Finance

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CHAPTER 7

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BONDS AND THEIR VALUATION

(Difficulty: E = Easy, M = Medium, and T = Tough)

Interest rates and bond prices Diff: E

1. Assume that a 10-year Treasury bond has a 12 percent annual coupon, while a 15-year Treasury bond has an 8 percent annual coupon. The yield curve is flat; all Treasury securities have a 10 percent yield to maturity. Which of the following statements is most correct?

a. The 10-year bond is selling at a discount, while the 15-year bond is selling at a premium.

b. The 10-year bond is selling at a premium, while the 15-year bond is selling at par.

c. If interest rates decline, the price of both bonds will increase, but the 15-year bond will have a larger percentage increase in price.

d. If the yield to maturity on both bonds remains at 10 percent over the next year, the price of the 10-year bond will increase, but the price of the 15-year bond will fall.

Interest rates and bond prices Diff: E

2. A 10-year Treasury bond has an 8 percent coupon. An 8-year Treasury bond has a 10 percent coupon. Both bonds have the same yield to maturity. If the yields to maturity of both bonds increase by the same amount, which of the following statements is most correct?

a. The prices of both bonds will increase by the same amount.

b. The prices of both bonds will decrease by the same amount.

c. The prices of the two bonds will remain the same.

d. Both bonds will decline in price, but the 10-year bond will have a greater percentage decline in price than the 8-year bond.

e. Both bonds will decline in price, but the 8-year bond will have a greater percentage decline in price than the 10-year bond.

Interest vs. reinvestment rate...