1. What is a bond?

a) A type of stock
b) A type of loan
c) A type of insurance
Answer: b) A type of loan

2. What is the maturity date of a bond?

a) The date the bond is issued
b) The date the bond is sold
c) The date the bond expires
Answer: c) The date the bond expires

3. What is the coupon rate of a bond?

a) The interest rate paid on the bond
b) The price of the bond
c) The face value of the bond
Answer: a) The interest rate paid on the bond

4. What is a callable bond?

a) A bond that can be redeemed before maturity
b) A bond that cannot be redeemed before maturity
c) A bond that has a fixed interest rate
Answer: a) A bond that can be redeemed before maturity
5. What is a junk bond?
a) A bond with a high credit rating
b) A bond with a low credit rating
c) A bond with no credit rating
Answer: b) A bond with a low credit rating
6. which of the following statements about a bond's yield to maturity (YTM) is true?
a) Yield to maturity represents the total return an investor will receive if they
hold the bond until it reaches its maturity date.
b) Yield to maturity does not consider any potential capital gains or losses from
changes in market prices.
c) Yield to maturity assumes that all future cash flows are reinvested at the same
interest rate as the current bond.
d) Yield to maturity only considers the bond's purchase price and its stated
interest payments.
Answer: a) Yield to maturity represents the total return an investor will receive if they
hold the bond until it reaches its maturity date.
7. How do zero-coupon bonds differ from traditional bonds?
a) Zero-coupon bonds pay no periodic interest payments; instead, their entire
interest payment is made upon redemption.
b) Zero-coupon bonds have lower yields compared to traditional bonds due to
their lack of regular income.
c) Zero-coupon bonds have higher yields compared to traditional bonds because
they offer larger returns upon redemption.
d) Zero-coupon bonds are less risky investments since they provide steady
income throughout their life.
Answer: a) Zero-coupon bonds pay no periodic interest payments; instead, their entire
interest payment is made upon redemption.
8. In which situation would an investor prefer a floating-rate note over a fixed-rate
bond?
a) When they expect interest rates to rise significantly during the investment
period.
b) When they believe interest rates will remain stable or decrease during the
investment period.
c) Floating-rate notes and fixed-rate bonds serve similar purposes, so there isn't a
specific preference between them based solely on interest rate expectations.
Answer: a) When they expect interest rates to rise significantly during the investment
period.
9. Which of the following factors influences the price of a bond when interest rates
increase?
a) Bond prices tend to fall when interest rates increase.
b) Bond prices tend to rise when interest rates increase.
c) Bond prices remain unchanged when interest rates increase.
Answer: a) Bond prices tend to fall when interest rates increase.
10. Why might investors choose municipal bonds over corporate bonds?
a) Municipal bonds typically offer higher yields than corporate bonds.
b) Investors may choose municipal bonds because they are tax-free at the federal
level.
c) Corporate bonds generally carry less default risk than municipal bonds.
Answer: b) Investors may choose municipal bonds because they are tax-free at the
federal level.
11. What is bond duration?
a) The time until a bond reaches maturity
b) The sensitivity of a bond's price to changes in interest rates
c) The annual interest payment on a bond
Answer: b) The sensitivity of a bond's price to changes in interest rates
12. Which of the following bonds has a longer duration?
a) A bond with a 5-year maturity and a 4% coupon rate
b) A bond with a 10-year maturity and a 3% coupon rate
Answer: b) A bond with a 10-year maturity and a 3% coupon rate
13. If a bond has a duration of 5 years and interest rates increase by 1%, what is the
approximate percentage change in the bond's price?
a) -5%
b) -1%
c) -4%
d) -6%

Answer: a) -5%

% Change in price = - Duration x Change in interest rates

% Change in price = -5 x 1% = -5%

14. Which of the following factors affects bond duration?

a) The bond's coupon rate
b) The bond's face value
c) The bond's maturity date
d) All of the above
 Answer: d) All of the above

15. If a bond has a duration of 7 years and a yield to maturity of 6%, what is the
approximate percentage change in the bond's price if interest rates decrease by 0.5%?
a) 3.5%
b) 2.5%
c) -2.5%
d) -3.5%
Answer: a) 3.5%

% Change in price = - Duration x Change in interest rates

% Change in price = -7 x (-0.5%) = 3.5%

16. Calculate the Macaulay duration of a bond with a face value of $1,000, a 5-year
maturity, and a 5% annual coupon rate.

PVF @ PV of cash
Year CFs 5% flows weights w*Y
1 40 ₹ 0.952 ₹ 38.10 0.039819 0.039819
2 40 ₹ 0.907 ₹ 36.28 0.037923 0.075846
3 40 ₹ 0.864 ₹ 34.55 0.036117 0.108352
4 40 ₹ 0.823 ₹ 32.91 0.034397 0.137589
5 1040 ₹ 0.784 ₹ 814.87 0.851743 4.258716
₹ 956.71 4.620322

• As YTM is not given , we have considered the coupon rate

17. Calculate the Macaulay duration and modified duration of a bond with a face value of
$1,000, a 3-year maturity, and a 3% annual coupon rate and YTM 5%.

PVF @ PV of cash
Year CFs 5% flows weights w*Y
1 30 ₹ 0.952 ₹ 28.57 0.030217 0.030217
2 30 ₹ 0.907 ₹ 27.21 0.028778 0.057557
3 1030 ₹ 0.864 ₹ 889.75 0.941004 2.823013
₹ 945.54 2.910787

Modified duration = 2.91 / ( 1+ (5% / 3)) = 2.8622

18. Suppose a bond has a Macaulay duration of 7 years and a yield to maturity of 6%.
Calculate the approximate percentage change in the bond's price if interest rates
decrease by 0.5%.

Approximate percentage change in price = - Macaulay duration x Change in interest

rates
 Approximate percentage change in price = - 7 x (-0.5%) = 3.5%

19. How does Macaulay duration differ from modified duration?

Macaulay duration is a measure of a bond's price sensitivity to changes in interest
rates, while modified duration is a measure of a bond's price sensitivity to changes in
yield.

20. Suppose a bond has a Macaulay duration of 7 years and a yield to maturity of 6%. If
interest rates increase by 1%, what is the approximate percentage change in the bond's
price
Approximate percentage change in price = - 7 x 1% = -7%

21. How can bond duration be used in portfolio management?

Bond duration can be used in portfolio management to manage interest rate risk. By
selecting bonds with different durations, a portfolio manager can adjust the portfolio's
sensitivity to changes in interest rates. For example, a portfolio manager may choose
to overweight bonds with shorter durations if they expect interest rates to rise, or
overweight bonds with longer durations if they expect interest rates to fall.

22. What are some factors to consider when investing in bonds, and how can they be
managed in a bond portfolio?

Factors to consider when investing in bonds include the bond's credit rating, maturity
date, coupon rate, and yield to maturity. These factors can be managed in a bond
portfolio by diversifying across different types of bonds, such as government bonds,
corporate bonds, and municipal bonds, and adjusting the portfolio's duration and
credit exposure based on market conditions and the investor's risk tolerance.
Additionally, investors can use bond funds to gain exposure to a diversified portfolio
of bonds managed by professional fund managers.

23. Suppose the spot rates for 1-year, 2-year, and 3-year bonds are 3%, 4%, and 5%,
respectively. What is the yield to maturity for a 2-year bond with a face value of
$1,000 and a coupon rate of 3% paid annually?
Answer: b) 3.98%

Solution:
The present value of the bond's cash flows can be calculated using the spot rates.
The present value of the coupon payments is $30/(1.03) + $30/(1.04)^2 = $56.70.
The present value of the face value is $1,000/(1.05)^2 = $907.03.
The total present value is $963.73.

$963.73 = $30 / (1+YTM) + $30 / (1+YTM)^2 + $907.03 / (1+YTM)^2

Solving for the yield to maturity using the formula for YTM, we get approximately
3.98%.
24. The spot rates for 1-year, 2-year, and 3-year bonds are 2%, 3%, and 4%, respectively.
What is the forward rate for the second year?
Solution :

The forward rate for the second year is (1 + 0.03)^2 / (1 + 0.01) - 1 = 5.04%
The forward rate for the Third year is (1 + 0.04)^3 / (1 + 0.03)^2 - 1 = 6.03%

25. An investor wants to buy a 3-year 4% annual coupon paying bond. The expected spot
rates are 2.5%, 3%, and 3.5% for the 1st, 2nd, and 3rd year, respectively. The price of
the bond considering the face value = 100$

Solution:
The present value of the bond's cash flows can be calculated using the spot rates.
The present value of the coupon payments is $4/(1.025) + $4/(1.03)^2 +
$104/(1.035)^3 = $101.475

26. According to the pure expectation theory, the shape of the term structure of interest
rates is determined primarily by:
a) Expectations of future short-term interest rates
b) Preferences among investors regarding risk and return
c) Market supply and demand for loans
d) None of the above
Answer: a) Expectations of future short-term interest rates
27. Which of the following shapes of the term structure of interest rates indicates that
long-term interest rates are expected to decline in the near future?
a) Upward sloping curve
b) Downward sloping curve
c) Flat line
d) No clear pattern
Answer: b) Downward sloping curve
28. The LIBOR (London Interbank Offered Rate) is often used as a benchmark for setting
interest rates on:
a) Government bonds
b) Mortgage loans
c) Credit card debt
d) Stocks
Answer: b) Mortgage loans
29. The forward rate hypothesis states that the forward rate equals the expected future
spot rate plus a premium for holding the asset through time.
a) True
b) False
Answer: a) True
30. The liquidity preference theory suggests that the term structure of interest rates
reflects differences in the preferences of investors regarding risk and return.
a) True
b) False
Answer: a) True
31. An investment offers a 10.5 percent total return over the coming year. Tyson thinks
the total real return on this investment will be only 6.2 percent. What does Tyson
believe the inflation rate will be for the next year?

Inflation rate=Nominal rate−Real rate

Inflation rate=10.5%−6.2%=4.3%

32. Reynolds bonds have a face value of $1,000 and are currently quoted at 98.4. The
bonds have a 5 percent annual coupon rate. What is the current yield on these bonds?

Current yield = Annual coupon payment / Bond price

Current yield = ($50 / $984) x 100%
Current yield = 5.08%
Therefore, the current yield on these bonds is 5.08%.

33. A 3-year $1,000 par value bond pays a 8% annual coupon. Given a YTM of 10%,
what is the price of the bond today?

Coupon: coupon rate*par value = 8%*1000 = 80.

Since this is paid semi-annually, 80/2 = 40

Final payment: par value + coupon rate = 1000 + 40 = 1040

In 3 years we get six semi-annual payments

Value = 40/1.05^1 + 40/1.05^2 + 40/1.05^3 + 40/1.05^4 + 40/1.05^5 + 1040/1.05^6

Value = $949.24

34. The annualized two year interest rate is 10% and one year interest rate is 8%. The
forward rate for second year ?

The forward rate for the second year is (1 + 0.10)^2 / (1 + 0.08) - 1 = 12.03%

35. An investor purchases Rs 1000 par value bond carrying coupon rate of 6.5% p.a. at Rs
750. The bond will mature after 5 years at par. If the bond is callable after 3 years at
Rs 1100, find out YTC and YTM using approximation.

𝑅𝑉−𝑃/𝑛
YTM = 𝐼 + 𝑅𝑉+𝑃/2

YTM = 65 + (1000 – 750)/5 / (1000+750) / 2

YTM = 13.14%

𝐶𝑉−𝑃/𝑛
YTC = 𝐼 + 𝐶𝑉+𝑃/2

= 65 + (1100 – 750)/3 /(1100+750)/2

= 19.64%