Interest Rate Structure

For items 1-4, indicate for each pair of bonds which bond, everything else the same, should promise the HIGHER yield.

1. a. puttable bond b. straight (no put feature) bond

2. For this item only, assume an inverted yield curve. a. 10 year maturity bond b. 2 year maturity bond

3. a. bond rated BB b. bond rated BBB

4. a. bond is traded in an active secondary market b. bond is not traded in a secondary market

5. Longer maturity bonds have more price risk as a result of interest rate changes. Therefore investors will demand a premium for holding longer-term bonds. This is a statement consistent with the ______ theory of term structure. a. liquidity preference b. pure expectations c. market segmentation

6. You observe that the 1-year interest rate now is 3.2%. You forecast the 1-year rates one and two years from now to be 3.6% and 4.1%. According to pure expectations theory, what should be the 3-year interest rate now? a. 4.60% b. 4.10% c. 3.71% d. 3.63%

7. You own two US Treasury bonds. In addition, you own one bond each with ratings B, BB, A, AAA, and CCC. How many investment-grade bonds do you own total? a. 2 b. 3 c. 4 d. 5

8. Bond investors tend to have fixed investment objectives that are best met by bonds with particular maturities. The interest rates at different maturities are therefore independently determined. This statement best describes the _______ theory of term structure. a. liquidity preference b. pure expectations c. market segmentation

9. The City of Bucksville Airport Authority bond has 10 years to maturity and yields 4.3%. If the investors tax rate is 28%, what is the taxable-equivalent yield on this bond? a. 15.36% b. 3.10% c. 5.50% d. 5.97%

10. Last year the risk premium between the average B-rated bond and the average A-rated bond was 350 basis points. This year, the average risk premium is 450 basis points. This is an example of ________ behavior by investors. a. flight to quality b. preferred habitat c. irrational d. risk seeking

11. Jane is an income-seeking investor with low risk tolerance. She is in a low marginal income tax bracket. Which of the following investments would be LEAST appropriate for Jane? a. Treasury bond b. Municipal bond c. AAA corporate bond d. Mortgage-backed bond

12. Today, the observed yields on 1-year and 3-year Treasury securities are 2.3% and 3.3%, respectively. According to expectations theory, what is the implied forecast of the 2-year rate, one year forward? a. 2.15% b. 3.80% c. 4.60% d. 2.56%

13. Given the following schedule of interest rates, what is the shape of the yield curve?

Maturity 1year 2year 3year 5year 10year 20year YTM 2.1% 2.31% 2.40% 3.1% 3.8% 4.4%

a. inverted b. humped c. normal

14. According to conventional economic wisdom, an inverted yield curve generally signals: a. rising interest rates c. lower than average default risk b. a very large liquidity premium d. a future slowdown in economic activity

15. Susan has high need for liquidity, but she will take a small amount of risk in order to get a higher return. Which of the following investments would be best for Susan? a. T-bill b. Commercial paper c. High-yield bonds d. Common stock

Bond Markets

16. A $1,000 face value, 90-day Treasury bill sells for $996.25. What is this bills Treasury discount yield? a. 1.50% b. 1.53% c. 1.47% d. 1.57%

17. What is the bond-equivalent yield for the T-bill in #16? a. 1.50% b. 1.53% c. 1.47% d. 1.57%

Use the following treasury auction information to answer items 18-20. The treasury is auctioning $150,000 of 90 day T-bills. Assume no limits on how much a single buyer may buy. Bidder Bid discount yield $ Amount bid for ABC 4.1% $75,000 XYZ 4.3% $25,000 LMO 4.2% $45,000 TSR 4.0% $35,000 QQQ 3.9% $55,000 Non-competitive bids $20,000

18. All of the following potential buyers will have their orders completely filled EXCEPT: a. Non-competitive b. QQQ c. TSR d. XYZ

19. What is the stop out rate for this auction? a. 3.9% b. 4.0% c. 4.1% d. 3.99%

20. What discount yield will the non-competitive buyers receive on their T-bills? a. 3.9% b. 4.0% c. 4.1% d. 3.99%

21. Which of the following entities is the largest single owner of US Treasury securities? a. US Government c. Bank of America b. Peoples Bank of China d. Warren Buffett

22. Which of the following money market securities has the longest potential initial maturity? a. Fed funds b. Negotiable CD c. Repurchase agreement d. Commercial paper

23. Which of the following money market instruments has interest that is added onto (NOT discounted from) the face value? a. T-bill b. Agency c. Commercial paper d. Negotiable CD

24. Of the following, which is the LEAST likely reason a business might issue a money market security? a. Finance the building of a new plant c. Meet short-term needs for liquidity b. Finance an inventory purchase d. Cover mis-matched cash inflows and outflows

25. A Treasury bond is quoted at 98:31. If you were to buy this bond ($1,000 par), how many dollars would you pay? (Ignore accrued interest.) a. $983.10 b. $989.69 c. $990.14 d. $993.36

26. A 10-year, 6% coupon Treasury bond is quoted in the market at 101:08-101:16. Which of the following statements is the most correct? a. This bond is selling at a discount. c. This bond has a YTM > 6%. b. This bonds ask yield is less than its bid yield. d. This bond has high default risk.

27. Each XYZ, Inc. bond is convertible into 50 shares of XYZ common stock. The price of the bond is $985.00. XYZ stock is worth $12 per share? What is the bonds conversion value? a. $82.08 b. $246.25 c. $600 d. $753.75

28. What is the after-tax rate of return on a corporate bond that yields 7.21% if the investor is in a 36% tax bracket? a. 2.60% b. 4.61% c. 9.81% d. 7.21%

29. A bond that adjusts its par value and coupon payment periodically to reflect inflation is a: a. CMO b. STRIP c. IDB d. TIP

30. Which of the following bonds requires a popular vote approving the issue? a. Revenue bonds b. T-bills c. Agencies d. General Obligation

31. A bond issue that has a range of staggered maturity dates for bonds in the issue, rather than only one maturity date, called a ________ issue. a. serial b. subordinated c. sinking-fund d. speculative

32. The contract between the bond issuer and the bond buyers that represents the lending agreement is called the:

a. debenture b. sinking fund c. indenture d. call provision

33. Prodigy, Inc. is a new firm with a credit rating of B. Prodigy issues bonds, but has the issue guaranteed by Moby, Inc., a AAA-rated insurance company. What will this bond issue be rated? a. AAA b. A c. BBB d. B

34. Krauss, Inc. is a US firm that has issued a bond in Germany. The bond and all coupon payments are in US dollars. This is an example of a: a. Yankee bond b. Eurobond c. Foreign bond d. Samurai bond

Mortgage Markets

Use the following data to answer items 35-40. Ricky and Lucy buy a house. The appraised value of the house = $165,000. The purchase price = $163,000. They borrow $150,000 at 4% for 30 years.

35. Under typical lending practices, will Lucy and Ricky be required to purchase mortgage insurance? a. Yes b. No

36. What is the total amount of Ricky and Lucys initial equity in the house? a. $2,000 b. $13,000 c. $15,000 d. $150,000

37. What is the amount of Ricky and Lucys MONTHLY loan payment? a. $722.88 b. $681.97 c. $693.82 d. $716.12

38. In the first monthly payment, how much of the payment is re-payment of principal? a. $500 b. $216.12 c. $222.88 d. $181.97

39. If Ricky and Lucy are required to pay a 1 point origination fee for this loan, What will be the effect on their actual cost of borrowing (APR)? a. APR will increase b. APR will not change c. APR will decrease

40. If Ricky and Lucy repay this loan as scheduled, how much total dollar interest will they pay over the life of the loan? a. $160,237 b. $95,509 c. $107,803 d. $98,637

41. Which of the following is the best reason for a home-buyer to use an adjustable rate mortgage loan? a. Buyer expects interest rates to increase. b. Spread between fixed and ARM interest rates is unusually small. c. Buyer has an easy time qualifying for a loan. d. Buyer does not expect to live in the house for more than 7 years.

42. Which of the following financial products is sometimes used by retirees to provide a monthly supplemental payment to their retirement income? a. Adjustable rate mortgage c. Graduated payment mortgage b. Reverse annuity mortgage d. Interest-only mortgage

43. Which of the following is NOT a major issuer of mortgage-backed securities? a. GNMA b. FNMA c. FDIC d. FHL