Question 1. When pricing bonds, if a bond's coupon rate is less than the required rate of return, then

a. the bond sells at a discount if it has a long maturity, a premium if it has a short maturity

b. the bond sells at par because the required rate of return is adjusted to reflect the discrepancy

c. the bond sells at a premium if it has a long maturity, a discount if it has a short maturity

d. the holder of the bond (the investor) is assured of a profit when the bond is sold regardless of when it was purchased

e. a portion of the income a buyer of this bond will receive comes from buying the bond at less than the par value

Question 2. Which of the following does not correctly complete this sentence: In general, bond yields increase as investors demand compensation for ________

a. default risk

b. interest rate risk

c. increased liquidity

d. increases in the real rate of interest

e. increases in expected future inflation

Question 3. A bond with an annual coupon rate of $100 originally sold at par for $1,000.  The current market interest rate on this bond is 9%.  Assuming no change in risk, this bond would sell at a _______ in order to compensate _______.

a. premium; the purchaser for the above market coupon rate

b. discount; the purchaser for the above market coupon rate

c. premium; the seller for the above market coupon rate

d. discount; the seller for the above market coupon rate

e. discount; the issuer for the higher cost of borrowing

Question 4. A bond sold five weeks ago for $1,100.  The bond is worth $1,050 in today's market.  Assuming no changes in risk, which of the following is true?

a. Interest rates must be lower now than they were five weeks ago

b. The coupon payment of the bond must have increased

c. The  face value of the bond must be $1,100.

d. The bond's current yield has increased from five weeks ago

d. The bond must be within one year of maturity

Question 5. Which of the following is a true statement?

I. All else equal, the value of a perpetual bond will remain unchanged from one year to the next unless market interest rates change

II. All else equal, bond prices and coupon prices are inversely related

III. All else equal, given two bonds identical but for coupon, the market price of the lower coupon bond will change more (in percentage terms) than that of the higher coupon bond for a given change in market interest rates

a.      I and II only

b.      I, II, and III

c.       I and III only

d.      II and III only

e.       I only

Question 6. Which of the following is a basic component that affects the slope of the term structure of interest rates?

a.      Liquidity premium

b.      Taxability premium

c.       Real rate of interest

d.      Default risk premium

e.       Inflation premium

Question 7. What is the market value of a bond that will pay a total of 40 semiannual coupons of $50 each over the remainder of its life?  Assume the bond has a $1,000 face value and an 8% yield to maturity.

a.      $1,215.62

b.      $1,135.90

c.       $634.86

d.      $1,197.93

e.       $642.26

Question 8. The market price of a bond is $1,236.94, it has 14 years to maturity, a $1,000 face value, and pays an annual coupon of $100.  What is its yield to maturity?

a.      3.18%

b.      7.25%

c.       6.11%

d.      4.26%

e.       5.37%

Question 9. As a corporate treasurer, you manage a $100 million bond portfolio.  Economists suggest (and you agree) that market interest rates are headed up over the next several months.  To reduce interest rate risk, you should attempt to

I. Reduce the average maturity of the portfolio by selling long-term bonds and buying short-term bonds

II. Lengthen the average maturity of the portfolio by buying long-term bonds and selling short-term bonds

III. Reduce the average coupon rate by selling high coupon bonds and buying low coupon bonds

IV. Increase the average coupon rate by buying high coupon bonds and selling low coupon bonds

a.      I, II, III, and IV

b.      I only

c.       II and III only

d.      I and IV only

e.       I and II only

Question 10. ABC company's preferred stock is selling for $25 per share.  It is expected that the company will pay its constant preferred dividend in perpetuity.  If the required rate of return is 12%, what will be the dividend two years from now?

a.      $2.50

b.      $2.39

c.       $3.30

d.      $3.76

e.       $3.00

Essay Questions

Question 1.

Does the value of a share of stock depend on dividends?  If yes, why?  If not, why not?

Question 2.

Suppose a company has a preferred stock issue and a common stock issue.  Both have just paid a $2 dividend.  Which do you think will have the higher price (and why), a share of the preferred stock or a share of the common stock?

Question 3.

a). What difference, if any, exists between a futures contract and an options contract?

b). Comment on the following: "A buyer of a futures contract realizes a profit if the futures price decreases.  The seller of a futures contract realizes a loss if the futures price increases."