FINA 3317 EVALUATION EXAMS ANSWERS AND
QUESTIONS SET A+
✔✔
✔✔The risk that a security cannot be sold at a predictable price with low transaction
costs at short notice is called liquidity risk.
True
False - ✔✔True.
Liquidity risk is the danger that an asset cannot be sold quickly, easily, and near fair
value.
✔✔Convertible bonds normally have lower promised yields than straight bonds of
similar terms and quality.
True
False - ✔✔True.
The conversion feature benefits investors, lowering the risk premium and therefore the
required yield.
✔✔We expect liquidity premiums to move inversely with interest-rate volatility.
True
False - ✔✔False.
Greater rate volatility increases price uncertainty and liquidity risk, so liquidity premiums
tend to rise with volatility.
✔✔All else equal, the interest rate required on a callable bond will be less than the rate
on a convertible bond.
True
,False - ✔✔False.
Callability benefits the issuer and adds reinvestment risk to investors, so callable bonds
generally require higher yields; convertibility benefits investors.
✔✔The term structure of interest rates is the relationship between interest rates on
bonds that are similar in all terms except maturity.
True
False - ✔✔True.
The term structure isolates how maturity affects yields for otherwise similar-risk
securities.
✔✔The unbiased expectations hypothesis states that long-term interest rates are
unrelated to expected future short-term rates.
True
False - ✔✔False.
Unbiased expectations theory directly links long-term rates to current and expected
future short-term rates.
✔✔Traditional liquidity-premium theory states that long-term interest rates are greater
than the average of current and expected future short-term rates.
True
False - ✔✔True.
Investors require an added liquidity/maturity premium for committing funds for longer
periods.
✔✔According to market-segmentation theory, short-term investors will not normally
switch to intermediate- or long-term investments.
True
False - ✔✔True.
Market-segmentation theory assumes investors tend to remain within maturity segments
that match their liquidity preferences.
✔✔As the liquidity of corporate bonds decreases, the risk premium required on those
bonds decreases as well.
True
, False - ✔✔False.
Lower liquidity means higher liquidity risk, so investors demand a larger—not smaller—
risk premium.
✔✔An increase in interest rates increases the demand for loanable funds.
True
False - ✔✔False.
Higher borrowing costs reduce the quantity of loanable funds demanded, all else equal.
✔✔A higher level of wealth causes the demand for loanable funds to increase and
interest rates to fall.
True
False - ✔✔False.
Higher household wealth primarily increases the supply of loanable funds, which tends
to lower interest rates; it does not increase demand in the way stated.
✔✔An investment pays $400 in one year, X in two years, and $500 in three years. Total
PV is $1,500. If the nominal interest rate is 6%, what is X?
A. $749.67
B. $600.00
C. $702.83
D. $789.70
E. $822.41 - ✔✔$789.70.
Solve 1500 = 400/1.06 + X/1.06² + 500/1.06³, giving X ≈ $789.70.
✔✔A retirement annuity pays 20 annual payments, with the first payment in 12 years.
You pay $50,000 today. If this is a fair deal at 8%, what must each payment be (nearest
dollar)?
A. $5,093
B. $11,874
C. $10,422
D. $12,824
E. $9,472 - ✔✔$5,093.
Using the annuity payment formula on $50,000 at 8% for 20 payments gives PMT ≈
$5,092.61, rounded to $5,093.
QUESTIONS SET A+
✔✔
✔✔The risk that a security cannot be sold at a predictable price with low transaction
costs at short notice is called liquidity risk.
True
False - ✔✔True.
Liquidity risk is the danger that an asset cannot be sold quickly, easily, and near fair
value.
✔✔Convertible bonds normally have lower promised yields than straight bonds of
similar terms and quality.
True
False - ✔✔True.
The conversion feature benefits investors, lowering the risk premium and therefore the
required yield.
✔✔We expect liquidity premiums to move inversely with interest-rate volatility.
True
False - ✔✔False.
Greater rate volatility increases price uncertainty and liquidity risk, so liquidity premiums
tend to rise with volatility.
✔✔All else equal, the interest rate required on a callable bond will be less than the rate
on a convertible bond.
True
,False - ✔✔False.
Callability benefits the issuer and adds reinvestment risk to investors, so callable bonds
generally require higher yields; convertibility benefits investors.
✔✔The term structure of interest rates is the relationship between interest rates on
bonds that are similar in all terms except maturity.
True
False - ✔✔True.
The term structure isolates how maturity affects yields for otherwise similar-risk
securities.
✔✔The unbiased expectations hypothesis states that long-term interest rates are
unrelated to expected future short-term rates.
True
False - ✔✔False.
Unbiased expectations theory directly links long-term rates to current and expected
future short-term rates.
✔✔Traditional liquidity-premium theory states that long-term interest rates are greater
than the average of current and expected future short-term rates.
True
False - ✔✔True.
Investors require an added liquidity/maturity premium for committing funds for longer
periods.
✔✔According to market-segmentation theory, short-term investors will not normally
switch to intermediate- or long-term investments.
True
False - ✔✔True.
Market-segmentation theory assumes investors tend to remain within maturity segments
that match their liquidity preferences.
✔✔As the liquidity of corporate bonds decreases, the risk premium required on those
bonds decreases as well.
True
, False - ✔✔False.
Lower liquidity means higher liquidity risk, so investors demand a larger—not smaller—
risk premium.
✔✔An increase in interest rates increases the demand for loanable funds.
True
False - ✔✔False.
Higher borrowing costs reduce the quantity of loanable funds demanded, all else equal.
✔✔A higher level of wealth causes the demand for loanable funds to increase and
interest rates to fall.
True
False - ✔✔False.
Higher household wealth primarily increases the supply of loanable funds, which tends
to lower interest rates; it does not increase demand in the way stated.
✔✔An investment pays $400 in one year, X in two years, and $500 in three years. Total
PV is $1,500. If the nominal interest rate is 6%, what is X?
A. $749.67
B. $600.00
C. $702.83
D. $789.70
E. $822.41 - ✔✔$789.70.
Solve 1500 = 400/1.06 + X/1.06² + 500/1.06³, giving X ≈ $789.70.
✔✔A retirement annuity pays 20 annual payments, with the first payment in 12 years.
You pay $50,000 today. If this is a fair deal at 8%, what must each payment be (nearest
dollar)?
A. $5,093
B. $11,874
C. $10,422
D. $12,824
E. $9,472 - ✔✔$5,093.
Using the annuity payment formula on $50,000 at 8% for 20 payments gives PMT ≈
$5,092.61, rounded to $5,093.
