International Finance- Interest Rates And Bond Valuation
Material comes from the Interest Rates and Bond Valuation slides from Lessons 9-1'0,
Questions and Answers
- 1.
When a corporation or governemnt wishes to borrow money from the public on a long-term basis, it usually does so by ....
- A.
Makes out an I.O.U.
- B.
Printing more of their own money.
- C.
Increasing the interest rate to collect more money on debts owed to them.
- D.
Issuing or selling debt securities that are generally called bonds.
Correct Answer
D. Issuing or selling debt securities that are generally called bonds.Explanation
When a corporation or government wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities that are generally called bonds. Bonds are a form of debt instrument where the issuer promises to repay the principal amount along with periodic interest payments to the bondholders. By issuing bonds, the corporation or government can raise funds from the public and use them for various purposes such as financing projects, infrastructure development, or meeting operational expenses. Bondholders, in turn, receive regular interest payments and the repayment of the principal amount at the maturity of the bond.Rate this question:
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- 2.
Regular interest payments on bonds are called _________________.
Correct Answer
coupons
couponExplanation
Regular interest payments on bonds are referred to as "coupons" or "coupon payments". This term comes from the historical practice of attaching physical coupons to bond certificates, which could be detached and redeemed for interest payments. Nowadays, these payments are typically made electronically or through direct deposit, but the term "coupon" is still used to describe the interest payments received by bondholders.Rate this question:
- 3.
The amount to be paid at the end of a bond's maturity is called the _______ value.
Correct Answer
face
parExplanation
The amount to be paid at the end of a bond's maturity is called the face value or par value. This is the predetermined amount that the bondholder will receive upon maturity. The face value is typically stated on the bond certificate and represents the principal amount of the bond that is repaid to the bondholder. It is important for investors to know the face value of a bond as it helps determine the bond's price and yield.Rate this question:
- 4.
How do you find the coupon rate of a bond?
- A.
Coupon payment divided by the face value of the bond
- B.
Coupon payment divided by maturity
- C.
Face value of the bond divided by the coupon payment
- D.
Maturity divided by the coupon payment
Correct Answer
A. Coupon payment divided by the face value of the bondExplanation
To find the coupon rate of a bond, you need to divide the coupon payment by the face value of the bond. The coupon payment is the fixed amount of interest paid to the bondholder annually or semi-annually, while the face value is the amount the bondholder will receive when the bond matures. By dividing the coupon payment by the face value, you can determine the percentage rate at which the bond pays interest to its holders.Rate this question:
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- 5.
As time passes, nterest rates change in the market place. The cash flows from the bond change with it.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
The cash flows from the bond stay the same, even thought the interest rates change. That means the the price of the bond changes over time.Rate this question:
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- 6.
To determine the value or Yield To Maturity of a bond at any point we need to know which of the following?
- A.
Time to maturity
- B.
Face value
- C.
Coupon rate required in the market for similar bonds
- D.
Interest rate required in the market for similar bonds
Correct Answer(s)
A. Time to maturity
B. Face value
C. Coupon rate required in the market for similar bonds
D. Interest rate required in the market for similar bondsExplanation
To determine the yield to maturity of a bond, we need to consider several factors. First, the time to maturity is important as it indicates how long the bond will be held before it matures. Second, the face value of the bond is necessary to calculate the future cash flows. Third, the coupon rate required in the market for similar bonds is crucial as it determines the interest payments the bondholder will receive. Finally, the interest rate required in the market for similar bonds is essential as it affects the present value of the bond's future cash flows. All these factors combined help in determining the yield to maturity of a bond.Rate this question:
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- 7.
What should a bond be sold for exactly?
- A.
Face value multiplied by 1+interest rate
- B.
Present value
- C.
Face value divided by 1+interest rate
- D.
Face value
Correct Answer
D. Face valueExplanation
A bond should be sold for its face value because the face value represents the principal amount that the bondholder will receive upon maturity. This is the amount that the bond issuer promises to repay to the bondholder. The face value does not include any interest payments, which are typically paid separately to the bondholder over the life of the bond. Therefore, selling a bond for its face value ensures that the investor receives the full principal amount that they initially invested.Rate this question:
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- 8.
If interest rates change, the price of the bond will change too.
- A.
True
- B.
False
Correct Answer
A. TrueExplanation
When interest rates change, the price of bonds will indeed change. This is because bond prices and interest rates have an inverse relationship. When interest rates rise, new bonds with higher interest rates become available, making existing bonds with lower interest rates less attractive. As a result, the demand for existing bonds decreases, causing their prices to fall. Conversely, when interest rates decrease, existing bonds with higher interest rates become more desirable, increasing their demand and driving up their prices. Therefore, it is true that the price of a bond will change when interest rates change.Rate this question:
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- 9.
If the interest rate rises, the value of the bond _______________ and if the interest rate falls, the value of the bond _____________. (seerate your answers with one space)
Correct Answer
rises falls
increases decreasesExplanation
When the interest rate rises, the value of the bond decreases because investors can earn higher returns from other investments with the higher interest rate. On the other hand, when the interest rate falls, the value of the bond increases as investors are willing to pay a higher price for the bond to secure a higher yield compared to the lower interest rate available in the market.Rate this question:
- 10.
Bonds sold for less thean its face value are called ________________ bonds.
- A.
Depreciated
- B.
Devalued
- C.
Discount
- D.
Premium
Correct Answer
C. DiscountExplanation
Bonds sold for less than their face value are called discount bonds because they are sold at a price lower than the amount that will be repaid at maturity. This discount represents a reduction in the bond's value and is typically due to factors such as changes in interest rates or perceived risk. Investors are willing to purchase these bonds at a discount because they can potentially earn a higher yield when the bond matures and the full face value is repaid.Rate this question:
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- 11.
Bonds sold for more thean its face value are called ________________ bonds.
- A.
Depreciated
- B.
Devalued
- C.
Discount
- D.
Premium
Correct Answer
D. PremiumExplanation
Premium bonds are bonds that are sold for more than their face value. This means that investors are willing to pay a higher price for these bonds because they offer a higher interest rate or other attractive features. The premium represents the additional amount paid by the investor above the face value of the bond. This extra amount is considered as a premium because it is an additional cost for the investor.Rate this question:
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- 12.
Holders of bonds are exposed to _____________ ________ risk.
Correct Answer
interest rateExplanation
Holders of bonds are exposed to interest rate risk because the value of a bond can fluctuate based on changes in interest rates. When interest rates rise, the value of existing bonds decreases because investors can earn higher returns elsewhere. Conversely, when interest rates fall, the value of existing bonds increases as they offer higher yields compared to new bonds issued at lower rates. Therefore, bondholders face the risk of potential losses or gains in the value of their bonds due to changes in interest rates.Rate this question:
- 13.
The longer the time to maturety, the lower the IR risk is.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
The longer until maturity, the GREATER the IR risk.Rate this question:
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- 14.
The higher the coupon rate, the greater the IR risk.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
The LOWER the coupon rate, the greater the risk.Rate this question:
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- 15.
The only way to find the implicit Yeild to Matuity when you know a bond price, coupon rate and maturity date is by trial and error.
- A.
True
- B.
False
Correct Answer
A. TrueExplanation
When you know a bond price, coupon rate, and maturity date, finding the implicit Yield to Maturity (YTM) involves calculating the discount rate that equates the present value of the bond's cash flows to its current market price. This calculation requires trial and error because it involves iteratively adjusting the discount rate until the present value matches the bond price. There is no direct formula to calculate YTM. Hence, the statement that the only way to find the implicit YTM is by trial and error is true.Rate this question:
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- 16.
Holders of bonds are exposed to _______________ risk.
Correct Answer
creditExplanation
Holders of bonds are exposed to credit risk. This means that there is a possibility that the issuer of the bond may default on their payments or fail to fulfill their financial obligations. This risk arises from the issuer's creditworthiness and financial stability. If the issuer's credit rating deteriorates, the value of the bond may decrease, and the bondholder may not receive the full amount of interest or principal they are entitled to. Therefore, credit risk is an important consideration for bondholders when assessing the potential return and safety of their investment.Rate this question:
- 17.
Governemtns are the biggest borrowers in the world.
- A.
True
- B.
False
Correct Answer
A. TrueExplanation
Governments are the biggest borrowers in the world because they often need to finance large-scale projects, such as infrastructure development, social programs, and defense expenditures. They borrow money by issuing bonds or taking loans from international organizations, other governments, or their own citizens. Due to their size and the magnitude of their financial needs, governments tend to have the highest levels of debt compared to other entities. This is why it is true that governments are the biggest borrowers in the world.Rate this question:
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- 18.
Because the owner of a zero coupon bondy doesn't get interest annualy, it doesn't have to pay taxes on interest each year.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
For tax purposes, the issuer of a zero coupon bond deducts interest every year and owner must pay taxes on interest even though no interest is actually paid. You use implicit interest which is the change in bond value for each year.Rate this question:
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- 19.
What are floating-rate bonds?
- A.
The holder of the bond has the right to purchase the stocks in the company for a fixed price
- B.
Coupon payments are adjustable to an interest rate index such as Treasury bond rate
- C.
Bonds with coupon payments depending on the company's income
- D.
Bonds that can be swapped for a fixed number of shares
- E.
The holder of the bond can force the issuer to buy back the bond at a stated price
Correct Answer
B. Coupon payments are adjustable to an interest rate index such as Treasury bond rateExplanation
Floating-rate bonds are a type of bond where the coupon payments are adjustable to an interest rate index such as the Treasury bond rate. This means that the interest payments on the bond will change based on the movement of the interest rate index. As the index rate increases or decreases, the coupon payments on the bond will adjust accordingly. This feature provides protection to investors against changes in interest rates and helps to maintain the value of the bond over time.Rate this question:
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- 20.
What are warrant bonds?
- A.
The holder of the bond has the right to purchase the stocks in the company for a fixed price
- B.
Coupon payments are adjustable to an interest rate index such as Treasury bond rate
- C.
Bonds with coupon payments depending on the company's income
- D.
Bonds that can be swapped for a fixed number of shares
- E.
The holder of the bond can force the issuer to buy back the bond at a stated price
Correct Answer
A. The holder of the bond has the right to purchase the stocks in the company for a fixed priceExplanation
Warrant bonds are a type of bond where the holder has the right to purchase stocks in the company for a fixed price. This means that if the holder chooses to exercise their right, they can buy shares of the company at a predetermined price. This feature provides potential upside for the bondholder if the company's stock price increases in the future.Rate this question:
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- 21.
What are income bonds?
- A.
The holder of the bond has the right to purchase the stocks in the company for a fixed price
- B.
Coupon payments are adjustable to an interest rate index such as Treasury bond rate
- C.
Bonds with coupon payments depending on the company's income
- D.
Bonds that can be swapped for a fixed number of shares
- E.
The holder of the bond can force the issuer to buy back the bond at a stated price
Correct Answer
C. Bonds with coupon payments depending on the company's incomeExplanation
Income bonds are a type of bond that have coupon payments depending on the company's income. Unlike traditional bonds that have fixed coupon payments, income bonds offer variable coupon payments that are based on the earnings of the company. This means that if the company's income increases, the coupon payments on the income bonds will also increase. Conversely, if the company's income decreases, the coupon payments will decrease as well. This feature makes income bonds more flexible and responsive to the financial performance of the company.Rate this question:
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- 22.
What are convertible bonds?
- A.
The holder of the bond has the right to purchase the stocks in the company for a fixed price
- B.
Coupon payments are adjustable to an interest rate index such as Treasury bond rate
- C.
Bonds with coupon payments depending on the company's income
- D.
Bonds that can be swapped for a fixed number of shares
- E.
The holder of the bond can force the issuer to buy back the bond at a stated price
Correct Answer
D. Bonds that can be swapped for a fixed number of sharesExplanation
Convertible bonds are a type of bond that can be exchanged or swapped for a fixed number of shares of the company's stock. This means that the holder of the bond has the option to convert their bond into shares of the company at a predetermined price. This feature provides the bondholder with the potential to benefit from any increase in the company's stock price. Convertible bonds often offer a lower interest rate compared to traditional bonds, as they provide the potential for additional returns through the conversion into equity.Rate this question:
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- 23.
What are put bonds?
- A.
The holder of the bond has the right to purchase the stocks in the company for a fixed price
- B.
Coupon payments are adjustable to an interest rate index such as Treasury bond rate
- C.
Bonds with coupon payments depending on the company's income
- D.
Bonds that can be swapped for a fixed number of shares
- E.
The holder of the bond can force the issuer to buy back the bond at a stated price
Correct Answer
E. The holder of the bond can force the issuer to buy back the bond at a stated priceExplanation
Put bonds are a type of bond where the holder has the right to force the issuer to buy back the bond at a predetermined price. This gives the bondholder the ability to sell the bond back to the issuer if they choose to do so. It provides the holder with an exit strategy if they no longer want to hold the bond or if they believe they can get a better return elsewhere. This feature adds flexibility and liquidity to the bond, making it an attractive option for investors.Rate this question:
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- 24.
The price of the bond net of accrued interest (typically quoted) is the _________________ price.
- A.
Clear
- B.
Complete
- C.
Current
- D.
Clean
Correct Answer
D. CleanExplanation
The price of the bond net of accrued interest is known as the "clean" price. This refers to the price of the bond without including any interest that has accumulated since the last coupon payment. The clean price is the actual price that an investor would pay to purchase the bond, as it does not include any additional interest that the buyer would not be entitled to receive.Rate this question:
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- 25.
The price of the bond including accrued interest (full, invoice price) *accrued interest- interest which is paid by the bond buyer to the bond seller for the period from last coupon payment .
- A.
Dry
- B.
Dirty
- C.
Deal
- D.
Done
Correct Answer
B. DirtyExplanation
The term "dirty" is commonly used in finance to refer to the price of a bond that includes the accrued interest. In this context, it means that the price of the bond being referred to includes the interest that has accumulated since the last coupon payment. This is in contrast to the "clean" price, which refers to the price of the bond without the accrued interest.Rate this question:
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- 26.
The __________________ rate on an investment is the percentage change in money you have at the end.
Correct Answer
nominalExplanation
The nominal rate on an investment refers to the stated or advertised rate of return, without taking into account any additional factors such as inflation or compounding. It represents the percentage change in the amount of money you have at the end of the investment period.Rate this question:
- 27.
The _____________ rate on an investment is the percentage change in your buying power (how much you can buy).
Correct Answer
realExplanation
The real rate on an investment refers to the percentage change in your buying power, which means it takes into account the effects of inflation. In other words, it measures the actual increase or decrease in the value of your investment after adjusting for inflation. This is important because inflation erodes the purchasing power of money over time, so the real rate helps investors understand the true return on their investment.Rate this question:
- 28.
What are tye 3 components of Nominal Interst rate?
- A.
Spot rate
- B.
Inflation rate
- C.
Real interest rate
- D.
Exchange rate
Correct Answer(s)
B. Inflation rate
C. Real interest rateExplanation
The correct answer is inflation rate and real interest rate. The nominal interest rate is composed of these two components. Inflation rate represents the rate at which the general level of prices for goods and services is rising and, therefore, eroding the purchasing power of currency. Real interest rate, on the other hand, is the nominal interest rate adjusted for inflation. It reflects the true cost of borrowing or the real return on investment. These two components are essential in determining the overall nominal interest rate.Rate this question:
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- 29.
When long-term interest rates are higher than short-term interest rates, term structure is ____________ sloping.
Correct Answer(s)
upwardExplanation
When long-term interest rates are higher than short-term interest rates, the term structure of interest rates is said to be upward sloping. This means that as the time to maturity increases, the interest rates also increase. This is typically the case in a normal economic environment, where investors expect higher returns for taking on longer-term investments and the risk associated with them.Rate this question:
- 30.
When long-term interst rates are lower than short-term interest rates, term structures are ________________ sloping.
Correct Answer(s)
downwardExplanation
When long-term interest rates are lower than short-term interest rates, the term structures are downward sloping. This means that the yield curve is inverted, with shorter-term bonds yielding more than longer-term bonds. This can occur when there is an expectation of economic downturn or when central banks are implementing tight monetary policy to control inflation. Investors may be willing to accept lower long-term yields due to the expectation of lower future interest rates.Rate this question:
- 31.
Term structure of interest rates depend on which of the following:
- A.
Real interest rate
- B.
Inflation premium
- C.
Interest risk premium
- D.
Default risk premium
- E.
Liquidity premium
Correct Answer(s)
A. Real interest rate
B. Inflation premium
C. Interest risk premium
D. Default risk premium
E. Liquidity premiumExplanation
The term structure of interest rates depends on various factors, including the real interest rate, inflation premium, interest risk premium, default risk premium, and liquidity premium. The real interest rate represents the rate of return adjusted for inflation, while the inflation premium accounts for the expected increase in prices over time. The interest risk premium reflects the compensation for the uncertainty associated with changes in interest rates. The default risk premium compensates for the risk of default by the borrower, and the liquidity premium compensates for the lack of marketability of certain investments. These factors collectively determine the shape and level of interest rates across different maturities.Rate this question:
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- 32.
In the term structure of interst rates, defautl risk premium depends on the crediblity of the issuer, and the lower rated bonds...
- A.
Erode the value of long-term investments
- B.
Will have lower yields
- C.
Will have higher yields
- D.
Influence the overall level of yield curve
Correct Answer
C. Will have higher yieldsExplanation
Lower rated bonds are considered riskier investments because there is a higher likelihood of default. As a result, investors demand a higher yield or return on these bonds to compensate for the increased risk. Therefore, lower rated bonds will have higher yields compared to higher rated bonds. This is because investors require a higher return for taking on the additional risk associated with lower rated bonds.Rate this question:
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- 33.
In the term structure of interst rates, anticipated high inflation in the future
- A.
Erode the value of long-term investments
- B.
Will have lower yields
- C.
Will have higher yields
- D.
Influence the overall level of yield curve
Correct Answer
A. Erode the value of long-term investmentsExplanation
Anticipated high inflation in the future erodes the value of long-term investments. When inflation is high, the purchasing power of money decreases over time. This means that the future returns from long-term investments may not be able to keep up with the rising prices, resulting in a decrease in the real value of these investments. As a result, investors may be less willing to invest in long-term assets, leading to a decrease in their value.Rate this question:
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- 34.
In the term structure of interst rates, real interest rates....
- A.
Erode the value of long-term investments
- B.
Will have lower yields
- C.
Will have higher yields
- D.
Influence the overall level of yield curve
Correct Answer
D. Influence the overall level of yield curveExplanation
Real interest rates refer to the interest rates adjusted for inflation. They reflect the true cost of borrowing or the return on investment after accounting for the effects of inflation. The term structure of interest rates refers to the relationship between the interest rates of different maturities. Real interest rates can have a significant impact on the overall level of the yield curve, which represents the relationship between the interest rates and the time to maturity of debt securities. Changes in real interest rates can cause shifts in the yield curve, affecting the yields of both short-term and long-term investments. Therefore, the correct answer is that real interest rates influence the overall level of the yield curve.Rate this question:
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- 35.
In the term structure of interst rates, less liquid bonds
- A.
Erode the value of long-term investments
- B.
Will have lower yields
- C.
Will have higher yields
- D.
Influence the overall level of yield curve
Correct Answer
C. Will have higher yieldsExplanation
Less liquid bonds will have higher yields in the term structure of interest rates. This is because investors demand a higher return for investing in bonds that are less liquid, meaning they are harder to buy or sell in the market. The higher yield compensates investors for the increased risk and potential difficulty in trading these bonds. Therefore, less liquid bonds will offer higher yields compared to more liquid bonds in the term structure of interest rates.Rate this question:
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- 36.
Stocks are more difficut to value than bonds because of... (check all that apply)
- A.
Stocks have no maturity
- B.
Stocks have a defined maturity date
- C.
Cash flows are known in advance
- D.
Cash flows are not known in advance
- E.
The required rate of return is obvious
- F.
It is difficult to find the required rate of return
Correct Answer(s)
A. Stocks have no maturity
D. Cash flows are not known in advance
F. It is difficult to find the required rate of returnExplanation
Stocks are more difficult to value than bonds because they have no maturity, meaning there is no fixed date when the investment will be repaid. Additionally, cash flows from stocks are not known in advance, as they depend on the company's performance and market conditions. Lastly, it is difficult to find the required rate of return for stocks, as it involves estimating future earnings and growth potential, which can be subjective and uncertain.Rate this question:
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- 37.
Which dividend discount model would value this stock? * a share of common stock in a company with a constant divident (much like a share of preferred stock) * Stock with promised constant dividents that occur forever * It can be viewed as an ordinary perpetuity
- A.
Zero growth
- B.
Constant growth
- C.
Non-constant growth
Correct Answer
A. Zero growthExplanation
The correct answer is zero growth. This is because the question states that the stock has a constant dividend, much like a share of preferred stock. In a zero growth dividend discount model, the dividends are expected to remain constant indefinitely, which aligns with the characteristics of the stock described in the question.Rate this question:
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- 38.
Which dividend discount model would value this stock? * for many companies a steady growth in dividents is an explicit goal * It can be viewed as growing perpetuity
- A.
Zero growth
- B.
Constant growth
- C.
Non-constant growth
Correct Answer
B. Constant growthExplanation
The dividend discount model that would value this stock is the constant growth model. This is because the statement mentions that for many companies, a steady growth in dividends is an explicit goal. The constant growth model assumes that dividends will grow at a constant rate indefinitely, making it appropriate for valuing stocks with a consistent dividend growth pattern.Rate this question:
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- 39.
Which dividend discount model would value this stock? * The dividents growth rate may change over time * There are companies which pay no dividends at the beginning whereas some companies have supernormal dividends at an early stage
- A.
Zero growth
- B.
Constant growth
- C.
Non-constant growth
Correct Answer
C. Non-constant growthExplanation
The correct answer is non-constant growth because the given information states that the dividend growth rate may change over time. This implies that the company's dividends are not expected to grow at a constant rate. Therefore, a non-constant growth dividend discount model would be appropriate to value this stock.Rate this question:
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