1. There is an inverse relationship between bonds\' quality ratings and their re

Question

1. There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns decrease as the bond ratings get higher.

A. True

B. False

2. Which of the following statements about sinking fund is NOT true ?

A. Sinking fund provision facilities the orderly retirement of the bond issue.

B. A company would prefer to use sinking fund to call bond if interest rate is higher than the coupon rate?

C. A company would use sinking fund to call bond if interest rate is well below coupon rate.

D. It is a good strategy for a firm to use its sinking fund to call bond if bond sells at a big premium.

3. The prices of high-coupon bonds tend to be more sensitive to a given change in interest rates than low-coupon bonds, other things held constant.

A. True

B. False

4. What is TRUE regarding long-term and short-term bonds ( Assume they have the same par value and coupon rate)?

A. Long-term bonds have lower interest rate risk

B. Short-term bonds have higher reinvestment risk.

C. Long-term bonds have higher reinvestment risk.

D. Short-term bonds have higher interest rate risk.

5. A 10-year corporate bond has an annual coupon payment of 5%. The bond is currently selling at par ($1,000). Which of the following statement is NOT correct?

A. The bond's yield to maturity is 5%

B. The bond's current yield is 5%

C. If the bond's yield to maturity remains constant, the bond's price will remain at par.

D. The bond's capital gain yield is 5%

6. A stock has a beta of 1.40, the risk-free rate is 4.25%, and the expected market risk premium is 6.75%. What is the required rate of return for the stock? (Please show your work)

A. 4.25%

B. 5.50%

C. 11.95%

D. 13.70%

7. Analyze the 20-year, 8% coupon rate (Semi-annual payment), $1,000 par value bond. The bond currently sells for $1,218. What's the bond's current yield, and capital gain yield? (Please show your work)

A. 6.57%, -0.47%

B. 6.07%, -0.69%

C. 6.57%, -0.47%

D. 6.07%, 0.69% 8.

A stock has a 40% chance of producing a 30% return, a 30% chance of producing a 10% return, and a 30% chance of producing a -20% return. What is Harper's expected return?

A. 9.0%

B. 15.0%

C. 6.0%

D. 18.0%

9. Analyze the 20-year, 8% coupon rate (Semi-annual payment), $1,000 par value bond. The bond currently sells for $1,218. What's the bond's yield to maturity?

A. 5.06%

B. 5.68%

C. 5.38%

D. 6.10%

10. A investor has $500,000 invested in a 2-stock portfolio. $250,000 is invested in Stock A and the remainder is invested in Stock B. The beta of Stock A is 2.0 and the beta of stock B is 0.8. What is the portfolio's beta?

A. 1.28

B. 1.22

C. 1.38

D. 1.40

Thank you!!

Explanation / Answer

4) B. short term bonds have higher reinvestment risk

There is a greater probability that interest rates will rise (and thus negatively affect a bond's market price) within a longer time period than within a shorter period. As a result, investors who buy long-term bonds but then attempt to sell them before maturity may be faced with a deeply discounted market price when they want to sell their bonds. With short-term bonds, this risk is not as significant because interest rates are less likely to substantially change in the short term. Short-term bonds are also easier to hold until maturity, thereby alleviating an investor's concern about the effect of interest rate driven changes in the price of bonds. Long-term bonds have greater duration than short-term bonds. Because of this, a given interest rate change will have greater effect on long-term bonds than on short-term bonds. This concept of duration can be difficult to conceptualize, but just think of it as the length of time that your bond will be affected by an interest rate change. For example, suppose interest rates rise today by 0.25%. A bond with only one coupon payment left until maturity will be underpaying the investor by 0.25% for only one coupon payment. On the other hand, a bond with 20 coupon payments left will be underpaying the investor for a much longer period. This difference in remaining payments will cause a greater drop in a long-term bond's price than it will in a short-term bond's price when interest rates rise.

6) D. 13.70%

E(Ri) = Rrf + Beta[E(Rm) – Rnf]

          = 4.25% + 1.40(6.75%)

           = 4.25% + 9.45%

            = 13.70%

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