1. A client is considering an investment in an 8%, $1,000 par value, 5-year Government of Canada bond.

Assuming a discount rate of 6%, and semi-annual coupon payments, what should the client pay for this bond? Student Value Correct Response Answer 1. Not pay more than $1,000. 2. Not pay more than $1,060. 3. Not pay more than $1,084.25. 100% 4. Not pay more than $1,085.30. The present value of the coupon payments is found using the APV formula: General Feedback: APV=C ((1-(1/(1+r)n))/r) = $40((1-(1/(1.03)10))/.03 = $40(8.5302) = $341.21 The present value of the principal is found using the PV formula: PV=FV/(1+r)n = $1,000/(1.03)10= $744.09 The present value of this bond is simply the sum of these two present values: PV = $744.09 + $341.21= $1,085.30 Score: 2. What is the yield of a 92-day T-bill with a price of 98.75? Student Value Correct Response Answer A. 3.19% B. 4.02% C. 4.96% D. 5.02% General 100% Feedback 1/1 Feedback

T-bill yield is calculated as (100-price)/price x (365/term) x 100. In this

Feedback: example, the T-bill yield of 5.02% is determined as (100-98.75)/98.75 x (365/92) x 100. Score: 3. What is the approximate yield to maturity (per $100 face value) for a bond with a 7.0% coupon, current market price of $107.50 and 5 years to maturity? Student Value Correct Response Answer A. 5.30% B. 5.50% C. 6.15% D. 8.19% General The approximate yield to maturity is determined as (annual interest income Feedback: +/- annual price change)/((purchase price + 100)/2) x 100. In this example, the return is determined as ($7.00 - ($7.50/5 years))/((107.50 + 100)/2) x100 = 5.30%. Score: 4. What expectations are implicit in a downward sloping yield curve? Student Value Correct Response Answer A. Investors expect rates to fall in the future. B. Investors expect rates to rise in the future. C. Investors expect rates to rise then fall. D. Investors expect rates to 100% Feedback 1/1 100% Feedback 1/1

remain fairly stable. General A downward sloping yield curve, where short-term rates are higher than longFeedback: term rates, indicates that investors expect interest rates to decline in the future. They require a high short-term rate, perhaps because current inflation rates are high, but are willing to accept lower long-term rates due to the expected rate declines. Score: 5. Which of the following bond theorems are correct? i) Bond prices move inversely to interest rates. ii) The longer the term to maturity the greater the interest rate risk. iii) Bonds with low coupon rates have more price volatility than bonds with high coupon rates. iv) Bond prices are more volatile when interest rates are high. Student Value Correct Response Answer 1. i) only. 2. iv) only. 3. ii), and iv) only. 4. i), ii), and 100% iii). General There are some conventional rules regarding the price action of fixed-income Feedback: securities. Each of these rules is explained separately below. First it must be understood that there is very little difference between interest rates and yields. After all, each represents a rate of return on an investment. Therefore, as interest rates rise, the yields on competing investments must also rise, and vice versa. Since interest payments are fixed, the only way to increase yields must be to decrease the market price, and vice versa. Bonds with long terms to maturity have more volatile prices i.e. when interest rates change, the price of longer term bonds change more than the price of shorter term bonds. Bonds with lower coupons have more volatile prices. When interest rates rise, bonds drop in price, but lower coupon bonds drop more than higher coupon bonds. This difference is material when larger coupon differences are considered, or when large sums of money are invested and even small price changes involve significant amounts of money. Bond prices are more volatile when interest rates are low. For example, a drop in yields from 12% to 10% will have a lesser impact on a bond's price than a drop in yields from 4% to 2%. Although both represent a drop of 200 basis points, or 2 percent, the former is a 17% change in yields, and the latter is a 50% change in yields. Feedback 1/1

Thus, bond prices are more volatile when interest rates are low. Score: 6. If an investor expects market interest rates to decline, what type of bonds should she buy? Student Value Correct Response Answer A. Shortterm, low coupon. B. Longterm, low coupon. C. Longterm, high coupon. D. Shortterm, high coupon. General If market interest rates decline, bond prices will increase and bondholders will Feedback: earn capital gains. The investor should attempt to maximize the potential capital gain by purchasing bonds that are more volatile. Long-term bonds are more volatile than short-term bonds and low coupon bonds are more volatile than high coupon bonds. Therefore, a long-term, low coupon bond offers the greatest potential for capital gains if interest rates decline. Score: 7. Why is the normal slope of the yield curve upward sloping to the right? Student Response Value Correct Answer Feedback 1/1 100% Feedback 1/1

100% A. Yields increase with time to reflect the increased risk of longer terms to maturity. B. Bond prices increase as

the term to maturity of the bond increases. C. Yields are higher for bonds with shorter terms to maturity to compensate for the short holding period. D. Yields decrease as term to maturity increases. General Bond yields normally increase as the term to maturity increases to reflect the Feedback: risk of holding a bond with a longer term. The actual slope of the yield curve can vary significantly depending on economic conditions and other factors such as supply and demand. Score: 8. What is the settlement period for Government of Canada bonds with terms to maturity of three years or less? Student Value Correct Response Answer A. Same day 100% B. Second clearing day after the transaction takes place. C. Third clearing day after the transaction takes place. Feedback 1/1

D. First clearing day on or after the fifteenth calendar day of the month. General Government of Canada (GoC) Treasury Bills are settled the same day. All GoC Feedback: Bonds and GoC Guaranteed Bonds with a term to maturity of three years or less, or to the earliest call date, where a transaction is completed at a premium, are settled the second clearing day after the transaction takes place. All GoC Bonds and GoC Guaranteed bonds with terms to maturity of more than three years are settled the third clearing day after the transaction takes place. Score: 9. What must an investor pay when purchasing a bond? Student Value Correct Response Answer A. The bond's market price plus interest accrued since the last interest payment. B. The market price of the bond. C. The market price of the bond as of the settlement date. D. The bond's market price less interest accrued 100% Feedback 1/1

since the last interest payment. General When a securities transaction takes place, the change in legal ownership of the Feedback: securities is effective immediately. However, payment for purchased securities does not have to be made until some time later, and delivery of sold securities also does not have to be done until the end of this time period, called the settlement period. The length of the settlement period varies depending on the type of security being transacted. The client who purchases a bond pays the purchase or market price plus the interest which has accrued or accumulated since the last interest date. This interest is regained if the bond is held until the next interest payment date, or if the bond is sold in the meantime, resulting in accrued interest being paid to that seller. Score: 10. Calculate the accrued interest on the following transaction. A 7% bond maturing April 12, 2018 is purchased on December 15th and settles on December 18th. The principal amount of the purchase is $100,000. Student Value Correct Response Answer 1. $642.47 2. 1,227.40 3. $1,284.93 100% 4. $4,794.42 General Accrued interest is determined from the day after the last interest payment Feedback: date up to and including the settlement date. Interest payments are semiannual on the anniversary date of maturity (e.g. April 12) and exactly six months later (e.g. October 12). Accrued interest is calculated as (Par value x % coupon rate x (# days accrued/365). In this example, the accrued interest = $100,000 x 0.07 x (67/365) = $1,284.93. The number of days for accrual is: October 13 - 31 = 19 days November 1 - 30 = 30 days December 1 - 18 = 18 days Total 67 days Score: 11. DDD Co. Inc. has an outstanding 12 year bond with a coupon of 8.75%. The financial press is quoting it with a yield of 6%. What does this imply with respect to the bond? Student Response Value Correct Answer Feedback 1/1 Feedback 1/1

A. The price of the bond will be below par. B. The price of the bond will be at par. C. The price of 100% the bond will be above par. D. The price of the bond will be slowing increasing to par as time to maturity approaches. General The most important bond pricing relationship to understand is the inverse Feedback: relationship between bond prices and interest rates (or bond yields) as interest rates rise, bond prices fall and as interest rates fall, bond prices rise. So if the yield of the bond has fallen below the coupon rate, the price must have increased above par. Score: 12. Sonoma is convinced that interest rates are going to drop. She wishes to buy a bond, hold it until rates have dropped, then sell it to earn a capital gain. Recommend a bond for her to purchase. Student Value Correct Response Answer A. A 6% 10 year bond. B. A 6% 8 year bond. C. A 6 month T-bill. D. 9 month T-bill. General Longer-term bonds are more volatile in price than shorter-term bonds. If she 100% Feedback 1/1

Feedback: wishes the price to move up more, she should choose the longer term bond. Score: 13. Neta has read that interest rates are expected to go up. She currently owns 4 bonds and is thinking of selling one before this happens. Recommend a bond she should sell? Student Value Correct Response Answer A. A 6% 8 year bond with a duration of 7. B. A 7% 9 year bond with a duration of 8. C. 5% 7 year bond with a duration of 6. D. A 6.5% 10 100% year bond with a duration of 9. General Duration is a measure of the sensitivity of a bonds price to changes in interest Feedback: rates. It is defined as the approximate percentage change in the price or value of a bond for a 1% change in interest rates. The higher the duration of the bond, the more it will react to a change in interest rates. If interest rates are going up, prices will fall. She should sell the bond which is the most volatile as its price will fall the most. That is the bond with the highest duration. Score: 14. The inflation rate is expected to be 3% next year. Sharif buys a bond at par with a 7% coupon. Calculate his real rate of return? Student Value Correct Response Answer A. 3% B. 4% 100% Feedback 1/1 Feedback 1/1

C. 7% D. 10% General Because inflation reduces the value of a dollar, the return that is received, Feedback: known as the nominal rate, must be reduced by the inflation rate to arrive at the actual or real rate of return. Real Rate = Nominal Rate - Inflation Rate. Score: 15. JVV Inc. is about to sell a new issue of debt. The maturity of the debt is expected to be 20 years. Interest rates in the market place are as follows: Government of Canada 10 year bonds are yielding 4%. Government of Canada 20 year bonds are yielding 8%. 10 year corporate bonds are yielding 5%. 20 year corporate bonds are yielding 9%. What coupon rate should the company set for its new issue? Student Value Correct Response Answer A. 4% B. 5% C. 8% D. 9% 100% Feedback 1/1

General The appropriate discount rate is chosen based on the risk of the particular Feedback: bond. The discount rate can be estimated by the yields currently applicable to bonds with similar coupon, term and credit quality. These yields are determined by the marketplace and change as market conditions change. Companies would set the coupon rate on a new issue of bonds by determining what similar bonds are yielding. Score: 1/1