Baran

AIM 6: Define reinvestment risk.

 

1、When planning to hold a coupon-paying Treasury bond until maturity, which of the following types of risk would be the most important?

A) Reinvestment.
 
 
B) Default.
 
 
C) Downgrade.
 
 
D) Interest rate.
 

Baran

  The correct answer is A

Since it is a Treasury bond, downgrade and default risk are not relevant. Interest rate risk is not important because the investor plans to hold the bond until maturity. Reinvestment risk is the most important. The investor will have to worry about the rates at which he/she will be able to reinvest the coupons over the life of the bond and the principal upon maturity.

Baran

2、Which of the following statements about reinvestment risk is least accurate?

A) A bond's yield calculation assumes that coupon cash flows and principal can be reinvested at the computed yield to maturity.
 
 
B) Reinvestment risk is greater for amortizing securities.
 
 
C) An investor concerned about reinvestment risk is most concerned with a decrease in interest rates.
 
 
D) A bond investor can eliminate reinvestment risk by holding a coupon bond until maturity.
 

Baran

4、A 3-year, 8 percent semiannual coupon bond with $100 par value currently yields 8.50 percent. What would be the price of the bond?

A) $95.49.
 
B) $99.24.
 
C) $119.50.
 
D) $98.70.

Baran

 The correct answer is D

I/Y = 8.50/2 = 4.25; FV = 100; N = 3x2 = 6; PMT = 0.08/2 x 100 = 4; PV = -98.70.

Baran

5、An investment pays $75 annually into perpetuity and yields 5%. Which of the following is closest to the price?

A) $1,000.
 
B) $375.
 
C) $750.
 
D) $1,500.

Baran

The correct answer is D

PV = C/I = $75 / 0.05 = $1,500.

Baran

The correct answer is D

N = 20; I/Y = 3.125; PMT = 40; FV = 1,000; CPT → PV = $1,128.69

Baran

2、What is the semiannual-pay bond equivalent yield on an annual-pay bond with a yield to maturity of 12.51 percent?

A) 12.00%.
 
 
B) 12.14%.
 
 
C) 11.49%.
 
 
D) 12.51%.

Baran

The correct answer is B

The semiannual-pay bond equivalent yield of an annual-pay bond = 2 * [(1 + yield to maturity on the annual-pay bond)0.5 – 1] = 12.14%.