes measures such as reducing government spending, increasing taxes, and reforming various sectors of the economy to improve competitiveness. The aim of such conditions is to restore market confidence and put the country on a path towards sustainable economic growth.

Question 3

Holding other factors constant, a higher budget deficit leads to ______ interest rates, and higher inflationary expectations lead to _______ interest rates.

Accepted Answer

A higher budget deficit means the government will need to borrow more money, leading to an increased demand for credit, which causes interest rates to rise. Higher inflationary expectations also cause interest rates to increase as lenders demand higher returns to compensate them for the loss in purchasing power of their money due to inflation.

Question 4

When holding other factors constant, increased borrowing by the Treasury can result in a _______ required return and therefore _______ prices on existing bonds.

Accepted Answer

An increased borrowing by the Treasury indicates that there is an increase in the supply of bonds, thereby leading to a decrease in bond prices. As a result, investors require a higher yield on the bonds they purchase to compensate for the decrease in bond prices, resulting in a higher required return.

Question 5

Although the European debt crisis had substantial effects on European financial markets, the crisis was contained and did not affect markets and financial institutions outside Europe.

Accepted Answer

The European debt crisis did have ripple effects in global financial markets and institutions outside of Europe, particularly in emerging markets and countries with close economic ties to Europe. The crisis also contributed to a slowdown in global economic growth.

Question 6

Stephanie would like to purchase a bond that has a par value of $1,000, pays $100 at the end of each year in coupon payments, and has three years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 12 percent, how much will Stephanie pay for the bond?

Accepted Answer

To calculate the price of the bond, we need to use the formula: 
Price of bond = (Coupon payment / Yield) x (1 - 1 / (1 + Yield) ^ n) + Par value / (1 + Yield) ^ n 
Where: 
Coupon payment = $100 
Yield = 12% = 0.12 
n = 3 years 
Par value = $1,000

Plugging in the values: 
Price of bond = ($100 / 0.12) x (1 - 1 / (1 + 0.12) ^ 3) + $1,000 / (1 + 0.12) ^ 3 
Price of bond = $790.79 + $161.18 
Price of bond = $951.97

Therefore, Stephanie will pay $951.97 for the bond.

Question 7

The ____________ was recently established to identify risks in the U.S. financial system and make regulatory recommendations that could reduce such risks.

Accepted Answer

The Financial Stability Oversight Council was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 with the purpose of identifying risks to the U.S. financial system and making regulatory recommendations to reduce such risks. The other options listed are not correct names of government entities related to financial regulation.

Question 8

To determine the present value of a bond that pays semiannual interest, which of the following adjustments should not be made to compute the price of the bond?

Accepted Answer

The par value of the bond should not be split in half as it represents the face value or the redemption value of the bond at maturity, and it remains the same regardless of whether the bond pays semiannual or annual interest. The other adjustments, such as splitting the annualized coupon in half, dividing the annual discount rate by 2, and doubling the number of annual periods, are necessary to compute the present value of the bond that pays semiannual interest.

Question 9

A bond has a $1,000 par value and an 8 percent coupon rate. The bond has four years remaining to maturity and a 10 percent yield to maturity. This bond's modified duration is ____ years.

Accepted Answer

Modified duration is calculated using the Macaulay duration formula adjusted for yield to maturity. Given the bond's characteristics, the modified duration is approximately 3.24 years.

Question 10

Because of a change in the required rate of return from 11 percent to 13 percent, the bond price of a zero-coupon bond will fall from $1,000 to $860. Thus, the bond price elasticity for thisbondis

Accepted Answer

The bond price elasticity is calculated as the percentage change in bond price divided by the percentage change in required rate of return. In this case, the bond price falls from $1,000 to $860, a decrease of $140 or 14%. The required rate of return increases from 11% to 13%, an increase of 2%. Therefore, the bond price elasticity is -14% / 2% = -7.

Question 11

The process by which higher credit risk in one country is transmitted to another country is known as

Accepted Answer

Credit contagion refers to the spread of credit risk from one entity to another, and can happen within a country or cross-border. In the context of this question, the spread of higher credit risk in one country to another country is referred to as credit contagion. Choices A and B are not accurate descriptions of this process. Choice D is incorrect as there is an answer that accurately describes the process.

Question 12

Julia just purchased a $1,000 par value bond with a 10 percent annual coupon rate and a life of 20 years. The bond has four years remaining until maturity, and the yield to maturity is 12 percent. How much did Julia pay for the bond?

Accepted Answer

To solve, we need to calculate the present value of the bond, which is the price Julia paid. Using the formula: 
PV = C * (1 - (1 + r/n)^(-n*t)) / (r/n) + FV / (1 + r/n)^n*t 
where PV is the present value, C is the annual coupon payment, r is the yield to maturity, n is the number of coupon payments per year, t is the number of years, and FV is the face value. 
Plugging in the values, we get: 
PV = 100 * (1 - (1 + 0.12/2)^(-2*4)) / (0.12/2) + 1000 / (1 + 0.12/2)^(2*4) 
PV = $939.25, which means Julia paid $939.25 for the bond. 
Therefore, the correct answer is C.

Question 13

The required rate of return on a certain bond changes from 12 percent to 8 percent, causing the price of the bond to change from $900 to $1,100. The bond price elasticity of this bond is

Accepted Answer

The bond price elasticity can be calculated using the formula: Elasticity = (Percentage change in price) / (Percentage change in yield) = [(1100 - 900) / 900] / [(8 - 12) / 12] = (200 / 900) / (-4 / 12) = 0.2222 / -0.3333 = -0.67.

Question 14

An economic announcement signaling ____ economic growth in the future will probably cause bond prices to ____.

Accepted Answer

The answer of An economic announcement signaling ____ economic growth...

Question 15

A $1,000 par value bond, paying $50 semiannually, with an 8 percent yield to maturity and five years remaining to maturity should sell for

Accepted Answer

The bond's price can be calculated using the present value of its cash flows, which include the semiannual coupon payments and the par value at maturity. With a semiannual coupon of $50, a yield to maturity of 8% (or 4% per period), and 10 periods (5 years), the bond's price is approximately $1,081.11.

Question 16

Assume a bond with a $1,000 par value and a 7 percent coupon rate, three years remaining to maturity, and a 9 percent yield to maturity. The duration of this bond is ____ years.

Accepted Answer

The duration of a bond is a measure of its sensitivity to interest rate changes. For a bond with a 7% coupon rate, 3 years to maturity, and a 9% yield to maturity, the duration is calculated to be approximately 2.8 years.

Question 17

Which of the following formulas best describes the value of a bond?

Accepted Answer

Formula C is the standard formula for the value of a bond, which is the present value of the future cash flows (interest payments and principal repayment) discounted at the bond's yield to maturity.

Question 18

If investors rely strictly on modified duration to estimate the percentage change in the price of a bond, they will tend to ____ the price decline associated with an increase in rates and ____the price increase associated with a decrease in rates.

Accepted Answer

The answer of If investors rely strictly on modified duration...

Question 19

Systemic risk could be avoided if all financial institutions would use derivative securities as a means of insuring against the default of the debt securities that they hold.

Accepted Answer

While derivative securities can be used to mitigate risk, they can also contribute to systemic risk if not used properly. In addition, requiring all financial institutions to use derivatives may not be feasible or practical.

Question 20

The credit risk premium tends to be larger for bonds that have longer terms to maturity.

Accepted Answer

The credit risk premium is the compensation investors require for taking on the risk of default by the issuer. This risk is higher for bonds with longer terms to maturity as there is more time for the issuer's financial situation to deteriorate, increasing the likelihood of default. Therefore, investors will demand a larger credit risk premium for these bonds.

Quiz 8: Bond Valuation and Risk