1. Under which conditions will an investor demand a larger return (yield) on a b
ID: 2626348 • Letter: 1
Question
1. Under which conditions will an investor demand a larger return (yield) on a bond?
A. The bond issue is upgraded from A to AA.
B. The bond issue is downgraded from A to BBB.
C. None of these conditions will cause an increase in the bond's yield.
D. Interest rates decrease due to a decline in inflation.
2. The main two sources of the time value of money are:
A. Interest Rates and Risk
B. Inflation and Interest Rates
C. Risk and timing of Consumption
D. Inflation and timing of Consumption.
Can someone please also let me know why the answer is correct? I have been straining my brain to figure these two out. Thanks!
Explanation / Answer
1) Investors demand large rate of return when the interest rates decrease due to a decrease in inflation. The interest rate is nothing but the coupon rate. When the inflation rate decreases, the general price level of goods will fall which brings to the state of deflation. Due to this, the coupon rate will decrease. At this point of time, investors will demand a higher return on the bond or notes for lower coupon or interest payments the receive till the maturity.
The correct option is (D)
2) The main two sources of time value of money are interest rate and risk.
Interest rate can be the discount rate while calculating the present value or the compounding rate while calculating the future value. The risk is nothing but the uncertainty.
For time value of money calculations, the two main components involved are Risk and the interest rate.
Hence, the correct option is (A).
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