Chapter 6: Interest Rates and Bond Valuation from Principles

Which of the following is not a component of the required return on an investment?

• Inflation

• Liquidity premium

• Risk premium

• Dividend payout ratio

What happens to a bond’s price when market interest rates increase?

• The bond price stays the same

• The bond price increases

• The bond price decreases

• The bond pays more interest

When a bond is trading at a premium, it means:

• The bond’s yield equals the coupon rate

• The coupon rate is less than the market rate

• The bond is risky

• The coupon rate is higher than the required return

Which yield curve shape usually signals a potential economic recession?

• Flat

• Normal

• Upward-sloping

• Inverted

Why might investors accept negative interest rates during financial crises?

• They prefer risk

• They expect inflation to rise

• They prioritize safety over returns

• They misunderstand the market

Explain the difference between nominal interest rate and real interest rate. Why is this distinction important in financial decision-making?

Describe the three theories that explain the shape of the yield curve (Expectations Theory, Liquidity Preference Theory, Market Segmentation Theory). Which do you think is most relevant today, and why?

How do risk premiums influence the interest rate charged on bonds? Give an example using a corporate bond and a government bond.

Imagine you are a financial manager considering issuing bonds for a new project. What factors should you consider to minimize the cost of issuing bonds?

1. Explain the impact of time to maturity on bond price sensitivity to interest rate changes. Why do long-term bonds carry more interest rate risk than short-term bonds?