Objective type questions on bond valuation.

1. Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.25%, and a maturity premium of 0.10% per year to maturity applies, i.e., MRP = 0.10 % (t), where it is the years to maturity. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

A. 5.95%

B. 6.05%

C. 6.15%

D. 6.25%

E. 6.35%

2. If 10-year T-bonds have a yield of 5.2%, 10-year corporate bonds yield 7.5%, the maturity risk premium on all 10-year bonds is 1.1%, and corporate bonds have a 0.2% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?

A. 2.00%

B. 2.10%

C. 2.20%

D. 2.30%

E. 2.40%

3. Suppose the rate of return on a 10-year T-bond is currently 5.00% and that on a 10-year Treasury Inflation Protected Security (TIP) is 2.10%. Suppose further that the MRP on a 10-year T-bond is 0.9%, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

A. 1.80%

B. 1.90%

C. 2.00%

D. 2.10%

E. 2.20%

4. Suppose the rate of return on a 10-year T-bond is 5.00% and that on a 10-year Treasury Inflation Protected Security (TIP) is 2.10%. Suppose further that the expected average rate of inflation over the next 10 years is 2.0%, that the MRP on a 10-year T-bond is 0.9%, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, what is the real risk free rate of return, r*? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

A. 1.70%

B. 1.80%

C. 1.90%

D. 2.00%

E. 2.10%

5. The real risk-free rate is 3%, inflation is expected to be 2% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond?

A. 4.90%

B. 5.00%

C. 5.10%

D. 5.20%

E. 5.30%

6. Walker Corporation is planning to issue new 20-year bonds. Initially, the plan was to make the bond non-callable. If the bond were made callable after 5 years with a 5% call premium, how would this affect the bond's required rate of return?

A. It is impossible to say without more information.

B. Because of the call premium, the required rate of return would decline.

C. There is no reason to expect a change in the required rate of return.

D. The required rate of return would decline because the bond would then be less risky to a bondholder.

E. The required rate of return would increase because the bond would then be more risky to a bondholder.

7. Which of the following bonds will have the greatest percentage increase in value if all interest rates decrease by 1%?

A. 20-year, zero coupon bond.

B. 10-year, zero coupon bond.

C. 20-year, 10% coupon bond.

D. 20-year, 5% coupon bond.

E. 1-year, 10% coupon bond.

8. Which of the following would be most likely to increase the coupon rate that is required to enable a bond to be issued at par?

A. Adding a call provision.

B. Adding additional restrictive covenants that limit management's actions.

C. Adding a sinking fund.

D. The rating agencies change the bond's rating from Baa to Aaa.

E. Making the bond a first mortgage bond rather than a debenture

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