LOS a: Explain the risks associated with investing in bonds.

Q1. The interest rate risk of a bond is the:

A)   risk that arises from the uncertainty about the bond's return caused by changes in interest rates over time.

B)   risk related to the possibility of bankruptcy of the bond's issuer.

C)   risks related to the possibility of bankruptcy of the bond's issuer and that arises from the uncertainty of the bond's return caused by the change in interest rates.

Q2. Which of the following situations lead to short-term profit opportunities in the bond market?

A)   Interest rates become more volatile.

B)   Inflation is expected to rise.

C)   Yields of all maturities start to rise.

Q3. Biggs, Inc., holds a bond portfolio that is, on average, trading below par value. They have faced some cash flow problems of late and have used the bond interest payments for operating expenses. The bonds are callable. Given the current situation, Biggs faces which types of risk?

A)   Interest rate risk.

B)   Interest rate risk and call risk.

C)   Call risk.

LOS a: Explain the risks associated with investing in bonds. fficeffice" />

Q1. The interest rate risk of a bond is the:

A)   risk that arises from the uncertainty about the bond's return caused by changes in interest rates over time.

B)   risk related to the possibility of bankruptcy of the bond's issuer.

C)   risks related to the possibility of bankruptcy of the bond's issuer and that arises from the uncertainty of the bond's return caused by the change in interest rates.

Correct answer is A)

Interest rate risk is the probability of an increase in interest rates causing a bond's price to decrease.

Q2. Which of the following situations lead to short-term profit opportunities in the bond market?

A)   Interest rates become more volatile.

B)   Inflation is expected to rise.

C)   Yields of all maturities start to rise.

Correct answer is A)

As interest rates become more volatile, accurate pricing of bonds becomes more difficult, and thus some bonds are likely to be priced incorrectly. This pricing discrepancy will allow for short-term profit opportunities by buying a bond that is priced too low and selling it at the market rate. Increases in inflation expectations or yield to maturities indicate increasing market required rates of returns for bonds. Bond prices typically have an inverse relationship to interest rates.

Q3. Biggs, Inc., holds a bond portfolio that is, on average, trading below par value. They have faced some cash flow problems of late and have used the bond interest payments for operating expenses. The bonds are callable. Given the current situation, Biggs faces which types of risk?

A)   Interest rate risk.

B)   Interest rate risk and call risk.

C)   Call risk.

Correct answer is A)

The bonds are trading below par, so rates have increased and, at this point, call risk is not significant. The firm faces interest rate risk because their bond portfolio has decreased in value due to increasing market interest rates.

thanks

AAC