Financial Markets and Institutions Anthony Saunders 7th Edition-Test Bank
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Sample Test
Financial Markets and Institutions, 7e (Saunders)
Chapter 3 Interest Rates and Security Valuation
1) If interest rates increase, the value of a fixed income
contract decreases and vice versa.
Answer: TRUE
Difficulty: 1 Easy
Topic: Impact of Interest Rate Changes on Security Values
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-04 Appreciate how security prices are affected
by interest rate changes.
Accessibility: Keyboard Navigation
2) At equilibrium a security’s required rate of return will be
less than its expected rate of return.
Answer: FALSE
Difficulty: 1 Easy
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
3) If a security’s realized return is negative, it must have
been true that the expected return was greater than the required return.
Answer: FALSE
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
4) Suppose two bonds of equivalent risk and maturity have
different prices such that one is a premium bond and one is a discount bond.
The premium bond must have a greater expected return than the discount bond.
Answer: FALSE
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
5) A bond with an 11 percent coupon and a 9 percent required
return will sell at a premium to par.
Answer: TRUE
Difficulty: 1 Easy
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
6) A fairly priced bond with a coupon less than the expected
return must sell at a discount from par.
Answer: TRUE
Difficulty: 1 Easy
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
7) All else equal, the holder of a fairly priced premium bond
must expect a capital loss over the holding period.
Answer: TRUE
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
8) The duration of a four-year maturity 10 percent coupon bond
is less than four years.
Answer: TRUE
Difficulty: 1 Easy
Topic: Duration
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
9) The longer the time to maturity, the lower the security’s
price sensitivity to an interest rate change, ceteris paribus.
Answer: FALSE
Difficulty: 1 Easy
Topic: Impact of Maturity on Security Values
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-05 Understand how the maturity and
coupon rate on a security affect its price sensitivity to interest rate
changes.
Accessibility: Keyboard Navigation
10) The greater a security’s coupon, the lower the security’s
price sensitivity to an interest rate change, ceteris paribus.
Answer: TRUE
Difficulty: 1 Easy
Topic: Impact of Coupon Rates on Security Values
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-05 Understand how the maturity and
coupon rate on a security affect its price sensitivity to interest rate
changes.
Accessibility: Keyboard Navigation
11) 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.
Answer: FALSE
Difficulty: 2 Medium
Topic: Impact of Maturity on Security Values
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-05 Understand how the maturity and
coupon rate on a security affect its price sensitivity to interest rate
changes.
Accessibility: Keyboard Navigation
12) Any security that returns a greater percentage of the price
sooner is less price-volatile.
Answer: TRUE
Difficulty: 1 Easy
Topic: Impact of Coupon Rates on Security Values
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-05 Understand how the maturity and
coupon rate on a security affect its price sensitivity to interest rate
changes.
Accessibility: Keyboard Navigation
13) A zero coupon bond has a duration equal to its maturity and
a convexity equal to zero.
Answer: TRUE
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
14) The lower the level of interest rates, the greater a bond’s
price sensitivity to interest rate changes.
Answer: TRUE
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
15) The higher a bond’s coupon, the lower the bond’s price
volatility.
Answer: TRUE
Difficulty: 1 Easy
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
16) Higher interest rates lead to lower bond convexity, ceteris paribus.
Answer: TRUE
Difficulty: 2 Medium
Topic: Appendix 3B: More on Convexity
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
17) A 10-year maturity zero coupon bond will have lower price
volatility than a 10-year bond with a 10 percent coupon.
Answer: FALSE
Difficulty: 1 Easy
Topic: Impact of Coupon Rates on Security Values
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-05 Understand how the maturity and
coupon rate on a security affect its price sensitivity to interest rate
changes.
Accessibility: Keyboard Navigation
18) Ignoring default risk, if a bond’s expected return is
greater than its required return, then the bond’s market price must be greater
than the present value of the bond’s cash flows.
Answer: FALSE
Difficulty: 1 Easy
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
19) The coupon rate represents the most accurate measure of the
bondholder’s required return.
Answer: FALSE
Difficulty: 3 Hard
Topic: Various Interest Rate Measures
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
20) The higher the interest rate is the higher the duration, all
else being equal.
Answer: FALSE
Difficulty: 1 Easy
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
21) The required rate of return on a bond is
1. A)
the interest rate that equates the current market price of the bond with the
present value of all future cash flows received.
2. B)
equivalent to the current yield for nonpar bonds.
3. C)
less than the E(r) for discount bonds and greater than the E(r) for premium
bonds.
4. D)
inversely related to a bond’s risk and coupon.
5. E)
None of these choices are correct.
Answer: E
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
22) Duration is
1. A)
the elasticity of a security’s value to small coupon changes.
2. B)
the weighted average time to maturity of the bond’s cash flows.
3. C)
the time until the investor recovers the price of the bond in today’s dollars.
4. D)
greater than maturity for deep discount bonds and less than maturity for
premium bonds.
5. E)
the second derivative of the bond price formula with respect to the YTM.
Answer: B
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
23) Which of the following bond terms are generally positively
related to bond price volatility?
1. Coupon
rate
2. Maturity
III. YTM
1. Payment
frequency
1. A) II
and IV only
2. B) I
and III only
3. C) II
and III only
4. D) II
only
5. E)
II, III, and IV only
Answer: D
Difficulty: 3 Hard
Topic: Impact of Maturity on Security Values; Impact of
Coupon Rates on Security Values; Impact of Interest Rate Changes on Security
Values
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-05 Understand how the maturity and
coupon rate on a security affect its price sensitivity to interest rate
changes.
Accessibility: Keyboard Navigation
24) The interest rate used to find the present value of a
financial security is the
1. A)
expected rate of return.
2. B)
required rate of return.
3. C)
realized rate of return.
4. D)
realized yield to maturity.
5. E)
current yield.
Answer: B
Difficulty: 1 Easy
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
25) A security has an expected return less than its required
return. This security is
1. A)
selling at a premium to par.
2. B)
selling at a discount to par.
3. C)
selling for more than its PV.
4. D)
selling for less than its PV.
5. E) a
zero coupon bond.
Answer: C
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
26) A bond that you held to maturity had a realized return of 8
percent, but when you bought it, it had an expected return of 6 percent. If no
default occurred, which one of the following must be true?
1. A)
The bond was purchased at a premium to par.
2. B)
The coupon rate was 8 percent.
3. C)
The required return was greater than 6 percent.
4. D)
The coupons were reinvested at a higher rate than expected.
5. E)
The bond must have been a zero coupon bond.
Answer: D
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
27) You would want to purchase a security if P ________ PV or
E(r) ________ r.
1. A) ≥;
≤
2. B) ≥;
≥
3. C) ≤;
≥
4. D) ≤;
≤
Answer: C
Difficulty: 3 Hard
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
28) A 10-year annual payment corporate bond has a market price
of $1,050. It pays annual interest of $100 and its required rate of return is 9
percent. By how much is the bond mispriced?
1. A)
$0.00
2. B)
Overpriced by $14.18
3. C)
Underpriced by $14.18
4. D)
Overpriced by $9.32
5. E)
Underpriced by $9.32
Answer: C
Explanation: PV = 100 × PVIFA [9%, 10 yrs.] + 1,000 × PVIF
(9%, 10 yrs.) = $1,064.18
Calculator Method:
N = 10
PMT = 100
I/Y = 9
FV = 1,000
Solve for PV which is $1064.18; Market value is underpriced by
$14.18.
Difficulty: 2 Medium
Topic: Various Interest Rate Measures; Bond Valuation
Bloom’s: Analyze; Apply; Evaluate
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.; 03-02 Calculate bond values.
Accessibility: Keyboard Navigation
29) A 12-year annual payment corporate bond has a market price
of $925. It pays annual interest of $60 and its required rate of return is 7
percent. By how much is the bond mispriced?
1. A)
$0.00
2. B)
Overpriced by $7.29
3. C)
Underpriced by $7.29
4. D)
Overpriced by $4.43
5. E)
Underpriced by $4.43
Answer: D
Explanation: FPV = 60 × PVIFA [7%, 12 yrs.] + 1,000 × PVIF
(7%, 12 yrs.) = $920.57
Calculator Method:
N = 12
PMT = 60
I/Y = 7
FV = 1,000
Solve for PV which is $920.57; Market value is overpriced by
$4.43.
Difficulty: 2 Medium
Topic: Various Interest Rate Measures; Bond Valuation
Bloom’s: Analyze; Apply; Evaluate
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.; 03-02 Calculate bond values.
Accessibility: Keyboard Navigation
30) An eight-year corporate bond has a 7 percent coupon rate.
What should be the bond’s price if the required return is 6 percent and the bond
pays interest semiannually?
62.
A) $1,062.81
63.
B) $1,062.10
64.
C) $1,053.45
65.
D) $1,052.99
66.
E) $1,049.49
Answer: A
Explanation: Price = 35.00 × PVIFA (3%, 16) + 1,000 × PVIF
(3%, 16)
Calculator Method:
N = 16
PMT = 35
I/Y = 3
FV = 1,000
Solve for PV which is $1062.81.
Difficulty: 2 Medium
Topic: Bond Valuation
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-02 Calculate bond values.
Accessibility: Keyboard Navigation
31) A 15-year corporate bond pays $40 interest every six months.
What is the bond’s price if the bond’s promised YTM is 5.5 percent?
261.
A) $1,261.32
262.
B) $1,253.12
263.
C) $1,250.94
264.
D) $1,263.45
265.
E) $1,264.79
Answer: B
Explanation: Using P/Y2 for semiannual; FV $1,000;
PMT $40; N 15 years; and I/Y 5.5 percent. Solve bond price (PV) = $1,253.12.
Calculator Method:
N = 30
PMT = 40
I/Y = 2.75
FV = 1,000
Solve for PV which is $1,253.12.
Difficulty: 2 Medium
Topic: Bond Valuation
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-02 Calculate bond values.
Accessibility: Keyboard Navigation
32) A corporate bond has a coupon rate of 10 percent and a
required return of 10 percent. This bond’s price is
924.
A) $924.18.
925.
B) $1,000.00.
926.
C) $879.68.
927.
D) $1,124.83.
928.
E) not possible to determine from the information given.
Answer: B
Explanation: When coupon rate = required return; price =
par
Difficulty: 1 Easy
Topic: Bond Valuation
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-02 Calculate bond values.
Accessibility: Keyboard Navigation
33) A 10-year annual payment corporate coupon bond has an
expected return of 11 percent and a required return of 10 percent. The bond’s
market price is
1. A)
greater than its PV.
2. B)
less than par.
3. C)
less than its E(r).
4. D)
less than its PV.
5. E)
$1,000.00.
Answer: D
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
34) An eight-year annual payment 7 percent coupon Treasury bond
has a price of $1,075. The bond’s annual E(r) must be
13.
A) 13.49 percent.
14.
B) 5.80 percent.
15.
C) 7.00 percent.
16.
D) 1.69 percent.
17.
E) 4.25 percent.
Answer: B
Explanation: $1,075 = 70 × PVIFA (E(r)%, 8) + 1,000 × PVIF
(E(r)%, 8), trial and error or calculator
Calculator Method:
N = 8
PMT = 70
PV = −1,075
FV = 1,000
Solve for I/Y which is 5.80%.
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
35) A six-year annual payment corporate bond has a required
return of 9.5 percent and an 8 percent coupon. Its market value is $20 over its
PV. What is the bond’s E(r)?
8. A)
8.00 percent
9. B)
10.21 percent
10.
C) 9.98 percent
11.
D) 9.03 percent
12.
E) 3.53 percent
Answer: D
Explanation: PV = 933.70 = 80 × PVIFA (9.5%, 6 yrs.) +
1,000 × PVIF (9.5%, 6 yrs.); (933.70 + 20) = 80 × PVIFA (E(r), 6 yrs.) + 1,000
× PVIF (E(r), 6 yrs.), trial and error or calculator
Calculator Method:
First find the Present Value of this bond.
N = 6
PMT = 80
I/Y = 9.5
FV = 1,000
Solve for PV which is 933.70.
The market value is 953.70, using this value solve for I/Y to
find E(r).
PV = −953.70
PMT = 80
N = 6
FV = 1,000
Solve for I/Y to get 9.03%.
Difficulty: 3 Hard
Topic: Various Interest Rate Measures
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
36) Corporate Bond A returns 5 percent of its cost in PV terms
in each of the first five years and 75 percent of its value in the sixth year.
Corporate Bond B returns 8 percent of its cost in PV terms in each of the first
five years and 60 percent 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.
III. Bond A is less price-volatile than Bond B.
1. Bond
B has a higher PV than Bond A.
1. A)
III only
2. B) I,
III, and IV only
3. C) I,
II, and IV only
4. D) II
and IV only
5. E) I,
II, III, and IV
Answer: D
Difficulty: 3 Hard
Topic: Various Interest Rate Measures; Duration; Impact of
Coupon Rates on Security Values
Bloom’s: Analyze; Evaluate
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-05 Understand how the maturity and
coupon rate on a security affect its price sensitivity to interest rate
changes.; 03-07 Understand how maturity, yield to maturity, and coupon rate
affect the duration of a security.; 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
37) A corporate bond returns 12 percent of its cost (in PV
terms) in the first year, 11 percent in the second year, 10 percent in the
third year and the remainder in the fourth year. What is the bond’s duration in
years?
3. A)
3.68 years
4. B)
2.50 years
5. C)
4.00 years
6. D)
3.75 years
7. E)
3.32 years
Answer: E
Explanation: 3.32 = (12% × 1) + (11% × 2) + (10% × 3) +
(67% × 4)
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Analyze; Apply; Evaluate
AACSB: Analytical Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
38) A semiannual payment bond with a $1,000 par has a 7 percent
quoted coupon rate, a 7 percent promised YTM, and 10 years to maturity. What is
the bond’s duration?
10.
A) 10.00 years
11.
B) 8.39 years
12.
C) 6.45 years
13.
D) 5.20 years
14.
E) 7.35 years
Answer: E
Explanation: Σ[(t × CFt/(1.035)t)]/($1,000)
Difficulty: 3 Hard
Topic: Duration
Bloom’s: Analyze; Apply; Evaluate
AACSB: Analytical Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
39) An annual payment bond with a $1,000 par has a 5 percent
quoted coupon rate, a 6 percent promised YTM, and six years to maturity. What
is the bond’s duration?
5. A)
5.31 years
6. B)
5.25 years
7. C)
4.76 years
8. D)
4.16 years
9. E)
3.19 years
Answer: A
Explanation: Σ[(t × CFt/(1.06)t)]/$950.83
Difficulty: 3 Hard
Topic: Duration
Bloom’s: Analyze; Apply; Evaluate
AACSB: Analytical Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
40) If an N year security recovered the same percentage of its
cost in PV terms each year, the duration would be
1. A) N.
2. B) 0.
3. C)
sum of the years/N.
4. D)
N!/N2.
5. E)
None of these choices are correct.
Answer: C
Difficulty: 3 Hard
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
41) The ________ the coupon and the ________ the maturity; the
________ the duration of a bond, ceteris
paribus.
1. A)
larger; longer; longer
2. B)
larger; longer; shorter
3. C)
smaller; shorter; longer
4. D)
smaller; shorter; shorter
5. E)
None of these choices are correct.
Answer: E
Difficulty: 3 Hard
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
42) A four-year maturity 0 percent coupon corporate bond with a
required rate of return of 12 percent has an annual duration of ________ years.
3. A)
3.05
4. B)
2.97
5. C)
3.22
6. D)
3.71
7. E)
4.00
Answer: E
Explanation: Duration of zero coupon bond definition.
Difficulty: 1 Easy
Topic: Duration
Bloom’s: Analyze; Apply; Evaluate
AACSB: Analytical Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
43) A decrease in interest rates will
1. A)
decrease the bond’s PV.
2. B)
increase the bond’s duration.
3. C)
lower the bond’s coupon rate.
4. D)
change the bond’s payment frequency.
5. E)
not affect the bond’s duration.
Answer: B
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
44) A 10-year maturity coupon bond has a six-year duration. An
equivalent 20-year bond with the same coupon has a duration
1. A)
equal to 12 years.
2. B)
less than six years.
3. C)
less than 12 years.
4. D)
equal to six years.
5. E)
greater than 20 years.
Answer: C
Difficulty: 1 Easy
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
45) A six-year maturity bond has a five-year duration. Over the
next year maturity will decline by one year and duration will decline by
1. A)
less than one year.
2. B)
more than one year.
3. C)
one year.
4. D) N
years.
5. E)
N/(N − 1) years.
Answer: A
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Analyze
AACSB: Analytical Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
46) An annual payment bond has a 9 percent required return.
Interest rates are projected to fall 25 basis points. The bond’s duration is 12
years. What is the predicted price change?
2. A)
−2.75 percent
3. B)
33.33 percent
4. C)
1.95 percent
5. D)
−1.95 percent
6. E)
2.75 percent
Answer: E
Explanation: −12 × (−0.0025/1.09) = 0.0275
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
47) A bond that pays interest annually has a 6 percent promised
yield and a price of $1,025. Annual interest rates are now projected to fall 50
basis points. The bond’s duration is six years. What is the predicted new bond
price after the interest rate change? (Watch your rounding.)
42.
A) $1,042.33
43.
B) $995.99
44.
C) $1,054.01
45.
D) $987.44
46.
E) None of these choices are correct.
Answer: C
Explanation: 1,025 + [−6 × (−0.0050/1.06) × $1,025] =
1,054
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
48) A bond that pays interest semiannually has a 6 percent
promised yield and a price of $1,045. Annual interest rates are now projected
to increase 50 basis points. The bond’s duration is five years. What is the
predicted new bond price after the interest rate change? (Watch your rounding.)
20.
A) $1,020.35
21.
B) $1,069.65
22.
C) $1,070.36
23.
D) $1,019.64
24.
E) None of these choices are correct.
Answer: D
Explanation: ((−5/1.03) × 0.0050 × $1,045) + $1,045 =
1,019.635
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
49) Convexity arises because
1. A)
bonds pay interest semiannually.
2. B)
coupon changes are the opposite sign of interest rate changes.
3. C)
duration is an increasing function of maturity.
4. D)
present values are a nonlinear function of interest rates.
5. E)
duration increases at higher interest rates.
Answer: D
Difficulty: 2 Medium
Topic: Appendix 3B: More on Convexity
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
50) The duration of a 180-day T-Bill is (in years)
1. A)
0.493.
2. B)
0.246.
3. C) 1.
4. D) 0.
5. E)
indeterminate.
Answer: A
Explanation: 180/365 = 0.493
Difficulty: 1 Easy
Topic: Duration
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
51) The duration of a 91-day T-Bill is (in years).
1. A)
0.325
2. B)
0.249
3. C)
0.715
4. D) 0
5. E)
Indeterminate
Answer: B
Explanation: 91/365 = 0.249
Difficulty: 1 Easy
Topic: Duration
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-06 Know what duration is.
Accessibility: Keyboard Navigation
52) For large interest rate increases, duration ________ the
fall in security prices, and for large interest rate decreases, duration
________ the rise in security prices.
1. A)
overpredicts; overpredicts
2. B)
overpredicts; underpredicts
3. C)
underpredicts; overpredicts
4. D)
underpredicts; underpredicts
5. E)
None of these choices are correct.
Answer: B
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
53) Suppose you owned stock in a company for the last three
years. You originally bought the stock three years ago for $30 and just sold it
for $56. The stock paid an annual dividend of $1.35 on the last day of each of
the past three years. What is your realized return on this investment?
15.
A) 15.36 percent
16.
B) 36.14 percent
17.
C) 26.85 percent
18.
D) 37.58 percent
19.
E) None of these choices are correct.
Answer: C
Explanation: Use a financial calculator to solve for IRR
as follows:
CF0 = −$30, CF1 = $1.35, CF2 = $1.35, CF3 =
$57.35
Compute IRR = 26.85%.
Difficulty: 2 Medium
Topic: Equity Valuation
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-03 Calculate equity values.
Accessibility: Keyboard Navigation
54) You are considering the purchase of a certain stock. You
expect to own the stock for the next four years. The current market price of
the stock is $24.50 and you expect to sell it for $55 in four years. You also
expect the stock to pay an annual dividend of $1.25 at the end of year 1, $1.35
at the end of year 2, $1.45 at the end of year 3 and $1.55 at the end of year
4. What is your expected return from this investment?
21.
A) 21.78 percent
22.
B) 18.36 percent
23.
C) 26.68 percent
24.
D) 32.85 percent
25.
E) None of these choices are correct.
Answer: C
Explanation: Use a financial calculator to solve for IRR
as follows:
CF0 = −$24.50, CF1 = $1.25, CF2 = $1.35,
CF3 = $1.45, CF4 = $56.55
Compute IRR = 26.68%.
Difficulty: 2 Medium
Topic: Equity Valuation
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-03 Calculate equity values.
Accessibility: Keyboard Navigation
55) A preferred stock is expected to pay a constant quarterly
dividend of $1.25 per quarter into the future. The required rate of
return, Rs,
on the preferred stock is 13.5 percent. What is the fair value (or price) of
this stock?
37.
A) $37.04
38.
B) $24.36
39.
C) $52.36
40.
D) $18.65
41.
E) None of these choices are correct.
Answer: A
Explanation: Rs =
(4 × 1.25) / 0.135 = 37.04
Difficulty: 2 Medium
Topic: Equity Valuation
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-03 Calculate equity values.
Accessibility: Keyboard Navigation
56) You are evaluating a company’s stock. The stock just paid a
dividend of $1.75. Dividends are expected to grow at a constant rate of 5 for
long time into the future. The required rate of return (Rs) on the stock is 12
percent. What is the fair present value?
26.
A) $26.25
27.
B) $22.50
28.
C) $35.26
29.
D) $50.25
30.
E) None of these choices are correct.
Answer: A
Explanation: P0 = (1.75 × 1.05)/(0.12 − 0.05) = 26.25
Difficulty: 2 Medium
Topic: Equity Valuation
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-03 Calculate equity values.
Accessibility: Keyboard Navigation
57) A common stock paid a dividend at the end of last year of
$3.50. Dividends have grown at a constant rate of 6 percent per year over the
last 20 years, and this constant growth rate is expected to continue into the
future. The stock is currently selling at a price of $35 per share. What is the
expected rate of return on this stock?
18.
A) 18.7 percent
19.
B) 22.5 percent
20.
C) 16.6 percent
21.
D) 8.4 percent
22.
E) None of these choices are correct.
Answer: C
Explanation: E(Rs)
= (3.5 × 1.06/35) + 0.06 = 0.166
Difficulty: 2 Medium
Topic: Equity Valuation
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-03 Calculate equity values.
Accessibility: Keyboard Navigation
58) A stock you are evaluating is expected to experience
supernormal growth in dividends of 12 percent over the next three years.
Following this period, dividends are expected to grow at a constant rate of 4
percent. The stock paid a dividend of $1.50 last year and the required rate of
return on the stock is 11 percent. Calculate the stock’s fair present value.
16.
A) $16.24
17.
B) $21.56
18.
C) $24.25
19.
D) $27.46
20.
E) None of these choices are correct.
Answer: D
Explanation: D1 = 1.5 × 1.12 = 1.68
D2 = 1.68 × 1.12 = 1.88
D3 = 1.88 × 1.12 = 2.11
D4 = 2.11 × 1.04 = 2.19
P3 = 2.19/(0.11 – 0.04) = 31.29
Use the Calculator to solve for the NPV:
CF0 = 0, CF1 = $1.68, CF2 = $1.88, CF3 = $33.40,
I/Y = 11 to get NPV = 27.46
Difficulty: 3 Hard
Topic: Equity Valuation
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-03 Calculate equity values.
Accessibility: Keyboard Navigation
59) The basic principle of valuation states that the value of
any asset is
1. A) the
present value of all future cash flows generated by the asset.
2. B)
the sum of all future cash flows generated by the asset.
3. C)
the present value of next year’s cash flow only.
4. D)
the degree of cash flow riskiness is not a relevant factor in valuation.
5. E)
None of these choices are correct.
Answer: A
Difficulty: 1 Easy
Topic: Bond Valuation; Equity Valuation
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-02 Calculate bond values.; 03-03
Calculate equity values.
Accessibility: Keyboard Navigation
60) Is the realized rate of return related to the expected
return? the required return? Explain.
Answer: Yes and no. The required return determines the
initial size of the coupon and the offer price and, as the r changes, forces
the market price to change. As the buy and sell prices and reinvestment rates
on coupons change, the realized return will be affected. However, the required
return is an ex-ante rate designed to compensate investors for risk. The
realized return may be less than or more than the expected or the required.
That is the nature of risk. If you repeated the same investment with the same
terms over and over, you should, on average, earn a realized return equal to
the required return.
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Understand; Analyze
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
61) You bought a stock three years ago and paid $45 per share.
You collected a $2 dividend per share each year you held the stock and then you
sold the stock for $47 per share. What was your annual compound rate of return?
8. A)
8.89 percent
9. B)
8.51 percent
10.
C) 5.84 percent
11.
D) 4.44 percent
12.
E) 2.96 percent
Answer: C
Explanation: Use a financial calculator to solve for IRR
as follows:
CF0 = −$45, CF1 = $2, CF2 = $2, CF3 = $49,
Compute for IRR = 5.84%.
Difficulty: 3 Hard
Topic: Equity Valuation
Bloom’s: Analyze; Apply; Evaluate
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-03 Calculate equity values.
Accessibility: Keyboard Navigation
62) Conceptually, why does a bond’s price fall when required returns
rise on an existing fixed income security?
Answer: Since the cash flows are set by contract, the only
way a new investor can expect to earn the new higher required return is to pay
less for the bond, so the price has to fall. Traders sell the existing bond in
favor of newer, higher rate bonds, dropping the price and raising the expected
return.
Difficulty: 1 Easy
Topic: Impact of Interest Rate Changes on Security
Valuation
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-04 Appreciate how security prices are
affected by interest rate changes.
Accessibility: Keyboard Navigation
63) A 15-year, 7 percent coupon annual payment corporate bond
has a PV of $1,055.62. However, you pay $1,024.32 for the bond. By how many basis
points is your E(r)
different from your r?
Answer:r =
6.41%
1,055.62 = 70 × [PVIFA15 yr, r] + 1,000 × [PVIFA15yr, r]
E(r)
= 6.74%
1,024.32 = 70 × [PVIFA15yr, E(r)]
+ 1,000 × [PVIFA15yr, E(r)]
E(r)
is 33 basis points more than your r.
Calculator Solution:
First solve for the required return:
PV = −1,055.62
FV = 1,000
PMT = 70
N = 15
Solve for I/Y = 6.41%.
Now solve for the E(r):
PV = −1,024.32
FV = 1,000
PMT = 70
N = 15
Solve for I/Y = 6.74%.
The difference between expected return and required return is
0.33% or 33 basis points.
Difficulty: 2 Medium
Topic: Various Interest Rate Measures
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-01 Understand the differences in the
required rate of return, the expected rate of return, and the realized rate of
return.
Accessibility: Keyboard Navigation
64) What is convexity? How does convexity affect duration-based
predicted price changes for interest rates changes?
Answer: Convexity is a measure of the nonlinearity
(curvature) of a change in a bond’s price caused by a change in interest rates.
The level of convexity increases for greater interest rate changes. Duration is
a linear estimate of a bond’s price change as the interest rate changes from
its current level. Due to convexity, the greater the interest rate change, the
greater the error in using duration to estimate the bond’s price change. For a
multimillion-dollar bond portfolio, the dollar errors can be quite significant.
In abnormal markets, bond investors may face more or less risk than the bond’s
duration would imply.
Calculus
Answer: Duration is the first derivative of the bond price
formula with respect to a change in interest rates. As such, it is accurate
only for extremely small changes in interest rates. Duration gives only an
approximation of the actual value change for interest rate movements that are
normally observed in the market.
Difficulty: 3 Hard
Topic: Appendix 3B: More on Convexity
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
65) An investor owned a 9 percent annual payment coupon bond for
six years that was originally purchased at a 9 percent required return. She did
not reinvest any coupons (she kept the money under her mattress). She redeemed
the bond at par. What was her annual realized rate of return? What if she did
reinvest the coupons but only earned 5 percent on each coupon? Why are your
answers not equal to 9 percent?
Answer: You can’t use the bond price formula in this case
because of the lack of reinvestment.
First alternative: Do not reinvest the coupons at all.
PV = $1,000 purchase price (coupon = YTM when purchased)
FV = $90 × 6 = $540 + $1,000 par = $1,540
With a financial calculator, input: PV = −1,000, FV = 1,540, N =
6, PMT = 0 and solve for I to get 7.46%.
Second alternative: reinvest coupons at 5%
PV = $1,000 purchase price (coupon = YTM when purchased)
The future value will be $1,000 plus the sum of the future
values of each of the $90 reinvested at 5%. With a financial calculator, first
find the sum of the future values of each of the $90. PMT = 90, I = 5, N = 6,
PV = 0, and solve for FV1 to get 612.17 and then add $1,000 to this amount
to get the FV = 612.17 + 1,000 = $1,612.17. Finally to solve for r, using the
financial calculator, input FV = 1,612.17, PV = 1,000, N = 6, PMT = 0, and
solve for I to get 8.29%.
The realized returns are less than 9 percent because the
investor did not reinvest the coupons at the required rate of return. In order
to earn a compound rate of return equal to the promised yield, an investor must
reinvest the coupons and earn the promised yield for the remaining time to
maturity.
Difficulty: 2 Medium
Topic: Bond Valuation
Bloom’s: Analyze; Apply; Evaluate; Create
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-02 Calculate bond values.
Accessibility: Keyboard Navigation
66) Explain the effects of coupon and maturity on volatility.
Answer: The longer the maturity, the greater the price
sensitivity of an asset with respect to interest rate changes. The larger the
coupon payments, or any interim cash flows, the lower the price sensitivity of
an asset with respect to asset changes. In general, any security that returns a
greater proportion of an investment more quickly will be less price-volatile
because this allows the investor to respond to the interest rate change,
minimizing the opportunity cost.
Difficulty: 1 Easy
Topic: Impact of Interest Rate Changes on Security
Valuation
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-05 Understand how the maturity and
coupon rate on a security affect its price sensitivity to interest rate
changes.
Accessibility: Keyboard Navigation
67) Which would have a longer duration: (a) a five-year fully
amortized installment loan with semiannual payments or (b) a five-year
semiannual payment bond, ceteris
paribus. Why?
Answer: The bond will have a longer duration because you
receive interest payments only until maturity, whereas the amortizing loan pays
principal and interest throughout the life of the loan. Hence, the loan pays
more (%) money back sooner. That makes the loan less volatile than the bond.
Difficulty: 1 Easy
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
68) How does an increase in interest rates affect a security’s
duration?
Answer: At higher interest rates the PV of more distant
cash flows is reduced by a greater amount than near-term cash flows due to
compounding. For example, the PV of the 10th cash flow falls more than the
PV of the first cash flow if rates rise. This shifts a greater portion of the
PV weights to the near-term cash flows, which, in turn, results in a shorter
duration. The converse is true for falling interest rates.
Difficulty: 2 Medium
Topic: Duration
Bloom’s: Analyze
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-07 Understand how maturity, yield to
maturity, and coupon rate affect the duration of a security.
Accessibility: Keyboard Navigation
69) An investor is considering purchasing a Treasury bond with a
16-year maturity, a 6 percent coupon and a 7 percent required rate of return.
The bond pays interest semiannually.
1. What
is the bond’s modified duration?
2. If
annual promised yields decrease 30 basis points immediately after the purchase,
what is the predicted price change in dollars based on the bond’s duration?
Answer:
908.
The bond’s price is $908.04 and the bond’s modified duration is
found as
Σ[(t × CFt/(1.035))t]/($904.66 × 2) = 10.19 years duration;
Modified duration = 10.19/1.035 = 9.85 years
1. With
a decrease of 30 basis points in annual promised yields:
Predicted Δ Bond Price = −9.85 × −.0030 = 2.95% or a $ price
change of 0.0295 × $904.66 = $26.72
Difficulty: 3 Hard
Topic: Duration
Bloom’s: Analyze; Apply
AACSB: Analytical Thinking
Learning Goal: 03-06 Know what duration is.; 03-08
Understand the economic meaning of duration.
Accessibility: Keyboard Navigation
70) You have five years until you need to take your money out of
your investments to make a planned expenditure. Right now bonds are promising
an 8 percent return. You buy a five-year duration bond. After you buy the bond,
interest rates fall to 6 percent and stay there for the full five years. You
reinvest the coupons and earn 6 percent. Will your realized return be more or
less than the originally promised 8 percent? Explain.
Answer: You will earn the promised 8 percent return.
Because you chose a bond with a duration equal to the five-year time period,
the loss in reinvestment income from reinvesting the coupons at 6 percent
instead of 8 percent will just be offset by having a higher-than-expected sale
price of the bond in five years.
Difficulty: 3 Hard
Topic: Duration
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
71) A nine-year maturity AAA-rated corporate bond has a 6
percent coupon rate. The bond’s promised yield is currently 5.75 percent and
the bond sells for its FPV. The bond pays interest semiannually and has an
annual duration of 7.1023 years.
1. What
is the bond’s convexity?
2. If
promised yields decrease to 5.45 percent, what is the bond’s predicted new
price, including convexity?
3. Based
on your result in b, would you prefer to have a bond with more or less
convexity? Explain.
Answer:
1. Bond’s
convexity:
|
|
|
|||||||||||||||||||||
|
|
|
|
rate change |
|
0.00005 |
|
|
|
|
|
|
|||||||||||
|
CX = 108 × [(ΔP−/P) + (ΔP+/P)] |
|
New r |
|
2.8800 |
% |
|
|
2.8700 |
% |
|
||||||||||||
|
P(Old) = |
$ |
1,017.37 |
|
|
|
P− |
|
|
|
P+ |
|
|
||||||||||
|
108 = |
|
100,000,000 |
|
|
$ |
1,016.67 |
|
|
$ |
1,018.08 |
|
|
||||||||||
|
ΔP−/P |
( |
0.000690093 |
) |
ΔP |
($ |
0.70208 |
) |
|
$ |
0.70268 |
|
|
||||||||||
|
ΔP+/P |
|
0.000690678 |
|
|
|
|
|
|
|
|
|
|
||||||||||
|
[(ΔP−/P) + (ΔP+/P)] |
|
5.84901E−07 |
|
|
|
|
|
|
|
|
|
|||||||||||
|
CX = |
|
58.49006 |
|
= Convexity |
|
|
|
|
|
|
|
|
||||||||||
5. With
a new promised YTM = 5.45 percent, the YTM change is 30 basis points and the
bond’s new predicted price is found as
ΔP/P = -DurMod × ΔYTM + 1/2 × CX × ΔYTM2 = (−6.90385 ×
−0.0030) + (½ × 58.49006 × 0.0032) = 2.09748%.
The bond’s new price should be $1,017.37 + (2.09748% ×
$1,017.37) = $1,038.714.
1. An
investor would prefer more convexity, with greater convexity or curvature; as
yields drop, the bond’s price will increase more.
Difficulty: 3 Hard
Topic: Appendix 3B: More on Convexity
Bloom’s: Analyze; Apply; Evaluate
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-08 Understand the economic meaning of
duration.
Accessibility: Keyboard Navigation
72) The preferred stock of ACE pays a constant $1.00 per share
dividend. The common stock of ACME just paid a $1.00 dividend per share, but
its dividend is expected to grow at 4 percent per year forever. ABLE common
stock also just paid a dividend of $1.00 per share, but its dividend is
expected to grow at 10 percent per year for five years and then grow at 4
percent per year forever. All three stocks have a 12 percent required return.
How much should you be willing to pay for a share of each stock? Which stock will
give you the best return? Explain.
Answer:
ACE: P = 1/0.12 = $8.33
ACME: P = 1(1.04)/(0.12 − 0.04) = $13.00
ABLE: D0 = $1; D1 through D5 grow at 10% per
year, D6 = D5 × (1 + g2); P5 = D6/(r − g2); g2 = 4%
|
|
g1 |
D1 |
D2 |
D3 |
D4 |
D5 |
D6 |
g2 |
r |
|
ABLE |
10% |
1.1 |
1.21 |
1.331 |
1.4641 |
1.61051 |
1.6749304 |
4.00% |
12% |
|
D0 |
|
|
|
|
P5 = |
20.93663 |
|
|
|
|
1 |
|
1.1 |
1.21 |
1.331 |
1.4641 |
22.54714 |
|
|
|
|
|
|
P0 = |
$16.62 |
|
|
|
|
|
|
If the stocks are priced at their fair values as calculated
above, all three will give the investor the same pretax rate of return of 12
percent. A good stock buy is one where the price is less than the present value
of the expected future cash flows, regardless of the expected growth rate in
the cash flows.
Difficulty: 3 Hard
Topic: Equity Valuation
Bloom’s: Analyze; Apply; Evaluate
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 03-03 Calculate equity values.
Accessibility: Keyboard Navigation
Financial Markets and Institutions, 7e (Saunders)
Chapter 5 Money Markets
1) Everything else equal, an effective annual rate will be
greater than the bond equivalent yield on the same security.
Answer: TRUE
Difficulty: 1 Easy
Topic: Yields on Money Market Securities
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
2) Money markets exist to help reduce the opportunity cost of
holding cash balances.
Answer: TRUE
Difficulty: 1 Easy
Topic: Money Markets
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
3) The majority of money market securities are low-denomination,
low-risk investments designed to appeal to individual investors with excess
cash.
Answer: FALSE
Difficulty: 1 Easy
Topic: Money Markets
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
4) Commercial paper is a short-term obligation of the U.S.
government issued to cover government budget deficits and to refinance maturing
government debt.
Answer: FALSE
Difficulty: 1 Easy
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money market
securities.
Accessibility: Keyboard Navigation
5) Commercial paper, Treasury bills, and banker’s acceptance
rates are all quoted as discount yields.
Answer: TRUE
Difficulty: 2 Medium
Topic: Yields on Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.; 05-02 Identify
the major types of money market securities.
Accessibility: Keyboard Navigation
6) Euro commercial paper is a short-term obligation of the
European Central Bank.
Answer: FALSE
Difficulty: 1 Easy
Topic: Euro money markets
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-05 Examine the extent to which foreign
investors participate in U.S. money markets.
Accessibility: Keyboard Navigation
7) The U.S. Treasury switched from a discriminating price
auction to a single price auction because the latter lowered the average price
paid by investors.
Answer: FALSE
Difficulty: 1 Easy
Topic: Money Market Securities
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-03 Examine the process used to issue
Treasury securities.
Accessibility: Keyboard Navigation
8) In the T-bill secondary market the ask yield will normally be
less than the bid yield.
Answer: TRUE
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
9) The largest secondary money market in the United States is
the secondary market for T-bills.
Answer: TRUE
Difficulty: 1 Easy
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
10) Fed funds are short-term unsecured loans while repos are
short-term secured loans.
Answer: TRUE
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
11) 360/n times
the difference between the face value and the current value divided by the face
value gives you the discount yield on an instrument.
Answer: TRUE
Difficulty: 3 Hard
Topic: Yields on Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
12) The bond equivalent yield times 365/360 is equal to the single
payment yield.
Answer: FALSE
Difficulty: 2 Medium
Topic: Yields on Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
13) LIBOR is the rate that would be charged when banks borrow
from other banks in Eurodollar market.
Answer: TRUE
Difficulty: 1 Easy
Topic: Euro money markets
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-05 Examine the extent to which foreign investors
participate in U.S. money markets.
Accessibility: Keyboard Navigation
14) Maturities on Eurodollar CDs are usually more than one year.
Answer: FALSE
Difficulty: 1 Easy
Topic: Euro money markets
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-05 Examine the extent to which foreign
investors participate in U.S. money markets.
Accessibility: Keyboard Navigation
15) In general, the federal funds rate is slightly lower than
the LIBOR.
Answer: TRUE
Difficulty: 1 Easy
Topic: Euro money markets
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-05 Examine the extent to which foreign
investors participate in U.S. money markets.
Accessibility: Keyboard Navigation
16) For the purposes for which they are used, money market
securities should have which of the following characteristics?
1. Low
trading costs
2. Little
price risk
III. High rate of return
1. Life
greater than one year
1. A) I
and III
2. B) II
and IV
3. C)
III and IV
4. D) I
and II
5. E) I,
II, and III
Answer: D
Difficulty: 1 Easy
Topic: Money Markets
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
17) Money market securities exhibit which of the following?
1. Large
denomination
2. Maturity
greater than one year
III. Low default risk
1. Contractually
determined cash flows
1. A) I,
II, and III
2. B) I,
III, and IV
3. C)
II, III, and IV
4. D) II
and IV
5. E) I,
II, III, and IV
Answer: B
Difficulty: 2 Medium
Topic: Money Markets
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
18) A repo is in essence a collateralized
1. A)
banker’s acceptance.
2. B)
certificate of deposit.
3. C)
Fed funds loan.
4. D) commercial
paper loan.
5. E)
Eurodollar deposit.
Answer: C
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
19) A short-term unsecured promissory note issued by a company
is
1. A)
commercial paper.
2. B) a
T-bill.
3. C) a
repurchase agreement.
4. D) a
negotiable CD.
5. E) a
banker’s acceptance.
Answer: A
Difficulty: 1 Easy
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
20) A time draft payable to a seller of goods with payment
guaranteed by a bank is a
1. A)
commercial paper security.
2. B)
T-bill.
3. C)
repurchase agreement.
4. D)
negotiable CD.
5. E)
banker’s acceptance.
Answer: E
Difficulty: 1 Easy
Topic: Money Market Securities
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
21) In the T-bill auction process, the competitive bidder is
guaranteed a ________ and a noncompetitive bidder is guaranteed a ________.
1. A)
minimum price; maximum price.
2. B)
maximum price; minimum price.
3. C)
maximum price; given quantity.
4. D)
minimum price; maximum quantity.
5. E)
None of these choices are correct.
Answer: C
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-03 Examine the process used to issue
Treasury securities.
Accessibility: Keyboard Navigation
22) A dealer is quoting a $10,000 face 180-day T-bill quoted at
2.75 bid, 2.65 ask. You could buy this bill at ________ or sell it at ________.
869.
A) $9,869.23; $9,864.36.
870.
B) $9,864.36; $9,869.23.
871.
C) $9,867.50; $9,862.50.
872.
D) $9,862.50; $9,867.50.
873.
E) None of these choices are correct.
Answer: C
Explanation: Buy at 10,000 × [1 − (0.0265 × 180/360)];
sell at 10,000 × [1 − (0.0275 × 180/360)].
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
23) Rates on federal funds and repurchase agreements are stated
1. A) on
a bond equivalent basis with a 360-day year.
2. B) on
a bond equivalent basis with a 365-day year.
3. C) as
a discount yield with a 360-day year.
4. D) as
an EAR.
5. E) as
a discount yield with a 365-day year.
Answer: A
Difficulty: 2 Medium
Topic: Yields on Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
24) The discount yield on a T-bill differs from the T-bill’s
bond equivalent yield (BEY) because
1. the
discount yield is the return per dollar of face value and the BEY is a return
per dollar originally invested.
2. a
360-day year is used on the discount yield and the BEY uses 365 days.
III. the discount yield is calculated without compounding, and
the BEY is calculated with compounding.
1. A) I
only
2. B) II
only
3. C) I
and II only
4. D) II
and III only
5. E) I,
II, and III
Answer: C
Difficulty: 3 Hard
Topic: Yields on Money Market Securities
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
25) The following formula is used to calculate the ________ of a
money market investment.
×
1. A)
EAR
2. B)
APR
3. C) single-payment
yield
4. D)
discount yield
5. E)
BEY
Answer: C
Difficulty: 2 Medium
Topic: Yields on Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-01 Define money markets.
Accessibility: Keyboard Navigation
26) The rate of return on a repo is
1. A)
determined by the rate of return on the underlying collateral.
2. B)
strongly affected by the current Fed funds rate at the time of the repo.
3. C)
determined at the time of the repo.
4. D)
determined by the rate of return on the underlying collateral and determined at
the time of the repo.
5. E)
strongly affected by the current Fed funds rate at the time of the repo and
determined at the time of the repo.
Answer: E
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
27) Which one of the following statements about commercial paper
is not true?
Commercial paper issued in the United States
1. A) is
an unsecured short-term promissory note.
2. B)
has a maximum maturity of 270 days.
3. C) is
virtually always rated by at least one ratings agency.
4. D)
has no secondary market.
5. E)
carries an interest rate above the prime rate.
Answer: E
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
28) A negotiable CD
1. A) is
a bank-issued transactions deposit.
2. B) is
a registered instrument.
3. C) is
a bank-issued time deposit.
4. D)
has denominations ranging from $50,000 to $10 million.
5. E)
pays discount interest.
Answer: C
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
29) A 180-day $3 million CD has a 4.25 percent annual rate
quote. If you buy the CD, how much will you collect in 180 days?
1. A)
$3,047,439
2. B)
$3,045.678
3. C)
$3,062,877
4. D)
$3,063,750
5. E)
$3,127,500
Answer: D
Explanation: $3 million × [1 + (0.0425 × 180/360)]
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Analyze; Apply; Evaluate
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
30) A banker’s acceptance is
1. A) a
time draft drawn on the exporter’s bank.
2. B) a
method to help importers evaluate the creditworthiness of exporters.
3. C) a
liability of the importer and the importer’s bank.
4. D) an
add-on instrument.
5. E)
for greater than one year maturity.
Answer: C
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
31) The most liquid of the money market securities are
1. A)
commercial paper.
2. B)
banker’s acceptances.
3. C) T-bills.
4. D)
Fed funds.
5. E)
repurchase agreements.
Answer: C
Difficulty: 1 Easy
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
32) In dollars outstanding in 2016, the largest money market
security was
1. A)
commercial paper.
2. B)
banker’s acceptances.
3. C)
T-bills.
4. D)
Fed funds and repos.
Answer: D
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Remember
AACSB: Reflective Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
33) You buy a $10,000 par Treasury bill at $9,575 and sell it 60
days later for $9,675. What was your EAR?
4. A)
4.44 percent
5. B)
6.29 percent
6. C)
6.35 percent
7. D)
6.52 percent
8. E)
6.67 percent
Answer: D
Explanation: (9,675/9,575)(365/60) − 1 = .06524 =
6.52%
Difficulty: 2 Medium
Topic: Money Market Securities
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
34) LIBOR is generally ________ the Fed funds rate because
foreign bank deposits are generally ________ than domestic bank deposits.
1. A)
greater than; less risky
2. B)
less than; more risky
3. C)
the same as; equally risk
4. D)
greater than; more risky
5. E)
less than; less risky
Answer: D
Difficulty: 2 Medium
Topic: International Aspects of Money Markets
Bloom’s: Understand
AACSB: Reflective Thinking
Learning Goal: 05-05 Examine the extent to which foreign
investors participate in U.S. money markets.
Accessibility: Keyboard Navigation
35) A U.S. exporter sells $150,000 of furniture to a Latin
American importer. The exporter requires the importer to obtain a letter of
credit. When the bank accepts the draft, the exporter discounts the 120-day
note at a 5.25 percent discount. What is the exporter’s true effective annual
financing cost?
5. A)
5.52 percent
6. B)
5.42 percent
7. C)
5.34 percent
8. D)
5.29 percent
9. E)
5.25 percent
Answer: A
Explanation: 150,000 × [1 − (0.0525 × 120/360)] = 147,375;
(150,000/147,375)365/120 − 1 = 5.52%
Difficulty: 3 Hard
Topic: Money Market Securities
Bloom’s: Analyze; Apply
AACSB: Reflective Thinking; Analytical Thinking
Learning Goal: 05-02 Identify the major types of money
market securities.
Accessibility: Keyboard Navigation
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