1. The interest rate on a bond is A. the difference between the face value and t

Question

1. The interest rate on a bond is
A. the difference between the face value and the yield, expressed as a percentage of the bond price.
B. the ratio of the face value and the bond price, expressed as a percentage.
C. the difference between the face value and the bond price, expressed as a percentage of the bond price.

2. Suppose you sell a $1,000 bond that matures in 1 year for $950. Calculate the interest rate you will have to pay on this bond.
A. 5.3%
B. 95%
C. 0.95%

3. Suppose you buy a bond with a face value of $1,000 for $800. What is the interest rate you receive on the bond?
A. 25%
B. 1.25%
C. 0.8%

4. The interest rate on a bond is
A. Directly related to its price
B. Inversely related to its price
C. Determined by its face value

Explanation / Answer

1. C. the difference between the face value and the bond price, expressed as a percentage of the bond price.

That is, Interest rate = (Face Value - bond price)*100/Bond price

2. A. 5.3%
The interest is calculated on the bond price.
Interest = face value - bond price =1000 - 950 = 50

Interest rate = interest*100/bond price = 50*100/950 = 5.3%

3. A. 25%

Interest = face value - bond price = 1000 - 800 = $200
interest rate = interest*100/bond price = 200*100/800 = 25%

4. B. Inversely related to its price

Basically, as interest rate increase, the price of a bond falls since the future cash flows are discounted by the interest rate. The latter would imply an inverse relationship between the two.

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