This paperwork of ECO 316 Week 1 Chapter 4 Interest Rates and Rates of Return consists of:

4.1 Multiple Choice Questions

1) When you place your funds in a savings account at a bank, those funds are

2) Debt instruments are also called

3) A debt instrument represents

4) Simple loans and discount bonds differ from coupon bonds and fixed-payment loans in that

5) Issuers of coupon bonds

6) A simple loan involves

7) The amount of funds the borrower receives from the lender with a simple loan is called the

8) The total payment to a lender for a simple loan is

9) Suppose First National Bank makes a one-year simple loan of $1,000 at 7% interest to Harry’s Restaurant. At the end of one year Harry’s Restaurant will pay First National

10) Suppose First National Bank makes a one-year simple loan of $1000 to Harry’s Restaurant. If at the end of one year Harry’s Restaurant pays First National $1400, then the interest rate on this loan must have been

11) The most common type of simple loan is a(an)

12) A discount bond resembles a simple loan in that

13) A discount bond involves

14) Which of the following is NOT a discount bond?

15) Suppose Matt’s Cars issues a one-year discount bond with a face value of $10,000, and received $9259, repaying $10,000 after one year. The interest rate on this bond would be

16) Suppose Matt’s Cars issues a discount bond with a face value of $10,000 payable in one year with an interest rate of 4%. How much will Acme receive for the bond?

17) A coupon bond involves

18) The coupon rate is the

19) Which of the following is a coupon bond?

20) Which of the following is NOT true of a fixed payment loan?

21) Which of the following is a fixed payment loan?

22) Which of the following is NOT a fixed payment loan?

23) Treasury STRIPS are

24) Treasury STRIPS came into existence because

25) The concept of present value

26) The key difficulty in answering the question: “Would you be better off financing your home with a 15-year mortgage at 9% or by borrowing for five years at 8% and refinancing

thereafter?” is that

27) The key to present value calculations is that they

28) Compounding refers to

29) If you deposit $500 in a savings account at an annual interest rate of 5%, how much will you have in the account at the end of five years?

30) If you deposit $10,000 in a savings account at an annual interest rate of 6%, how much will you have in the account at the end of three years?

31) $1 received n years from now has a value today of

32) At an interest rate of 6%, what is the present value of $10,000 to be received five years from now?

33) At an interest rate of 3%, what is the present value of $1000 to be received five years from now?

34) If the interest rate is 8%, what would you expect to pay for a discount bond paying $10,000 in ten years?

35) If the interest rate is 9%, what would you expect to pay for a discount bond paying $10,000 in two years?

36) The yield to maturity is equal to

37) For simple loans, the yield to maturity

38) What is the yield to maturity on a simple loan that requires payment of $500 plus $30 in interest one year from now?

39) The yield to maturity on a one-year discount bond equals

40) A one-year discount bond with a par value of $5000 sold today, at issuance, for $4750 has a yield to maturity of

41) A one-year discount bond with a par value of $1000 sold today, at issuance, for $943 has a yield to maturity of

42) On a coupon bond, the yield to maturity

43) What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1000, a yield to maturity of 10%, and a maturity of three years?

44) What is the price of a coupon bond that has annual coupon payments of $75, a par value of $1000, a yield to maturity of 5%, and a maturity of two years?

45) What is the yield to maturity of a consol with a coupon of $85 and a price of $944.44?

46) If i is the yield to maturity of a fixed-payment loan

47) If, while you are holding a coupon bond, its market price falls, you can be sure that

48) If, while you are holding a coupon bond, the interest rates on other similar bonds fall, you can be sure that

49) If investors are willing to pay more than the par value for a bond, you can be sure that

50) The current yield is equal to

51) A coupon bond has a coupon of $75, a par value of $1000, and a market price of $900. Its current yield equals

52) Which of the following is NOT fixed on a coupon bond?

53) Which of the following is fixed on a coupon bond?

54) If the current price of a bond is equal to its face value,

55) If the current price of a bond is less than its face value,

56) If the current price of a bond is greater than its face value

57) A bond’s price and its yield to maturity are inversely related because

58) For a specific change in the yield to maturity

59) If an investor is certain that market interest rates will decline in the future, which of the following will she be most likely to purchase?

60) An investor who buys a fifty-year corporate bond

61) U.S. Treasury bonds

62) Investors who attempt to reduce their risk of fluctuating market interest rates by holding only short-term instruments

63) Suppose that a coupon bond is listed in The Wall Street Journal as having a coupon rate of 8.25% and a bid price of 120:19. Its current yield is

64) When a bond is listed as having two maturity dates

65) The bid price for a bond is

66) With respect to U.S. Treasury bills

67) What is the yield on a discount basis for a U.S. Treasury bill that has a face value of $10,000, has a price of $9500, and will mature in 180 days?

68) In comparing the yield to maturity on a Treasury bill with the yield on a discount basis on the same bill, we can say that the yield to maturity

69) The current yield is

70) We would expect yields on long-term corporate bonds

71) The only case for which the bond price does not react to a change in the yield to maturity is when

72) The total rate of return is equal to the

73) What is the total rate of return on a bond with a coupon of $55 that was purchased for $900 and sold one year later for $950?

74) Which of the following statements about the total rate of return is NOT correct?

75) The total rate of return is equal to

76) The expected real interest rate equals

77) Which of the following is the correct expression for the expected real interest rate?

78) The Fisher hypothesis holds that

79) Nominal interest rates are higher than real interest rates as long as

80) If the nominal interest rate is 5%, the tax rate is 25%, and the expected inflation rate is 3%, what is the real after-tax return?

4.2 Essay Questions

1) Suppose that the inflation rate is currently 8% and that most investors believe that inflation will remain at this level indefinitely. You are convinced, however, that the inflation will decline to 5% or less. Should you buy a 10-year Treasury bond or a 10-year TIPS?

2) Suppose you are considering buying one of two coupon bonds. Bond A has a current market price of $975 and a face value of $1000. Bond B has a current market price of $1025 and a face value of $1000. Is Bond A the better investment?

3) Winners of state lotteries are often given the choice of receiving their winnings either as one lump sum or as annual payments spread out over a period of twenty or more years. For example, a state lottery winner may be given the choice of receiving $1.2 million at once, or $125,000 per year for twenty years. In states where it is allowed, investors will sometimes approach lottery winners and offer to pay them a lump sum greater than the state is offering them (in this case, say, $1.4 million) in exchange for the lottery winner signing over to the investor the right to receive the annual payments. Under what circumstances might this be a good deal for both the lottery winner and the investor?

4) During the late nineteenth century many farmers in the American Midwest complained that the real interest rates they were paying on their mortgages were higher than the nominal rates. Is this possible? Aren’t real rates always lower than nominal rates?