Reading 61: Risks Associated with Investing in Bonds- LO

investor, security, interest, decrease

LOS i: Identify the factors that affect the reinvestment risk of a security and explain why prepayable amortizing securities expose investors to greater reinvestment risk than nonamortizing securities.

Q1. The risk that an investor will earn less than the quoted yield-to-maturity on a fixed-coupon bond due to a decrease in interest rates is known as:

A) reinvestment risk.

B) prepayment risk.

C) event risk.

Q2. An investor holds a 20-year, semi-annual 8.00% coupon Treasury bond issued at par. Market interest rates are currently at 6.50%. The bond is noncallable. A coupon payment is due this week. Which of the following choices best represents the type of risk the investor faces?

A) Reinvestment risk.

B) Prepayment risk.

C) Credit risk.

Q3. Which of the following statements about reinvestment risk is least accurate?

A) A bond investor can eliminate reinvestment risk by holding a coupon bond until maturity.

B) A bond's yield calculation assumes that coupon cash flows and principal can be reinvested at the computed yield to maturity.

C) An investor concerned about reinvestment risk is most concerned with a decrease in interest rates.

Q4. Silhouette Enterprises must make a balloon loan payment of $1,000,000 in 3 years. The firm’s treasurer wants to purchase a bond that will provide funds for repayment and minimize reinvestment risk. Assume the company has the following four investment options (all with face values of $1,000,000). Market rates are at 8.0%. All bonds are noncallable and are otherwise similar except as noted. Which option best meets the treasurer’s requirements?

A) A 3-year, zero coupon bond priced to yield 8.0%.

B) A 4-year, zero coupon bond priced to yield 8.5%.

C) A 2-year, zero-coupon bond priced to yield 9.0%.

Q5. Kyle Barnes, CFA, is meeting his friend, Lita Rombach, about possible bond investments. Rombach is concerned about reinvestment risk. Which of the following statements about Rombach is TRUE? Rombach:

A) will prefer a higher coupon bond to a lower coupon bond.

B) need only be concerned about reinvestment risk on coupon payments.

C) will prefer a noncallable bond to a callable bond.