Homework 7 - Chapter 3

Question 1

If you deposit $500 in a savings account at an annual interest rate of 5%, how much will you have in the account at the end of five years? 
A) $625
B) $392
C) $638
D) $550

Answer 1

C) $638

Question 2

Which of the following will lead to a higher interest rate on a loan?
A) lower inflation
B) lower opportunity cost
C) increased perceived risk of default
D) reduced likelihood of borrower not paying the loan

Answer 2

C) increased perceived risk of default

Question 3

$1 received n years from now has a value today of: 
A) ($1 + i)/i
B) $1/(1 + i)
C) [($1+i)^n] /i 
D) $1/(1 + i)^n

Answer 3

D) $1/(1 + i)^n

Question 4

Suppose Matt's New Cars issues a bond in which they'll need to pay $10,000 in one year, which includes 4% interest. How much will they receive for the bond?
A) $9,600
B) $9,615
C) $10,000 
D) $10,400

Answer 4

B) $9,615

Question 5

The price of a financial asset equals the:
A) future value of all payments
B) sum of all payments
C) present value of all future payments
D) difference between the future value and present value of all payments

Answer 5

C) present value of all future payments

Question 6

Simple loans and discount bonds differ from coupon bonds and fixed-payment loans in that:
A) interest on simple loans and discount bonds is taxable, while interest on coupon bonds and fixed-payment loans is not.
B) interest on coupon bonds and fixed-payment loans is taxable, while interest on simple loans and discount bonds is not.
C) interest rates on simple loans and discount bonds are generally higher than interest rates on comparable coupon bonds and fixed-payment loans.
D) interest on simple loans and discount bonds is paid in a single payment, while issuers of
coupon bonds and fixed-payment loans make multiple payments of interest and principal.

Answer 6

D) interest on simple loans and discount bonds is paid in a single payment, while issuers of
coupon bonds and fixed-payment loans make multiple payments of interest and principal.

Question 7

The amount of funds the borrower receives from the lender with a simple loan is called the:
A) principal.
B) equity.
C) claim.
D) collateral.

Answer 7

A) principal.

Question 8

The coupon rate is the
A) annual coupon payment divided by the face value of the bond.
B) annual coupon payment divided by the market value of the bond.
C) difference between the face value of the bond and its par value.
D) coupon paid every 6 months divided by par value.

Answer 8

A) annual coupon payment divided by the face value of the bond.

Question 9

A coupon bond involves:
A) interest payments from the borrower to the lender periodically during the life of the loan and
payment by the borrower to the lender of the face value of the loan at maturity.
B) interest and principal payments from the borrower to the lender periodically during the life of the loan.
C) periodic payments by the borrower to the lender that include both principal and interest.
D) periodic payments by the borrower to the lender that include principal, but not interest.

Answer 9

A) interest payments from the borrower to the lender periodically during the life of the loan and
payment by the borrower to the lender of the face value of the loan at maturity.

Question 10

When the price of a coupon bond increases: 
A) the coupon rate declines
B) the coupon rate increases
C) the current yield declines
D) the current yield increases

Answer 10

C) the current yield declines

Question 11

The current yield is equal to:
A) the coupon divided by the market price of the bond.
B) the yield to maturity, if the bond is a coupon bond.
C) the coupon divided by the par value of the bond.
D) the market price of the bond divided by its par value.

Answer 11

A) the coupon divided by the market price of the bond.

Question 12

The yield to maturity on a new one-year discount bond equals:
A) (F V- P)/P. 
B) (D - FV)/P. 
C) (FV - P)/FV. 
D) (P - FV)/FV.

Answer 12

A) (F V- P)/P.

Question 13

If the current price of a bond is greater than its face value:
A) an investor will receive a capital gain by holding the bond until maturity.
B) the yield to maturity must be less than the coupon rate.
C) the coupon rate must be less than the current yield.
D) the coupon rate must be equal to the current yield.

Answer 13

B) the yield to maturity must be less than the coupon rate.

Question 14

The rate of return is equal to the:
A) sum of the coupon rate and the current yield.
B) yield to maturity.
C) sum of the current yield and the actual rate of capital gain or loss.
D) sum of the current yield and the expected rate of capital gain.

Answer 14

C) sum of the current yield and the actual rate of capital gain or loss.

Question 15

Interest-rate risk can best be characterized as the risk that
A) you could have earned a higher interest rate if you waited to purchase a bond.
B) fluctuations in the price of a financial asset in response to changes in market interest rates.
C) you could have gotten a lower interest rate if you waited to lock in a mortgage.
D) short-term interest rates may exceed long-term interest rates.

Answer 15

B) fluctuations in the price of a financial asset in response to changes in market interest rates.

Question 16

How can a bond have a negative rate of return?
A) if the current yield is greater than the coupon rate
B) if the current yield is less than the coupon rate
C) if the rate of capital loss exceeds the current yield
D) if the rate of capital gains is less than the current yield

Answer 16

C) if the rate of capital loss exceeds the current yield

Question 17

A sustained decrease in the price level is known as 
A) inflation.
B) disinflation.
C) reflation.
D) deflation.

Answer 17

D) deflation.

Question 18

Which of the following is the correct expression for the approximate expected real interest rate?
A) r = i + p^e
B) r = i - p^e
C) r = i / p^e
D) r = i * p^e

Answer 18

B) r = i - p^e

Question 19

Suppose you had $1000 and were deciding between two investments. One pays 5% a year for two years while the other pays 8% the first year and 2% the second year. Which investment would provide a higher return?(6”)

Answer 19

The first investment which earned 5% a year for two years would result in
$1,102.50 after two years. The second investment would result in $1,101.60. Thus,
the first investment provides the higher return.


Question 20

Suppose a bond has a coupon of $40, face value of $1000, and current price of $950. What is the coupon rate? What is its current yield? Report a percentage with two decimal places. (8”)

Answer 20

The coupon rate is $40/$1000 = 4.00%. The current yield is $40/$950 =4.21%.

Question 21

A corporation issues a three-year bond with a coupon of $50 and a face value of $1000. A year later, market interest rates have declined to 4%. What is the price of the bond a year after it was issued? Report your answer to the nearest dollar. (4”)

Answer 21

Since the price of the bond equals its present value, the price is $50/1.04 + $50/(1.04)2+$1050/(1.04)=$1029


Question 22

If the real interest rate is 2% and expected inflation is 2%, the nominal interest rate is?

Answer 22

i = r + π^e

2% + 2% = 4%

Question 23

Suppose you purchase a bond with a coupon of $30 for $1025. You sell it one year later for $1050. What rate of return did you earn? Report a percentage with two decimal places.

Answer 23

The rate of return is $30/$1025 + ($1050 - $1025)/$1025 = 5.37%.

Question 24

Explain are people hurt or benefit by inflation than expected?

Answer 24

A) holders of TIPS —-slightly hurt
B) lenders of fixed-rate mortgages —-hurt
C) borrowers with fixed-rate mortgages —–benefit