1. Which of the following statements is true? Explain why.

1. Ignoring interest accrued between payment dates, if the required rate of return on a bond is less than its coupon interest rate, and the cost of debt remains below the coupon rate until maturity, then the market value of that bond will be below its par value until the bond matures, at which time its market value will equal its par value.

2. Assuming equal coupon rates, a 20 year original maturity bond with one year left to maturity has more interest rate risk than a 10 year original maturity bond with one year left to maturity.

3. Regardless of the size of the coupon payment, the price of a bond moves in the same direction as interest rates; bond prices also rise.

4. For bonds, price sensitivity to a given change in interest rates generally increases as years remaining to maturity increases.

2. Which of the following is true? explain why.

1. Bonds C and Z both have a $1,000 par value and 10 years to maturity. They have the same default risk, and they both have a yield of 8%. If Bond C has a 15% annual coupon and Bond Z a zero coupon, then Bond Z will be exposed to more interest rate risk, which is defined as the percentage loss of value in response to a given increase in the going interest rate.

2. The interest rate paid by the state of Florida on its debt would be lower, other things held constant, if interest on the debt were not exempt from federal income taxes.

3. Given the conditions in the first statement, we can be sure that the price of Bond Z would be greater than that of Bond C.