Chapter Eight
Valuation of Known Cash Flows: Bonds
This chapter con tai ns 50 multiple choice questi on s, 18 short problems and 9 Ion ger problems. Multiple Choice 1. A ________ is a quantitative method used to infer an asset's value from market information about the
prices of other assets and market in terest rates.
(a) (b) (c) (d)
fixed model
perpetual valuation model valuation model variable model
An swer: (c)
2. ______ are examples of fixed-income securities. (a) (b) (c) (d)
Common stock and pension funds Mortgages and pension annuities Mutual funds and com mon stock Preferred stock and com mon stock
An swer: (b)
3. Consider a fixed-income security that promises to pay $150 each year for the next five years. How
much is this five-year annuity worth if the appropriate discount rate is 7% per year?
(a) (b) (c) (d)
$534.74 $615.03 $802.50 $867.96
An swer: (b)
4. Consider a fixed-income security that promises to pay $120 each year for the next four years. Calculate
the value of this four-year annuity if the appropriate discount rate is 6% per year.
(a) $415.81 (b) $508.80 (c) $531.85
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(d) $629.06 Answer: (a)
5. The price of any existing fixed-income security ______ when market interest rates rise because
investors will only be willing to _______ them if they offer a competitive yield.
(a) (b) (c) (d)
rises; buy rises; sell falls; buy falls; sell
Answer: (c)
6. A fall in interest rates causes a _______ in the market value of a fixed-income security.
(a) (b) (c) (d)
a rise a fall
no change
it cannot be determined from the information given
Answer: (a)
7. A change in market interest rates causes ________ in the market values of all existing contracts
promising fixed payments in the future.
(a) (b) (c) (d)
a change in the same direction a change in the opposite direction no change
an unpredictable variation
Answer: (b)
8. What happens to the value of a four-year fixed-income security promising $100 per year if the market
interest rate rises from 5% to 6% per year?
(a) (b) (c) (d)
A rise of 1% causes a drop of $4.87 in market value. A rise of 1% causes a rise of $4.87 in market value. A rise of 1% causes a drop of $8.09 in market value. A rise of 1% causes a rise of $8.09 in market value.
Answer: (c)
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9. What happens to the value of a four-year fixed-income security promising $100 per year if the market
interest rate falls from 6% to 5% per year?
(a) (b) (c) (d)
A fall of 1% causes a drop of $4.87 in market value. A fall of 1% causes a rise of $4.87 in market value. A fall of 1% causes a drop of $8.09 in market value. A fall of 1% causes a rise of $8.09 in market value.
Answer: (d)
10. A zero-coupon bond is also known as _______
(a) (b) (c) (d)
a perpetual bond a pure discount bond a market rebate an infinite bond
Answer: (b)
11. The promised cash payment on a pure discount bond is called its _______
(a)
(b) (c) (d)
face value par value fixed interest both a and b
Answer: (d)
12. What is the yield of a 1-year pure discount bond with a price of $850 and a face value of $1,000?
(a) (b) (c) (d)
8.50% 9.09% 15.00% 17.65%
Answer: (d)
13. What is the yield of a 1-year pure discount bond with a price of $900 and a face value of $1,000?
(a) (b) (c) (d)
5.26% 10.00% 11.11% 15.79%
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Answer: (c)
14. Consider a four-year pure discount bond with a face value of $1,000. If its current price is $850,
compute its annualized yield.
(a) (b) (c) (d)
1.17% 4.15% 5.57% 17.60%
Answer: (b)
15. Consider a three-year pure discount bond with a face value of $1,000. If its current price is $900,
compute its annualized yield.
(a) (b) (c) (d)
1.036% 1.111% 3.57% 5.41%
Answer: (c)
16. Consider a five-year pure discount bond with a face value of $1,000. If its current price is $780, what is
its annualized yield?
(a) (b) (c) (d)
5.09% 2.82% 1.28% 1.05%
Answer: (a)
17. A _______ obligates the issuer to make periodic payments of interest to the bondholder for the life
of the bond and then to pay the face value of the bond when the bond matures.
(a) (b) (c) (d)
pure discount zero-coupon perpetual bond coupon bond
Answer: (d)
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18. The _______ of the bond is interest rate applied to the _______ of the bond to compute the
periodic payment.
(a) (b) (c) (d)
coupon rate; face value maturity rate; face value coupon rate; price maturity rate; price
Answer: (a)
19. For a bond with a face value of $1,000 and coupon rate of 11%, what is the annual coupon payment?
(a) (b) (c) (d)
$100 $110 $1,000 $1,100
20. For a bond with a face value of $1,000 and a coupon rate of 9%, what is the annual coupon payment?
(a) (b) (c) (d)
$90 $99 $1,000 $1,190
Answer: (a)
21. If the market price of a coupon bond equals its face value, it is also termed a _______
(a)
(b) (c) (d)
par bond
premium bond discount bond
zero-discount bond
Answer: (a)
22. If the bond ' s market price is higher than its face value, it is terme_d__a ___ .
(a) (b) (c) (d)
par bond
premium bond discount bond
zero-discount bond
Answer: (b) Answer: (b)
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